Compass - February 2021
This month in Compass, we find out how VCTs can help Britain build back better and explore the implications of a new Mr. President for the US and China.
By Annabel Brodie-Smith
Well we’ve survived another month of lockdown here. The home schooling is driving me mad and the whole family would benefit from more fresh air and exercise, but my mother has had the jab and daylight is lasting longer. Most importantly, I’m looking at a bunch of daffodils on my kitchen table – spring will come sooner or later.
The exciting news is we have exchanged on a converted barn in a tiny village in Oxfordshire. The barn should accommodate the needs of the whole family, including my mother who has her own annex. It’s very rural, next to a farm and opposite a 900-year-old church - a long way from our former life in a central London flat. Let’s hope we like it!
This week I have been doing one of the things I enjoy most, talking to fund managers. In this case it’s been the managers of Venture Capital Trusts (commonly known as VCTs) who invest in the UK’s most innovative and exciting fast-growing companies. Do watch my discussion with them on the bottom right of the page to immerse yourself in VCTs and find out more about new areas like deep tech and edtech, the impact of the pandemic, the challenges of Brexit and how they approach ESG investing. I spoke to David Hall, Managing Director at YFM Equity Partners, managers of the British Smaller Companies VCTs, Stuart Veale, Managing Partner of Beringea, which manages the ProVen VCTs and Warren Rogers, Head of Downing Ventures and Partner at Downing, managers of the Downing VCTs. You can also read the views of these managers and others on a diverse range of topics.
If you’re not familiar with VCTs, they provide finance and support to young businesses by allowing smaller investors to pool their resources and invest in a diversified portfolio of investments to spread risk. The companies VCTs invest in are high-risk and the government offers generous tax benefits to compensate you for the risks involved. To find out more about them read our guide to VCTs.
As ever, there is plenty going on. In the US Joe Biden is now president and the socially distanced inauguration day was quite a spectacle. Joe’s speech conveyed his vision of “bringing America together, uniting our people, uniting our nation” and on a similar theme there was the 22-year-old Amanda Gorman’s inspiring poem “The Hill We Climb”. For those of us who enjoy drama, Lady Gaga’s national anthem was a highlight, with the singer dressed in black and red flounces with an oversized dove of peace brooch. But what does Biden’s presidency mean for the US and for the many investment companies investing there? Ian Cowie takes a look at the challenges facing Biden and how investment companies have achieved “big returns” on the back of US strength in sectors including healthcare and technology. He delves into the many investment company opportunities, concluding with the words of the legendary investor Warren Buffett: “Never bet against America”.
VCT managers discuss the impact of the pandemic on their portfolios, their recent investment activity, the economic and social benefits of VCT investing and an outlook for the sector.
One of the challenges Biden will face is the US’s relationship with China. This month we take a look at the prospects for China as Chinese New Year, the Year of the Ox, approaches. Interestingly, our investment company managers investing in China believe these tensions will “be with us for decades to come.” However, they remain positive about China’s prospects looking at the exciting opportunities from online gaming and food delivery to renewable energy.
Recently, Faith Glasgow has gone bargain hunting for unloved investment companies on wide discounts whose fortunes may be about to change. Of course, there’s no guarantee a bargain won’t stay a bargain but it’s always good to look out for value.
Finally, you might be interested in Jonathan Davis’ new book, ‘The Investment Trusts Handbook’ which includes views from a host of investment company legends including Walter Price, manager of Allianz Technology Trust, Harry Nimmo, manager of Standard Life UK Smaller Companies and Charles Plowden, manager of Monks. The link to the free eBook is here and there is a special 25% discount for anyone who may want to purchase the hardback edition (RRP £29.99). The offer ends 31 March 2021 and you need to use the promotion code ITHB25OFF.
Wishing you all a good month.
Communications Director, AIC
Building back better
How VCTs handled the pandemic, Brexit and ESG investing
VCTs are a vital part of our economy and have been investing in and supporting cutting-edge UK businesses for over 25 years. As we find ourselves in yet another lockdown, with serious implications for the health of the economy, providing investment to these new companies has arguably never been more important.
AIC research has found that VCT-backed businesses have created tens of thousands of new jobs since the scheme was created. But how can VCT investment help young British businesses survive and even thrive during the pandemic and beyond? What is the outlook for the sector, and what are the implications of the recent Brexit deal?
