Aurora, Henderson Smaller Companies and Temple Bar are trusts that could be poised to take advantage of any further gains for sterling, according to analysis by Peel Hunt’s Priyan Rayatt and Anthony Leatham.
Sentiment towards the UK has warmed somewhat more recently as the prospect of a ‘no deal’ Brexit has receded. Open-ended UK equity funds saw net inflows of £92m during October, according to data from the Investment Association, for the first time in several months.
The calling of a December general election by prime minister Boris Johnson to seek a parliamentary majority to back his deal has been also welcomed by markets.
“Over the last three years, sterling has been the pressure valve for UK risk and has been an indicator of sentiment for the variety of Brexit scenarios that have been entered [into] the political debate,” said the analysts.
“Sterling [found] itself at a seven-month high with less than one week to go until polling day [and] has typically strengthened as the odds of a Conservative majority have increased.”
Over the past three months, sterling has risen by 6.79 per cent against the US dollar as prime minister Johnson secured a withdrawal agreement with EU negotiators.
Performance of sterling vs US dollar over 3mths
Source: FE Analytics
Should the Conservative party emerge with a significant majority, the deal is likely to secure parliamentary backing and pave the way for a trade deal next year, removing some of the Brexit uncertainty.
As such, to determine which trusts might be able to benefit from any potential further uplift for sterling, the Peel Hunt analysts looked at the 33 most-liquid trusts from the three UK equity sectors to find out the sterling correlation of underlying holdings.
Nevertheless, Rayatt and Leatham warned that any election predictions are difficult ahead of the general election result.
“It is worth noting that election polls have been wrong before – particularly given how difficult it is to predict tactical voting,” they said. “The largest risk, from a probabilistic standpoint, would be a hung parliament, and this outcome would likely lead to material downside for sterling and UK plc from here.”
Below, the Peel Hunt analysts highlight several trusts that should benefit from any potential uplift in sterling.
On a portfolio level, the analysts looked at the latest available portfolio and analysed 12-month correlation between the movement of each stock position and the movements of sterling.
As such, the analysts found that Aurora, Henderson Smaller Companies and Temple Bar had the strongest correlation to sterling.
Overseen by Gary Channon, Aurora Investment Trust takes a value approach similar to those espoused by famous investors such as Warren Buffett, Charlie Munger, Benjamin Graham and Phillip Fisher.
The £141.3m trust targets high-quality businesses “run by honest and competent management purchased at prices that even with low expectations will deliver excellent returns”.
Over 2019 to 10 December, the trust made a total return of 21.38 per cent compared with a 17.48 per cent gain for the average IT UK All Companies peer and a 13.64 per cent return for the FTSE All Share index.
The £824.8m Henderson Smaller Companies is managed by Neil Hermon and is a quality-growth strategy focused lower down the market cap scale.
So far this year, the trust has made a total return of 31.3 per cent, outperforming both the Numis Smaller Companies Excluding Investment Companies benchmark (up 16.33 per cent) and the average IT UK Smaller Companies peer (14.86 per cent).
Finally, the Temple Bar investment trust overseen by veteran value investor Alastair Mundy was also highlighted by the Peel Hunt analysts as one of those with a greater correlation to sterling.
In 2019, Temple Bar has made a total return of 24.1 per cent compared with a 12.22 per cent gain for the average IT UK Equity Income trust.
Performance of trust vs sector & benchmark YTD
Source: FE Analytics
In addition to examining the underlying holdings in each of the trusts, the analysts looked at the sterling correlation for every stock in the FTSE All Share and FTSE AIM All Share indexes to find out the sensitivity of different sectors to currency movements.
Rayatt and Leathham found that sectors with the highest correlation to sterling were banks, life insurers, construction companies, real estate and retailers. Conversely, sectors most negatively correlated to sterling were beverages, telecom services, leisure goods, precious metals and mining.
As well as finding out which trusts should benefit from a rise in sterling, the Peel Hunt analysts found two trusts that were inversely correlated to the currency: Finsbury Growth & Income and Troy Income & Growth.
The five FE fundinfo Crown-rated Finsbury Growth & Income trust is overseen by Alpha Manager Nick Train.
In his most recent fund factsheet, the manager noted that recent underperformance had been caused by the increased confidence that a ‘no deal’ Brexit was likely to be avoided and as such “so-called defensive” companies making up a significant part of the portfolio had become “less highly valued by investors”.
Since the start of the year, Finsbury Growth & Income has made a total return of 20.06 per cent. However, over the past three months it has fallen by 3.18 per cent.
The second trust – Troy Income & Growth – is overseen by Alpha Manager Francis Brooke and Hugo Ure. With a capital preservation and income focus, the portfolio has more of a defensive bias than some of its peers and so far this year it has made a 17.59 per cent return.