Global trusts are lagging – but that might be about to change

Equity markets have been buoyant so far this year, but global equity investment trusts have not followed with a similar level of returns. Many are lagging their benchmarks as they try to adjust to a changed investment landscape, and market dynamics will have to change considerably for the tide to turn. But with this year’s rally hinging on the performance of a few technology stocks, this is unsurprising and perhaps even a good thing.

A narrow rally 

For the first few months of this year, the positive performance of the stock market was driven by just a few tech stocks, the so-called ‘magnificent seven’ – Apple (US:APPL), Alphabet (US:GOOGL), Microsoft (US:MSFT), Meta Platforms (US:META), Amazon (US:AMZN), Tesla (US:TSLA) and Nvidia (US:NVDA). These companies are so big that it’s hard for funds to ‘bet’ on them by taking large positions relative to global indices, so the narrow rally has made it extremely difficult for active funds, including global equities investment trusts, to outperform.

Towards the end of July, the performance of some of these seven stocks started softening while the rest of the market was still holding up, and there were timid mentions of a broadening of the stock rally. Although the first half of August was broadly flat, the ‘magnificent seven’ did not have such a disproportionate impact on performance during that time, as you can see by comparing the performance of the MSCI All Country World index with that of its equal-weighted equivalent.

In the month to 15 August, Apple, Microsoft, Meta, Tesla and Nvidia underperformed the market. If the trend continues, and other stocks and geographies gradually catch up with them, global equity trusts will have a better chance of outperforming. But this is a longer-term problem for global equities funds. Laith Khalaf, AJ Bell (AJB) head of investment analysis, points out that while funds that were underweight the US tech titans struggled to keep pace with the global stock market this year, “this dynamic plays out over longer time periods too. There is some concern over the valuations that the US tech sector commands, though it does seem to continually confound the doubters with its performance.”

Over the past few years, it has been quite easy to do well with an index tracker fund. Add higher interest rates to the mix, and global equity investment funds now have competition from both passive vehicles and from fixed-income investments. So weaker demand, including from wealth managers, has translated into pretty hefty discounts to net asset values (NAV) on global equities investment trusts, with the average discount for the Association of Investment Companies (AIC) Global sector 13.49 per cent as of 17 August.

Outperformers

An investment trust that has been outperforming this year is Alliance Trust (ATST). It attempts to combine both diversification and focused stockpicking via a multi-manager approach that employs 10 different active managers. A holding in this trust is similar to investing in 10 different fairly high-conviction funds.

In the trust’s half-year report to 30 June 2023, its managers explain that while market concentration and the predominance of tech stocks had been a headwind to their strategy in the past, this time the trust’s underweights in Tesla, Meta, Apple and Nvidia were compensated for by overweight positions in Alphabet, Amazon and Microsoft. Five out of seven of these stocks made up about 14.7 per cent of its portfolio as of 31 July compared with 16.5 per cent of MSCI AC World Index. 

Having managed the tech concentration issue this way, the trust registered strong returns from other companies that helped tip the balance towards outperformance, such as Latin American ecommerce business MercadoLibre (US:MELI), Adidas (DE:ADS), cement producer Heidelberg Materials (DE:HEIX) and Swiss logistics group Kuehne und Nagel (CH:KNIN). 

Witan Investment Trust (WTAN), another generalist that could be used by investors as a 'one-stop shop', has also done well so far this year. This is despite a significant underweight to those big US tech stocks, only four of which featured in the trust's 20 largest holdings, accounting for 5.5 per cent of its portfolio as of 31 July.

Witan also invests via multiple underlying managers. After a difficult 2022, its performance in the first half of this year was driven by global growth manager Jennison, followed by UK manager Artemis, which runs a special situations portfolio and emerging markets manager GQG, who comfortably beat their benchmarks over this period.

Gearing (debt), which was at 15 per cent as of 22 August, also helped the trust. Mick Gilligan, head of managed portfolio services at Killik & Co, says that in a difficult environment, Witan is “using the tools it has available to good effect”. He says that the gearing is a “very valuable” £155mn of long-term borrowings, locked in at a blended 3 per cent rate for an average of 25 years, alongside dividend increases, low costs and share buybacks. 

Unlisted exposure

After holding up comparatively well last year because it sold some US growth stocks near the top of the market in 2021, F&C Investment Trust (FCIT) is having a tougher 2023. It is underweight in the big tech stocks, while its private equity exposure, which accounted for 11.8 per cent of its portfolio as of June, was down 4.1 per cent over the first six months of this year. At the end of last year, F&C Investment Trust’s discount to NAV was 2.7 per cent against the Global sector’s 6.8 per cent weighted average, but this has since widened and is now closer to the Global sector average at 11.35 per cent, as of 17 August.

The ability to invest in unlisted assets is one feature that sets global investment trusts apart from global equity trackers, although they have had mixed results so far this year. Aside from the well-known woes experienced by Scottish Mortgage Investment Trust (SMT), Witan’s small portfolio of unquoted growth companies, which accounts for about 1.6 per cent of its assets, lost 8.8 per cent in the first half of this year. However, the trust's portfolio of alternative asset investment trusts, which includes Princess Private Equity (PEY) and BlackRock World Mining Trust (BRWM), was broadly flat. 

AVI Global Trust's (AGT) portfolio is very exposed to investment trusts with unlisted holdings. Oakley Capital Investments (OCI), Pershing Square Holdings (PSH), Princess Private Equity and Pantheon International (PIN) alone accounted for 22.2 per cent of its portfolio as of 31 July.

The wide discounts of private equity trusts correspond with this trust’s strategy of looking for “valuation anomalies” to build a concentrated portfolio, and these holdings have done well so far this year. But AVI Global Trust is not a standard generalist global fund and has a strong emphasis on engaging with its holdings.

As the chart below shows, more mainstream global equity investment trusts tend to be underweight the US, which has caused them to underperform in the past.

While the first half of the year has been difficult for global equity trusts, the second half might give them a better chance to outperform. This will depend on factors including how the macroeconomic environment evolves, the impact of interest rates on growth stocks and how well high valuations of US tech stocks hold up. It can also make sense for UK investors to have a core global equity holding that is less skewed to the US than a standard tracker.

But in the long term, the predominance of the US stock market is unlikely to go away and, in order to compete with trackers, generalist global trusts will have to keep demonstrating that they can still add value.