To discuss these issues, a media webinar was held by the AIC featuring Stuart Veale, Managing Partner at Beringea, which manages the ProVen VCTs, Warren Rogers, Head of Downing Ventures and Partner at Downing, which manages the Downing VCTs, and David Hall, Managing Director at YFM Equity Partners, which manages the British Smaller Companies VCTs.
Their comments have been collated alongside views from Jo Oliver, Manager of Octopus Titan VCT, and Rupert West, Managing Director at Puma Private Equity, which manages the Puma VCTs.
Impact of the pandemic on VCTs’ portfolios
Stuart Veale, Managing Partner at Beringea, which manages the ProVen VCTs, said: “We have been remarkably impressed by the resilience, innovation and leadership shown throughout the ProVen VCTs’ portfolio during the past twelve months. During this period we have worked alongside leadership teams to guide companies through the commercial and operational disruption of the pandemic and Brexit, while grasping the substantial market opportunities that have emerged for some businesses as a result of the social and economic constraints of lockdown.”
Warren Rogers, Head of Downing Ventures and Partner at Downing, which manages the Downing VCTs, said: “Many of our portfolio companies have found themselves right in the thick of the pandemic and have seen their businesses grow exponentially during this unprecedented time.
“Across our healthcare portfolio, companies such as Touchlight have been critical components in developing the vaccine with their revolutionising DNA technology. Within our enterprise portfolio sit some of the very best education technology companies in the world, such as EdPlace, who have made the transition to home learning that bit easier for teachers, parents and children. Behind the scenes are the deep tech companies, such as Cornelis Networks, whose technologies are being used to enable huge amounts of data to be processed for COVID-19 research, working alongside the likes of the US government. In all the chaos and sadness, we are proud to see our portfolio rise up to the challenges of this pandemic.”
Investing during the pandemic
Rupert West, Managing Director of Puma Private Equity, which manages the Puma VCTs, said: “COVID-19 restrictions have forced private equity fund managers like us to face the question of whether we’d ever close an investment without meeting management teams face to face. Ultimately the answer has had to be yes, but while video communications have come a long way our model rests on working extremely closely with the companies we back and video calls do have their limits.”
Warren Rogers, Head of Downing Ventures and Partner at Downing, which manages the Downing VCTs, said: “The pandemic has actually driven positive changes to investing. One of them is the pronounced focus on deeper due diligence and data analysis. With the continuing unknowns in the current economic picture, it has forced us to be far more exacting in our assessments. From a logistical perspective, we spend far less time travelling or arranging in-person events. The time and money saved there have been reinvested into research.
“We are, and have been, proactively originating long-term opportunities with top companies who are, or are becoming, category leaders, rather than working on a reactive basis. This requires us to have a strong pipeline of opportunities with different investment timelines. We typically have longer initial engagements where we get to intimately know the company, their technology, and how it fits into our thematic view, rather than just meeting a company, doing quick work, and investing.”
David Hall, Managing Director at YFM Equity Partners, which manages the British Smaller Companies VCTs, said: “Much like our portfolio we spent a few weeks changing our processes and adapting working so that new investment activity could continue. What I think was probably the biggest challenge was reduced face-to-face meetings. Companies choose investors as much as we choose them; making a decision about who your partner is going to be over the next few years is a big one and getting time together was the one factor that it turned out we couldn’t change. So it just became essential to meet, there were more masks, hand sanitiser and open windows on cold autumn days, but it had to be done.”
Implications of the Brexit deal
Warren Rogers, Head of Downing Ventures and Partner at Downing, which manages the Downing VCTs, said: “We see a limited impact due to Brexit. However, we are conscious that there are bound to be unintended consequences that we need to pay attention to. The UK has been working hard to build an economy based on innovation. Despite this, interestingly, the UK government has considerably underinvested in the innovation sector. After the divorce, it remains unclear if many EU agencies and organisations, that have supported some of our portfolio, will continue to fill the void that it seems the UK government is not prepared for yet.”
