Investment trusts are cheap for a reason – but not one that should stop us snapping them up, Nick Greenwood tells Merryn Somerset Webb.
At MoneyWeek we have always been very keen on investment trusts. We like the fact that they give their managers pools of permanent capital. This frees them from the worry of having to buy and sell investments as investors take money in and out.
As a result, the investment trust manager knows he can invest for the long run without worrying about liquidity. We like the fact that they can borrow money to leverage returns, and that the interests of their investors are protected by independent boards. And we like the fact that their long-term track record is rather better than that of open-ended funds.
We’re always pleased to meet fellow fans, which is why I went to talk to Miton’s Nick Greenwood earlier in the month: he is such a fan that he runs a fund (Miton Global Opportunities) that invests only in investment trusts. I wonder how he ended up specialising in this way. Simply because he can find “incredible inefficiencies”: the typical trust in his fund today trades at a 29% discount to its net asset value (NAV). He can buy a pound’s worth of assets for 71p – “overlooked assets at a very cheap level”.
The vanishing traditional buyer
What makes them so overlooked, I wonder? It seems amazing that, given the number of people looking for value in stockmarkets, there could be any left at all. In the case of investment trusts, says Greenwood, it’s because their traditional buyers are deserting them. It used to be that private client stock brokers bought and held investment trusts for their clients, and financial advisers bought open-ended funds for theirs.
However, the old-school brokers – the “maybe 100 companies that were the member firms of the London Stock Exchange, the old Sheppards & Chases of this world” – have all merged into much bigger groups – ones that are now looking to cut costs and risks (regulatory and commercial) by standardising their portfolios.
But this means that trust size becomes an issue: if your business has assets under management of, say, £25bn, and you want all your clients to have more or less the same portfolio, you need to buy a lot of every investment that goes into them. Today, says Greenwood, if a trust hasn’t got a market capitalisation of around £400m or more, the big wealth managers won’t – can’t – buy them. So if you are a smaller trust, you have lost your natural buyer – and your share price is likely to fall and keep falling.
That’s how Greenwood (and ordinary investors like us) is able to buy “stocks at 71p in the pound when the vehicles are actually doing nothing wrong” – except lose their client base and not yet find a replacement for it. OK. But what changes that dynamic? If the old buyers aren’t coming back, what will happen to allow the new buyers (us!) to get their hands on the 29p? If there aren’t enough of us to fully replace them, won’t prices of small investment trusts just languish for ever? Hello value trap…
That’s not how it works, says Greenwood. Small trusts on 30%-plus discounts tend to come to a sad end. They get wound up: the assets are sold and the cash distributed to shareholders. “Probably half of my exits come that way.” The other possibility is that a trust finds a new, bigger client base or a reason to exist that allows it to grow. When that works it is fabulous: “you can get a powerful combination of a rising NAV and a narrowing discount. If you [buy] at a 30% discount and it moves to 10%, and you get a 10% move in the NAV, you can get a spectacular move”.
This reminds us both of the Aurora Investment Trust, which was in just this position – it was sitting at a nasty discount, but management was then taken over by Phoenix’s Gary Channon (who I interviewed here at the time). The discount shut almost immediately as investors anticipated hugely improved performance. It now trades at a premium – and remains one of Greenwood’s core holdings.
Indian stocks and German property
So where will one of these two things happen next? The fund’s biggest holding is the India Capital Growth Fund (LSE: IGC). It trades on a discount of 24% to NAV, thanks to having had “a capital structure that the market didn’t understand”, a set of managers who “lost half the money (now replaced!) and a large oversupply of shares (37 million new shares were recently issued)”. But the fact that the “share price has not remotely kept up with the value of the underlying assets” should give investors a good chance to get into a market “we like” on the cheap.
Not everyone is entirely impressed with Prime Minister Narendra Modi, but Greenwood sees him as a “supreme administrator”; rather than causing huge disruption with attempts to create new systems, he is trying to make what India has work better. Think moving planning systems online to cut bureaucracy and avoid corruption, for example. India’s central bank also still has tools it can use, and the market isn’t that expensive.
You might pay 17-18 times earnings for the portfolio, but those earnings are growing at 5%-10% a year. The other nice thing about India is that it works for stockpickers. “The top 20 firms in India tend to be owned by the big multinationals and tend to be on very high ratings and often rather unexciting… But you’ve got several thousands of firms in India and therefore, you can generally stock pick. The new managers at India Capital Growth – who focus on mid-caps – are quite good.” Buying in is an “arbitrage between perception and reality”.
Another top holding is the Taliesin Property Fund (LSE: TPF), a German property fund. This trades on a 9% premium to its published NAV. But, says Greenwood, it still offers amazing value – because the published NAV is wrong. The investment trust world is used to treating NAVs as exact. But when the investments inside a trust are unlisted and illiquid, that isn’t the case: values are much more subjective, so a big part of an analyst’s day job is to look at them afresh. Taliesin’s properties are all valued as if they were rental properties.
That is what they are now, but if you could sell those flats on the open market, their value would be very significantly higher (rents are kept low in Germany by various “landlord unfriendly rules”). “Our view is these flats will be sold over the next few years into the private market at a big premium,” with the money handed back to investors – assuming the entire trust isn’t taken over by a bigger investor before that. Property in Berlin still costs a seventh of that in London: this bull market will run for “years and years”.
The biggest opportunity right now
Another area where NAVs can’t be exact is private equity. There discounts are still wide, partly because the 2008 blow-ups left investors nervous of the sector, and partly because many funds “have market values of £200m-£400m, which is the dangerous area”. But there is a huge amount of capital around the world “looking for a home”. So the trusts will be able to sell the mature investments in their portfolios into “a market that is desperate”. His preferred trust here is Pantheon International (LSE: PIN).
We’ve moved around the world a lot in our interview (it’s worth watching our full chat here), so I end by asking which trust he reckons has the most potential. It is Geiger Counter (LSE: GCL), a tiny trust that focuses on owning uranium and uranium miners in north America, and generally trades at a discount of about 20%. Since the accident at Fukushima, uranium mining exploration has come to a halt. That’s not yet been a problem (the world is using Japan’s stockpiles).
But it could be; there is political risk in Kazakhstan (where around half of the world’s uranium is mined) and that aside, there isn’t enough uranium being mined to support the 450 nuclear reactors in the world, let alone the 150 being built. That points to a “massive spike in price at some point… I’m just surprised it hasn’t happened already.” If he could just buy one of his trusts, says Greenwood, it would be Geiger. The rest of us might just buy his trust and leave the decisions to him.
Fact file: Nick Greenwood
Greenwood started his career in finance in the late 1970s, joining Miton after its 2007 merger with Exeter Fund Managers. He now manages the Miton Global Opportunities trust and the CF Miton Worldwide Opportunities fund. The annualised total return of his investments over nearly 14 years measured by Trustnet comes in at 8.8%, a performance that puts him ahead of his peer group over one, three, five, seven and ten years.