It’s not often you see a high-profile company founder voicing concerns about their share price being too high.
But then, not many founders have increased their shareholders’ wealth more than tenfold in the last 15 years.
That probably gives Nick Train – manager of the Lindsell Train investment trust – a little more scope to voice his honest concerns.
There are many things to like about investment trusts
The Lindsell Train investment trust, run by Nick Train and Michael Lindsell, has been the UK’s top-performing investment trust over the last ten years, returning more than 500%. If you’d owned it since it launched in 2001, you’d be laughing ¬– every £1,000 you invested would have turned into around £11,000.
Train also runs the Finsbury Growth and Income Trust, which has also proved to be extraordinarily successful over the long run – this one is in MoneyWeek’s investment trust model portfolio.
We’ll have a lot more about investment trusts, what they are, and why we like them in the next issue of MoneyWeek magazine, out on Friday (sign up here if you’re not already a subscriber). But keeping it simple for now, an investment trust is simply a company that owns other companies.
Superficially, it’s a lot like a standard unit trust or Oeic (also known as open-ended funds). You give money to a fund manager, and he or she puts together a portfolio of shares, bonds and other assets, that they hope will deliver a market-beating return over the long run.
But the fact that investment trusts are listed on the stock exchange, and the fact that they don’t have to be constantly handing money back to investors or investing new cash (new investors just buy a stake from previous investors in the stockmarket), makes them – in our view – a much better vehicle for collective investment than open-ended funds.
In effect, the value of the portfolio (the net asset value, or NAV) and the value of the investment trust itself are two separate things. Obviously, the value of the investment trust should reflect the value of its underlying portfolio – because that’s where it derives its value – but this isn’t always the case.
Indeed, trusts typically trade at a small (or even relatively large) “discount” to NAV. In other words, you can buy the shares for a bit less than the price of the underlying portfolio. Others – particularly popular trusts – will sometimes trade at a “premium” to NAV.
This separation of portfolio and holding vehicle is useful, because it means that an investment trust doesn’t have to worry about always being able to sell parts of its underlying portfolio to fund redemptions. As a result, it has the ability to own less liquid assets. (Remember the freeze on withdrawals from commercial property funds amid the initial post-Brexit panic? That wasn’t an issue for investment trusts.)
The nice thing about illiquid assets is that they can provide very attractive returns if you’re able to hang on to them for long enough. In effect, the liquidity risk you take pays off in terms of returns.
One of the most interesting things about the Lindsell Train trust – and one of the reasons it’s done so well over the years – is that it owns a stake in a very specific private company. That company is Lindsell Train Limited, the privately-owned fund manager which is owned by Train and Lindsell.
How do fund management companies make money? Well, ultimately, they get a cut of all the money that they invest on the behalf of their clients. So the bigger the pile of money they have to manage (also known as “assets under management”), the more profit they make.
As a fund manager, if you want to boost your assets under management, then it’s very helpful to have a good investment record. It’s also helpful to be relatively media-friendly, so that people get to hear about you. Lindsell Train ticks both of those boxes nicely.
So when the trust performs well, people get to hear about it and they invest more money. As a result, the value of the underlying fund management company goes up, which boosts the value of the trust itself, which draws more investors in, and so on, in a virtuous circle.
But of course, when investors wake up to the fact that this is happening, they start to price in all sorts of future expected growth. And that’s why Train, in his latest portfolio update, sounded a note of caution.
Incentives matter
In 2016, the fund saw its NAV rise by 31%. The share price rose by even more – more than 60%. And a great deal of this was down to an increase in the value of its holding in Lindsell Train Limited. The share portfolio (the trust also owns stocks including Diageo, Nintendo and London Stock Exchange) was up a more modest 12%.
Train doesn’t scream “SELL!” or anything that dramatic. But he does point out that “just as the performance delivered by our investment approach cannot be guaranteed to outperform every year, so there is now law that says LTL’s business must keep growing every year either.”
That sort of caution is not something you typically see in the stockmarket. Now, I’ve got a feeling that Train would be pretty straight with his investors regardless. But I also think that the investment trust structure helps a lot. It comes back to this premium/discount mechanism.
You can value a company’s share price in lots of different ways. You can argue the toss about all sorts of ratios, and at the end of the day, you can justify any price you want. But with investment trusts, the premium or discount is quite a glaring indicator of the market’s judgement on the trust. It’s not easy to ignore.
And given that Lindsell Train was trading on an eye-watering premium of more than 60% when Train wrote that note earlier this month – well, that’s pretty hard to ignore. When the market seems to believe that your portfolio is worth more than one-and-a-half times what you say it’s worth, you have to at least say something about it.
Of course, since Train warned that the trust might be a bit expensive, the share price has dropped a good bit. It’s already down more than 20% this year. The premium still clocks in at around 28%, but that’s certainly an improvement. I’d probably still rather hang on to the Finsbury trust, but I’ll be keeping an eye on LT.
My point though, is not about buying either of these investment trusts. It’s pointing out that one of the reasons investment trusts historically have done better than many open-ended funds, is down to better accountability combined with a focus on the long run. It doesn’t always pay off, but at least the non-financial incentive structures are set up in such a way as to help rather than hinder a competent active manager.
Anyway, this week’s issue of MoneyWeek will be all about investment trusts, why we like them so much, and which ones we think are best. If you’re not already a subscriber, sign up here.