David Hall, Managing Director at YFM Equity Partners, which manages the British Smaller Companies VCTs, said: “It’s early days and for those moving goods across borders there’s a lot more friction. For many it’s the lack of clarity about what needs to be done and no real source of information other than hard yards on the internet. We’ve also got some financial service businesses that in the short term are seeing revenues with Europe dropping by around a third as a result of the inability to passport. This is meaning that we are, in some cases, perversely increasing headcount outside of the UK and Europe rather than in the UK. This isn’t something we want to do but until we get clarity it will hold us back. It is to be hoped that the friction will reduce and clarity increase, but it is likely to dampen growth in 2021 rather than help it. Thereafter, it will depend on the approach to trade and freedoms.”
Jo Oliver, Manager of Octopus Titan VCT, said: “The companies we invest in tend to have global ambitions and often look beyond Europe to the US and Asia when they start thinking about international expansion. There may be some adjustments required in the short term, but entrepreneurs are uniquely able to adapt and find solutions in changing environments.”
Opportunities and risks
Jo Oliver, Manager of Octopus Titan VCT, said: “There is massive innovation going on wherever you look. Adoption of digital health was already growing before the pandemic, but that has accelerated rapidly in the last 12 months due to COVID-19 and this will undoubtedly continue. E-commerce is another area that’s booming as people adjust their shopping habits and spend more online, with some sectors experiencing a decade of growth in a few months. Some of that online spending will return to the high street once things get back to ‘normal’, but the majority will represent a permanent shift, creating new opportunities for start-ups within e-commerce.”
Stuart Veale, Managing Partner at Beringea, which manages the ProVen VCTs, said: “E-commerce businesses in the ProVen portfolio, such as MPB, My 1st Years, MYCS, and Papier, have been able to harness the spike in consumer demand that arose from the shutdown of physical retail and the shift to online spending. Similarly, software businesses that enable retailers to tap into online demand, like Zoovu, and enable automated customer communication, like ContactEngine, have also thrived.”
Approach to ESG and wider economic and social benefits of VCT investing
David Hall, Managing Director at YFM Equity Partners, which manages the British Smaller Companies VCTs, said: “Over recent years ESG, or impact investing, has been an increasing part of business activity. It may be a high aim but our investors look not only for a financial return but a social return, and there is much evidence that being a ‘better’ business enhances the financial return. Where we can we’ll always have as a goal that a business should be better after the end of our ownership than at the beginning; of course that won’t always work out, but from the outset we’ll agree some objectives with each business that they want to work towards. For many businesses this is around culture, employee engagement, community impact and employee development. This can be anything from developing apprenticeship schemes to skills enhancement, allowing volunteering days to managing home/work balance, a particular focus over the last 12 months. As an example we’ve widened all our medical policies to include families and are undertaking a living wage review of our suppliers. It’s different things for different businesses.”
Rupert West, Managing Director of Puma Private Equity, which manages the Puma VCTs, said: “The ESG mindset has real momentum and is an investable trend which features prominently in our portfolio through companies such as My Kinda Future, a tech-enabled HR firm that works with a blue chip client base to enhance and maintain diversity in the workplace, and Tictrac, a health and wellness platform provided to corporate clients and their staff by major insurers.”
What is your outlook for the sector?
Warren Rogers, Head of Downing Ventures and Partner at Downing, which manages the Downing VCTs, said: “We feel bright and hopeful about all that is to come. Our strategy is to invest thematically into companies that are pioneering in the deep tech, enterprise and healthcare industries. We are working with founders who are focused on the largest global value propositions that drive significant trend shifts and innovation across the industry and plan on continuing to do so. It’s a busy time and we feel like we’re in the forefront of some momentous changes.”
David Hall, Managing Director at YFM Equity Partners, which manages the British Smaller Companies VCTs, said: “We are very, very lucky to work in a sector where the main goal is to seek out and invest in growth. The ‘only constant is change’ adage probably applies. There is always opportunity, and our sector continues to raise cash and deliver returns and as long as it does that its future and that of the businesses in which it invests should be positive.”
A new dawn
Ian Cowie discusses the implications of the Biden presidency
Shareholders in investment companies focussed on the world’s biggest economy have been well-rewarded for many years. But will the new American President, Joe Biden, be able to extend that trend? Or will he struggle to cope with challenges as various as the coronavirus, climate change and China’s re-emergence as the world’s second-largest economy?
