The global manager looking to the UK for returns

Finding good investments at good values can mean searching far and wide, and CT Managed Portfolio Trust, which runs two distinct portfolios – Income (CMPI) and Growth (CMPG) – can deploy its assets in investment trusts focused on pretty much any part of the world. But its manager, Peter Hewitt, argues that, at the moment, it is UK companies that offer patient investors the prospect of attractive returns on a longer-term basis – and smaller ones in particular.

As a result, Hewitt has been increasing exposure to investment companies focused on UK equities in both the trust's income and growth portfolios over the past year. He says: “The UK market has been unloved and has in relative terms underperformed most global equity markets since the Brexit referendum in 2016; it is the only major stock market valued below its long-term average. [As of late July] the estimated next-12-month price/earnings ratio was around 10.5 times against a long-term average of 14 times. All other major equity markets, particularly that of the US, are valued at premiums to their long-term average.”

This is partly due to the FTSE 250 Index, which “has been significantly de-rated, yet the growth prospects of many of the underlying companies are unchanged”, he adds. “Among smaller listed companies in the UK, the de-rating has been particularly severe. That UK equities offer very attractive value is no guide to whether [they] will outperform in the near term. However, it is a good indicator that over the medium to long term excellent returns can be achieved from these very modest valuation levels. While the chances of a recession over the next year have increased, valuations of UK companies in particular have already gone some way to take account of this possibility. They are at historically low levels both in absolute and relative terms.”

The UK accounted for 37 per cent of the Managed Portfolio Trust’s growth portfolio at the end of July, up from around 25 per cent at the beginning of 2022, and 37 per cent of its income portfolio, up from 30 per cent at the beginning of 2022.

The growth portfolio

Growth portfolio additions include Aberforth Smaller Companies Trust (ASL), whose managers invest via a ‘value’ approach – buy shares in companies that they calculate to be selling below their intrinsic value. They determine this through a valuation approach that focuses on both stock market and corporate worth. The trust's largest holdings at the end of June were bus and rail operator FirstGroup (FGP), carbon and ceramics manufacturer Morgan Advanced Materials (MGAM), van rental company Redde Northgate (REDD) and publisher Wilmington (WIL). The trust was on a discount to net asset value (NAV) of 12.4 per cent as of 16 August, according to Winterflood.

Hewitt has also topped up an already significant position in Finsbury Growth & Income Trust (FGT) run by Nick Train, and this accounted for 3.9 per cent of the growth portfolio at the end of July. It was also one of the trusts which contributed the most to the growth portfolio's return in the trust’s financial year to 31 May 2023. “Finsbury Growth & Income Trust experienced a share price gain of 13 per cent which also marked a welcome recovery after a difficult 2022,” says Hewitt. “Its highly concentrated portfolio is focused on UK companies with consistent earnings growth. There is exposure to global consumer brands through Diageo (DGE), Unilever (ULVR) and Burberry (BRBY), and data analytics and platform services through Relx (REL), London Stock Exchange (LSEG) and Sage (SGE). Having been de-rated in 2022, the inflation resilience of much of the portfolio, along with inherent growth prospects, have been rewarded with a strong recovery over the past year.”

The income portfolio

In the income portfolio, Hewitt increased holdings in trusts focused on UK equities that also offer an attractive dividend yield, including Mercantile Investment Trust (MRC). It has assets worth over £2bn and focuses on mid-caps, with the largest holdings including Intermediate Capital (ICP), Inchcape (INCH) and Softcat (SCT) at the end of July. This trust has significantly de-rated and was on a discount to NAV of 14.4 per cent as of 16 August, according to Winterflood.

Hewitt also increased its position in the Invesco Perpetual UK Smaller Companies Investment Trust (IPU). This trust pays a dividend in each of its financial years to give a yield of 4 per cent based on its year-end share price, drawing on capital reserves to fund it, if necessary.

However, while these moves might end up producing long-term growth, in the short term they have not been rewarding. The Managed Portfolio Trust’s income shares’ NAV and share price total returns were -7.4 per and -2.1 per cent, respectively, with the growth shares' respective NAV and share price total returns at -5.8 and -7.8 per cent, for the year to 31 May. By comparison, the FTSE All-Share and FTSE Closed End Investment Companies indices made total returns of 0.4 per cent and -4.4 per cent, respectively.

