Increasing concentration of the portfolio and becoming more of an activist with existing holdings are two ways fund manager Joe Bauernfreund has turned British Empire Trust from a bottom-quartile performer into one of the sector’s best performers.
Over the last decade, the trust has been a disappointment for investors, sitting in as the third worst performer in the 21-strong IT Global sector, although this is ahead of its MSCI ACWI ex USA index benchmark.
Performance of fund vs benchmark over 10yrs
Source: FE Analytics
The style of the fund hasn’t changed – it remains a specialist value investor focusing on companies trading at discounts to net asset value.
However, since taking over in 2015 Bauernfreund has implemented a much more hands-on approach to dealing with portfolio companies.
“What we’re about is identifying inefficiencies, mispricings and anomalies,” the manager of the £845m trust said.
“But when we find a discount that we think is anomalous the next question is what is going to happen to make that change? And here is where I think we have made the biggest changes in the last three or four years.
“We don’t want to sit idly by waiting for discounts to just appear and value to be unlocked, we want some kind of activism.”
The form of activism differs from company type, however.
The fund is made of three buckets: 45 per cent in closed-end funds, 40 per cent in family-owned holding companies – effectively diversified portfolios of assets – and a group of special situation equities in Japan.
“In a closed-end fund we can and often will be the largest shareholder and accordingly we can be a driving force for engagement with the boards and that could ultimately lead to measures adopted that see the discount eliminated,” Bauernfreund said.
“In other areas where families are in control we can’t be the activist. We can engage and make suggestions and they don’t have to listen to us.”
Bauernfreund said he has found over time that many of the proposals suggested are often picked up by owners who end up becoming more active themselves.
In Japan, the third area, the British Empire Trust has taken a more hands-on approach than normal, although again this is seen as a last-ditch measure.
Indeed, the manager is quick to point out that the trust is not a hedge fund strategy, which typically buys stakes in companies with greater assets than the share price and forces them to sell in order to make a higher return.
“We are not in the hedge fund camp. There are two drivers of our returns – one is the net asset value [NAV] growth and the other is the discount changes,” he explained.
“So, if NAV goes up and the discount narrows you have got good drivers of performance and that is the double whammy that we are after,” he said.
“We invest in companies where we don’t know that we are going to have success on the discount side so therefore we are left with the NAV side driving our returns. We only invest in situations where we like the NAV.”
The manager said the trust only takes a more aggressive stance where they face strong resistance from a board.
The other new implementation within the fund since Bauernfreund took charge is the emphasise on concentration.
“We are fundamentally different to a passive investor or benchmark-hugging investor because our universe is so different. The more holdings we have the more our underlying exposure begins to look like an index and there is no point in that,” he said.
Performance of fund vs sector and benchmark since manager start
Source: FE Analytics
Since these changes have taken place, the trust has shot into the top quartile of the sector, as the above chart shows, with the investment company returning 73.86 per cent since October 2015.
In a wider portfolio, the manager said with investors using passive holdings as their core passive holdings, it fits as a specialist core alpha driver.
“We are buying at the top level names you have never heard of but at the underlying level names you will be familiar with but in a cheaper way,” he said.
And Bauernfreund remains confident that the portfolio can continue to outperform for some time, as the underlying holdings remain compelling.
Currently the average holding of the portfolio is on a 30 per cent discount to NAV, which is nearer the top of its historical range of between 10 and 35 per cent.
“We saw 10 per cent in 2006 so at the peak of the bull market prior to the financial crisis and that is rational and logical,” he said.
“As bull markets mature confidence builds and the outlook is promising you tend to get investors move from core equities towards cheap ways to play the market and they bid up stocks, becoming more efficient and you get narrower discounts.”
Discount/premium over 5yrs
Source: FE Analytics
“The 35 per cent we saw occurred in 2009 and 2011. Again there is some rationality here. We are talking about stocks that are less well-known, less liquid, less covered and because of that you tend to get exaggerated pricing moves at times of panic.”
However, he said that with equities appearing to be more towards the end of the bull market than the beginning, it is surprising that the portfolio remains so cheap.
“That we can still build a portfolio of high-quality assets with compelling catalysts at this stage of a bull market and get a 30 per cent discount is quite remarkable to me and I wouldn’t have expected it,” he said.
“When we look at our universe we have started to see selective narrowing of discounts so there are cases of companies trading at or above NAV but it hasn’t yet hit the entire universe as it would have done in 2006.
“The reason we are so confident is we find amazing anomalies which are in our portfolio which we can’t explain and we just take them.”
The British Empire Trust is currently trading at a 10.3 per cent discount to NAV, according to the Association of Investment Companies (AIC). It is worth noting that when the portfolio’s underlying holding discount was at its narrowest (10 per cent in 2006), the investment company traded at a small premium.
The trust is 4 per cent geared, has a yield of 1.6 per cent and ongoing charges of 0.86 per cent, according to the AIC.