His appointment of Janet Yellen, former chair of the US Federal Reserve or central bank, as Treasury Secretary, gave investors reasonable grounds to be cheerful - and fearful. The first woman to have held both posts confirmed that the incoming administration intends to spend more on healthcare as part of a $1.9 trillion stimulus for the economy but warned that taxes on companies and the wealthy will need to rise.
During Senate confirmation hearings, Yellen described climate change as “an existential threat” and accused China of “abusive, unfair and illegal practices”. Closer to home, she said: “Neither the President, nor I, propose this relief package without an appreciation for the country’s debt burden. But right now, with interest rates at historic lows, the smartest thing we can do is act big.”
While the past is not necessarily a guide to the future, big returns have already been achieved by investment companies in the North America sector. They beat the average from all types of investment companies - excluding venture capital trusts - over the last year, five years and 10 years. Over these periods, the average North America investment company delivered total returns of 29 per cent, 131 per cent and 217 per cent, according to independent statisticians Morningstar. By contrast, the averages from all types of conventional investment companies were 17 per cent, 93 per cent and 184 per cent.
Meanwhile, UK All Companies lagged with returns of minus 4 per cent, 57 per cent and 164 per cent respectively. UK Equity Income was left even further behind with minus 9 per cent, 33 per cent and 99 per cent.
America’s short, medium and long-term outperformance can largely be explained by this economy’s strength in sectors including healthcare and technology. Both have been boosted by bids to find vaccines for the coronavirus - or even a cure - and global trends toward working from home and shopping online. For example, Baillie Gifford US Growth (stock market ticker: USA) is the top performer in its sector over the last year. It generated an eye-stretching total return of 131 per cent from a technology-focussed portfolio where the three largest holdings are the electric carmaker, Tesla, the Canadian online retailer, Shopify, and its bigger American competitor, Amazon.
JPMorgan American (JAM) is this sector’s leader over the last 10 years with total returns of 285 per cent, followed by 20 per cent over the last year. JAM’s biggest holdings are the technology giants Apple and Microsoft, with Amazon in third place. Neither company pays much in the way of dividends, USA’s yield is zero and JAM’s is just 1.1 per cent. So income-seekers in this sector may favour alternatives such as North American Income (NAIT) and Middlefield Canadian Income (MCT), which yield 4 per cent and 5.5 per cent respectively. However, it’s only fair to say that the price of a higher income has been lower total returns recently. The latter were negative over the last year at both MCT and NAIT, at minus 8 per cent and minus 17 per cent respectively.
Higher total returns have been achieved by JPMorgan US Smaller Companies (JUSC), a long-established constituent of my ‘forever fund’ which seeks capital growth from mid-sized businesses and corporate tiddlers. JUSC delivered 14 per cent, 169 per cent and 344 per cent over the last one, five and 10-year periods. Of course, it is not necessary to have “America” or “US” in an investment company’s name to obtain exposure to the world’s biggest economy. Polar Capital Technology (PCT) has been a top 10 holding in my forever fund or life savings for more than a decade. PCT’s portfolio is led by Apple, Microsoft and Alphabet - the name under which Google is listed in New York - and 68 per cent of its assets are based in the USA and Canada. This investment company’s returns over the three standard periods were 41 per cent, 323 per cent and 515 per cent.
Similarly, Worldwide Healthcare (WWH) - another top 10 holding in my forever fund for more than a decade - has 67 per cent of its assets in America. Its three biggest assets are Boston Scientific, Bristol-Myers Squibb and Merck. Total returns were 22 per cent, 141 per cent and 538 per cent.
A more recent investment, International Biotechnology Trust (IBT), has 94 per cent of its net asset value (NAV) allocated to America. The search for a vaccine boosted IBT to return 42 per cent over the last year with 141 per cent and 571 per cent over five and 10-year periods. Here and now, IBT yields healthy income of 3.4 per cent. Another recent investment of mine, US Solar Fund (USF), also pays us to be patient with a yield of 5.1 per cent.
That’s some comfort to investors as stock markets suffer a bout of uncertainty about valuations and fears of a resurgent virus. Whether medium to long-term investors will enjoy a Biden bounce or endure a bumpy ride remains to be seen. But global leadership in healthcare and technology is likely to be significant. Or, as the legendary investor Warren Buffett advises: “Never bet against America.”