“The UK stock market has once again underperformed and, while this may continue in the near term, valuations of UK equities are discounting the most pessimistic of outcomes and are substantially below long-term averages,” says Hewitt. “There is no doubt that patience is required and will likely be tested. However, there is a significant opportunity for positive returns”.

Another key theme is remaining invested in secular growth investment companies exposed to the technology, biotechnology, healthcare and digital platform sectors. “Taking a longer view, it is from these types of investment companies that strong performance will most likely be achieved,” says Hewitt. “And how do you play artificial intelligence (AI)? Nvidia (US:NVDA) and some semiconductor companies provide chips for AI applications, but really Microsoft (US:MSFT), to some extent Alphabet (US:GOOGL), and Meta (US:META) are the ones to play.”

Although he had reduced exposure in areas such as technology and healthcare, since the end of May he has been building up holdings in Polar Capital Technology Trust (PCT) and Allianz Technology Trust (ATT). These were the growth portfolio's fifth and seventh-largest holdings, accounting for 3 and 2.8 per cent of assets, respectively, at the end of July.

Falling for income

The holdings that experienced the largest falls in the trust’s financial year to 31 May were alternative asset trusts. In the income portfolio, these included Digital 9 Infrastructure (DGI9), whose share price total return fell 42 per cent as a wide share price discount of 45 per cent opened up. This trust owns subsea fibre assets, the infrastructure for terrestrial television and radio broadcasting in the UK, and Ireland’s largest wireless internet provider.

“The jewels in the crown are data centres mainly in Iceland and Finland which are powered by renewables,” says Hewitt. “However, they also require significant capital expenditure to exploit the opportunity ahead for them. When the trust's shares initially moved to a small discount, the possibility of raising funds via an equity issue disappeared and the market began to be concerned over levels of gearing that would be needed to fund future growth. Management is evolving a plan to complete the strategy and, if successful, there is considerable upside. It is quite high-risk but they're pretty committed to trying to maintain the dividend."

Hewitt thinks the plan, which partly involves the syndication of assets to third parties, is “doable”, but concedes the position is not one of his largest due to the risks involved.

Higher discount rates have also proved a particular issue for alternative trusts, whose portfolios are valued by reference to a discount rate applied to the cash flows generated by underlying assets. Higher base rates have increased those discount rates, leading to a corresponding reduction in asset value. Although dividends form a large part of their total returns and these have generally continued to be paid – and in certain cases increased – asset values and share prices have fallen – a key reason why the income portfolio has underperformed over the past year. And if these trusts have been geared their interest costs may have gone up. But Hewitt strikes an optimistic note, saying: “I think the underperformance is drawing to a close, though [the point] when they will start outperforming is still a little while off. In the meantime, you're getting a fantastic income return.”

CT Managed Portfolio Trust’s own income shares increased their dividend for the year to 31 May by 8.3 per cent – up from 6.65p to 7.2p a share – the 12th consecutive year of increases. And the trust’s board plans to pay a dividend of at least 7.2p per income share in respect of the year to 31 May 2024. Global equity income holdings such as Murray International Trust (MYI), JPMorgan Global Growth & Income (JGGI), Scottish American Investment Company (SAIN) and Henderson International Income Trust (HINT) paid solid dividends. And UK equity holdings Merchants Trust (MRCH), City of London Investment Trust (CTY), Lowland Investment Company (LWI) and Murray Income Trust (MUT), which “managed to edge ahead their dividends through the pandemic”, have continued to grow them this year, Hewitt notes.

He only holds “the highest quality investment companies with strong balance sheets and experienced, proven management.” He starts by looking at the report and accounts “to appraise the balance sheet of the investment trust and how much gearing it has got”, as well as the cost and duration of the debt and its revenues. 

“Once you’ve got a feel for that you look at what they’ve been investing in and whether it is in line with the investment style and approach of the fund manager – has it changed? [I also often have] questions about portfolio sizing: why is a holding 10 per cent [of assets] and is that not a bit big? Or what size do you put a new holding in at, as well as sector exposure.”

If a trust’s yield seems unusually high, Hewitt wants to find out whether its manager is investing in ‘value traps’ or whether the companies are just out of favour. And he wants to know how trusts generate their income. “Some managers have certain very high income producers – that could be bonds which maybe yield 6 per cent or financials and property companies in Asia.”