A Happy New Year
Will the Year of the Ox see the Chinese bull run continue?
Friday 12 February marks Chinese New Year, ushering in the Year of the Ox. Oxen are said to be honest and hard-working and known for their strength and determination, characteristics which will be vital this year as vaccination programmes are rolled out across the globe.
When it comes to Chinese equities, will the Year of the Ox see the bulls maintain their grip and how will the Biden administration impact opportunities in the region? The AIC has spoken to investment company managers investing in China. Their thoughts are gathered below.
To reflect the increasing importance of China’s equity market, the AIC will soon be launching a China / Greater China sector.
Dale Nicholls, Portfolio Manager of Fidelity China Special Situations, said: “As I have said in the past, I believe tensions between China and the US will be with us for decades to come. The company remains focused on opportunities supported by ongoing structural shifts in China within the domestic economy. It’s also worth noting that previous sell-offs due to increased geopolitical concerns, have provided attractive entry points for new and existing opportunities.”
Pruksa Iamthongthong, Co-Manager of Asia Dragon Trust, said: “We would expect the evolving US-China dynamics to be a feature of the geopolitical landscape for years to come. While Biden is likely to pursue a multilateral and more predictable stance when it comes to China, his initial moves are sending a pointed message that his administration is unlikely to be a pushover when it comes to managing its relationship with Beijing. It is still early days yet, though, and we will continue to monitor developments from here.”
Roddy Snell, Co-Manager of Baillie Gifford China Growth Trust, said: “Tensions between China and the US are unlikely to diminish. However, despite the headlines, it is noteworthy how unaffected China has been by US actions. For example tariffs have failed to impact Chinese exports which are booming and growing more strongly than any time in the past decade as they take share from Western markets. Threats to delist Chinese companies have simply led to Chinese companies dual listing or listing in Hong Kong where they are welcomed with open arms and many sanctioned stocks have seen their share prices rise after they have been identified by the US. In the meantime, China has prepared extremely well for future tensions by rapidly moving up the manufacturing value chain, rebalancing its economy away from investment, and is arguably innovating faster than any country in the world. R&D already exceeds the US and EU combined.”
COVID’s impact on opportunities and risks
Rebecca Jiang, Co-Manager of JPMorgan China Growth & Income Trust, said: “While COVID-19 caused a short-term shock to the Chinese economy, the government’s quick and comprehensive mobilisation at the start of the pandemic meant that the impact to consumption and business confidence has been largely cyclical and not structural. While some industries are still seeing some short-term pain as a result of the pandemic, overall we are finding that activity levels on the supply side of the economy have recovered more quickly than on the demand side, although both are showing some encouraging signs.”
Dale Nicholls, Portfolio Manager of Fidelity China Special Situations, said: “Government stimulus has clearly been a factor supporting the recovery, but overall has been more restrained and targeted than measures seen in most Western economies. This therefore leaves room for further policy support if required. Regarding markets, while valuations are clearly not as attractive as they were earlier in the year, they continue to trade at a significant discount to the US markets despite arguably better growth prospects. The return to ‘normality’ in China should mean lower risks relative to many other countries with higher uncertainty as they still struggle to get the virus under control. On a stock level while some individual stocks have done quite well, particularly the COVID-19 beneficiaries, there are many laggards and still significant value in many parts of the market.”
Roddy Snell, Co-Manager of Baillie Gifford China Growth Trust, said: “As is the case in other markets, we’ve seen growth for online-centric businesses increase as lockdown accelerated adoption and penetration of services such as e-commerce, online food delivery, and online entertainment. Whilst share prices have reacted strongly, we believe the opportunity set for many of these companies has actually increased. At the same time their competitive positions have strengthened markedly. As such, we think returns going forward are likely to be very strong and in most cases remain very happy with our holdings.”
Opportunities in food delivery and lower carbon
Ian Hargreaves, Co-Head of Asia and Emerging Market equities and manager of the Invesco Asia Trust, said: “The opportunities we like most in China are consumer-related names, exposed to favourable structural growth trends such as the emergence of the middle-class, growth in domestic consumption and increased usage of the internet. Internet companies such as online gaming developer NetEase and e-commerce player JD.com have been very good long-term investments, while more recently we’ve enjoyed strong returns from the likes of baijiu distiller Jiangsu Yanghe and Suofeiya Home Collection, which manufactures and sells customised wardrobes and cabinets.”
Rebecca Jiang, Co-Manager of JPMorgan China Growth & Income Trust, said: “As Chinese millennials continue to seek various services at their fingertips, the growth opportunities in the consumer discretionary sector look compelling. Meituan Dianping, the Chinese equivalent of Deliveroo, is a prime example of a multi-level technology service platform witnessing an accelerated growth in its user base. The company, whose USP is its ability to have fresh food delivered in 30 minutes within a 3-kilometre radius, is the country’s leading website for locally found food delivery services, consumer products and retail services. Since the beginning of the pandemic, merchants have accelerated their migration to online distributers such as Meituan, particularly branded restaurants with high quality supply, which have traditionally focused on in-store dining instead of delivery services.
“Furthermore, the technology sector continues to offer huge potential over the long term. Chinese millennials are more tech-savvy than their previous generations, with over 90 percent of this population having access to a smartphone. One of the companies benefiting from the acceleration in demand for technology is Bilibili, a Chinese video sharing platform themed around animation, comics and games, similar to the app TikTok. It is a prime example of a ‘New China’ company that is profiting from the changing consumption patterns of a new generation. Highlighting the exceptional levels of daily user activity on its platform, Bilibili reported total net revenues of US$475.1 million, representing an increase of 74% from the same period of 2019.”
Pruksa Iamthongthong, Co-Manager of Asia Dragon Trust, said: “We are also seeing China becoming more committed to a greener and lower carbon future, as it aims to be less dependent on imports of fossil fuels (especially oil) which leaves it vulnerable to supply disruptions from overseas. This presents long-term investment opportunities in the renewables supply chain that supports industries such as wind power, solar power and electric vehicles. Many of the companies within this renewables value chain are located in China. With the Asia Dragon Trust, we have exposure via Yunnan Energy New Material, the world’s largest maker of lithium-ion battery separators for electric vehicles; Longi Green Technology, the world’s largest solar wafer maker; and China Resources Gas, one of the top city gas distributors, with the growing share of gas in China’s energy mix supporting its prospects.”
Ian Hargreaves, Co-Head of Asia and Emerging Market equities and manager of the Invesco Asia Trust, said: “The pandemic has been enormously disruptive, but China has fared relatively well compared to other countries in the region, with activity levels now back to pre-COVID-19 levels in many sectors. The economic recovery has also been managed without the authorities having to rely on the sort of fiscal impulse manufactured in developed economies, with suggestions that some form of modest monetary tightening is a possibility. Such relative restraint is a positive for the longer-term outlook. We are confident that China’s large and growing equity market will continue to provide us with a good selection of companies to choose from.”
Pruksa Iamthongthong, Co-Manager of Asia Dragon Trust, said: “We are big believers in China’s premiumisation story, wherein higher disposable incomes spur demand for healthcare products, wealth management services, insurance and luxury goods and services. Structural growth drivers such as the adoption of cloud applications, 5G and artificial intelligence also remain intact. China’s capital markets have continued to function extremely well despite COVID-19 and geopolitical tensions. Increasing foreign participation, underpinned by structural growth opportunities connected to a growing middle class, supports our positive long-term view on this market.”
Dale Nicholls, Portfolio Manager of Fidelity China Special Situations, said: “We remain firm believers in China’s long-term structural growth story and are focused on identifying companies – across both public and private markets – that are best placed to benefit from a growing middle class and the shift towards a more consumption-driven economy. With our in-depth bottom-up fundamental analysis, we are uniquely placed to identify – very early on – the many opportunities available among mispriced companies that offer direct exposure to China’s long-term growth story – in effect: tomorrow’s winners.”
Roddy Snell, Co-Manager of Baillie Gifford China Growth Trust, said: “As Chinese companies continue to ramp up their investments in research and development, combined with the world’s largest middle class whose appetite to consume and adopt technology is arguably faster than anywhere else in the world, we are confident China will be one of the fastest growing countries over the next decade. We are also confident it will become the world’s largest economy and be home to many of the world’s leading technology firms.
“It is perhaps surprising that despite these attractions China is significantly underrepresented in global portfolios: Globally China is 18 per cent of market cap, 30 per cent of listed stocks, but only 2.5 per cent of global funds’ allocations. As the market continues to open up and its vast potential is realised, this simply has to change. We believe investors would be wise to consider holding China now to get ahead of this substantial anomaly.”
Investment companies with highest exposure to Chinese mainland, Hong Kong and Taiwan. Source: AIC. Data as at 31 December 2020.
Faith Glasgow goes shopping for investment company bargains
Last year was a difficult year for most of us, but investment companies rode the market storms pretty well.
The sector started 2020 with share prices trading at an average discount to net asset value (NAV) of less than 2%; despite a dramatic widening of discounts to more than 20% when markets crashed in mid March, they recovered to end the year more or less as they had started it. Winterflood shows the current average investment company discount at just 3.6%.
In other words, attractive opportunities priced substantially below the value of their underlying assets are not easy to come by at present. Equity-focused investment trusts in particular are providing thin pickings for bargain-hunters. However, it’s possible to find a few offering decent value.
Andrew McHattie of the McHattie Group, which publishes investment trust newsletters, highlights Templeton Emerging Markets (TEMIT), the oldest emerging markets trust and second largest in its sector.
TEMIT beats the NAV performance average for the emerging markets sector over all timeframes and tops the table over five years. Yet it is presently sitting on a 10.7% discount to NAV, slightly wider than its 52-week average. In contrast, the current average discount for the emerging market sector is well below its 52-week average, reflecting the recent resurgence of investor interest.
“I don’t think its discount reflects either its record, its status and liquidity, or the money flows into emerging markets at the start of 2021,” McHattie comments.
Broker Stifel takes a similar view, upgrading its view of TEMIT to positive. “Since management changes in 2018, the fund has performed strongly. We are now more comfortable with the team and the fund offers value on a 10.7% discount,” says Stifel analyst Anthony Stern.
For income-seekers, Stern points out in a recent note that Asia offers better prospects than the UK, not least because Asian economies have recovered so much faster from the effects of the COVID-19 pandemic.
He likes Aberdeen Asian Income (AAIF) as a mispriced choice – particularly compared to its peer Henderson Far East Income. HFEL made no NAV gains in the last 12 months and has consistently trailed the sector over recent years, but trades on a 2.5% premium, supported by its “chunky” 6.9% yield.
In contrast, AAIF yields 4% and saw 12-month NAV growth of 18%. Yet it sits on an 11% discount and is trading at the bottom end of its discount range; moreover, Stern adds, “the board has been buying back stock as it looks to narrow the discount to the 5% target level, suggesting there is the potential for discount narrowing”.
Much less high-profile is the global smaller companies trust ScotGems (SGEM). It had a grim 2020, has net assets of just £48 million and currently sits on a discount of 18.2%. Andrew McHattie believes it offers “some speculative value” as a potential target for takeover or other intervention, which could boost the share price and narrow the discount.
“Buying underperforming trusts on wide discounts in the expectation of corporate action can be a mug’s game, as years can pass without anything changing, but we would have to say that ScotGems looks like a strong candidate for intervention,” he says.
Away from mainstream equity trusts, there are more opportunities to find big discounts. Both McHattie and Kepler have been eyeing Tetragon Financial Group (TFG) in the flexible sector, which McHattie describes as “perhaps the greatest bargain of them all” as the discount has widened to 60%.
Asset value fell by 1.3% and the dividend was cut in 2020. But, says McHattie: “That’s no disaster, and we do find it very difficult to square with the further widening of the discount. On a yield of 4.2% we think that holders are being paid to wait, and an improvement in the rating is likely from here, particularly if the dividend cut is reversed.”
However, Kepler warns: “TFG is currently pursuing legal action against Ripple, a constituent holding of its portfolio. We fear this may drag on, and think it is unrealistic to see a significant discount narrowing until the action is resolved.”
1. Winterflood investment trusts daily research note, 25 January 2021. All data as at 25 Jan.
2. Stifel note, “Macro tailwinds & more reasonable valuations”, 20 January 2021
3. Stifel, “Looking for Income, Look to Asia”, 16 September 2020 and confirmed by phone 26.1.21 that view still holds.