Investment Trusts: The City s Best Kept Secret

Transcription

1 Investment Trusts: The City s Best Kept Secret Tom Treanor & Jackie Beard 2009 Morningstar, Inc. All rights reserved. 1

2 Morningstar Founding & Mission Mission: Create great products that help investors reach their financial goals Started in 1984 with print publication on mutual funds for individual investors Business expanded to financial advisors, then institutions Key value: Investors come first 2

3 Morningstar s Quantitative-based Research Methodologies Innovative, proprietary research tools Holdings-based analysis 3

4 Research Staff at Morningstar: Global and Local 220 researchers worldwide Quantitative methodologies team (PhDs, CFAs, MBAs) 120+ equity analysts, 2,000 stocks worldwide 70+ fund analysts; 3,000 funds worldwide US: 25 fund analysts; 2,000 funds Australia: 7 analysts; 250 strategies Canada: 7 analysts; 400 funds Europe & Asia: 38 researchers; current coverage of >1,000 funds ETF & Closed-End Team: 12 analysts 4

5 Retail Distribution Review Aims To increase the professional standards of investment advisers To improve the clarity with which firms describe their services to customers To address the potential for adviser remuneration to distort customer outcomes Source: FSA Consultation Paper 5

6 Choices Post-2012 Leave the industry Retain Independent tag Need to look at whole-of-market - Investment Trusts - Exchange-Traded Funds (ETFs) - Structured Products - National Savings Offer restricted advice No requirement to research whole-of-market, but must understand wholeof-market 6

7 Advisers Reaction to RDR Steadfast Rejecters 11% Reluctant Adapters 16% Unknown 3% Enthusiastic Advocates 36% Willing Adapters 34% Survey by NMG Financial Services Consulting, May

8 Most Popular Products from Whole-of-Market 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Unregulated collective None of these Other investments that Structured investmentinvestments in investment investment schemes offer exposure to underlying financial assets, but in a packaged form products (excluding structured deposit products) trusts (excluding those in Investment Trust savings schemes) Survey of advisers described as advocates, NMG Financial Services Consulting, May

9 Polarised Opinions and Misconceptions Investment Trust Discounts are Potty Jeremy Lang, Liontrust, June 2003 The City s Best Kept Secret I do not think the investment trust industry is capable of being revived. It s run by a lot of fuddy duddies who have no place in the industry Peter Hargreaves, Financial Times, 22 nd February 2010 Investment Trusts are bought, not sold 9

10 What is an Investment Trust? Investment Trusts Listed Equities Unit Trusts 10

11 What is an Investment Trust? Closed to new capital after initial public offering Structure suited for long term investment and in illiquid asset classes (e.g, direct property, hedge funds, private equity), as no need to sell securities to satisfy redemptions Listed on a stock exchange, so can be traded intraday Fixed number of shares, so price determined by supply and demand. Board of Directors External management contract (usually) Ability to use leverage (Gearing) 11

12 Terminology London-listed Investment Companies/ Closed-end Funds UK Investment Trusts Offshore Investment Companies 12

13 Terminology Investment Trusts are compliant with Section 842 of the Income & Corporations Tax Act 1988 Exempt from Capital Gains at the portfolio level; must pay out 85% of income; must be UK-domiciled Not all London-listed Investment Companies are Investment Trusts Restrictions of Section 842 have led to much of new issuance over recent years coming from offshore-domiciled funds 13

14 London-listed Investment Company Universe Number of Funds 600 Total London-listed Investment Companies Dec Dec Dec Dec Dec Dec Dec Dec Dec Dec-09 10th June

15 London-listed Investment Company Universe Number of Funds Dec Dec Dec Dec Dec Dec Dec Dec Dec Dec-09 10th June 2010 Total London-listed Investment Companies Investment Trusts Offshore Investment Trusts ex VCTs 15

16 London-listed Investment Company Universe Assets by Sector 160, ,000 Total Assets (GBP, '000s) 120, ,000 80,000 60,000 40,000 20,000 Fixed Income VCTs Other Alternative Hedge Funds Private Equity Property Equity

17 London-listed Investment Company Universe Assets ( 118bn) by Sector as at 10-Jun-2010 (566 funds) VCTs 2% Hedge Funds 6% Other 3% Fixed Income 1% Private Equity 16% Equity 48% Property 24% 17

18 Investment Trusts vs OEICs/Unit Trusts: Annual % compound outperformance over 10 years to 31-Dec Global Global UK Growth North Europe ex UK Growth Far East ex Japan Emerging Growth America UK & Income Japan 18

19 Key Reasons for Outperformance Closed-end structure = long-term investment horizon Gearing Discount Contraction Lower TERs 19

20 What is Gearing? Enhances returns in rising markets; magnifies losses when markets fall Hypothetical Fund raises 500m at IPO; takes on bank debt of 100m; holds 25m in cash Gross Gearing = (Total Assets / Net Assets) * 100 Gross Gearing = (600 / 500) * 100 = 120 If market rises by 10%, fund s NAV will rise 12% (assuming Beta = 1) Net Gearing = [(Total Assets Cash) / Net Assets] * 100 Net Gearing = [(600 25) / 500] * 100 =

21 Gearing Levels across Investment Trust Sectors Asia Ex Japan Japan Japan Smaller Global Growth Global Growth UK Growth UK Growth & Companies & Income Income Gross Gearing Net Gearing Highest Geared Fund 21

22 London-listed Average Weighted Discount vs FTSE All Share FTSE All Share Perform ance (% ) Discount (% ) Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10

23 Some suggested explanations for Discounts Illiquidity of underlying assets Discounting future management fees Poor past performance Lack of board action to keep discount narrow 23

24 Better Performance, Narrower Discounts? NAV Performance 5y Witan Scottish Mortgage Monks British Empire Securities Bankers F&C Investment Trust RIT Capital Partners Caledonia Investments Scottish Investment Trust 35 Alliance Trust Discount (%) 24

25 Benefits of buying at a discount Buying a fund at a 15% discount effectively means you purchase 1 of assets for 85p If this same fund is paying out a 5p dividend, you lock in a 5.9% yield 90bps higher than you would by buying into an equivalent open-ended fund at NAV But the discount can get wider so when should you buy? 25

26 Relative Discount Analysis: F&C IT Discount since 31-Dec Dec-99 Jun-00 Dec-00 Jun-01 Dec-01 Jun-02 Dec-02 Jun-03 Dec-03 Jun-04 Dec-04 Jun-05 Dec-05 Jun-06 Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09

27 Relative Discount Analysis F&C Investment Trust: Normal Distribution of Discounts since 31-Dec-99 Current Discount = % Average Discount = % One Standard Deviation = 2.96 Z-Stat = [(Current Discount Average Discount) / Standard Deviation] = [( ) / 2.96] = 0.02 Current Discount: % Mean Discount: % -2 St Devs -1 St Dev +1 St Dev +2 St Devs Discount (%) 27

28 Relative Discount Analysis Henderson EuroTrust: currently looking cheap with Z Stat of Current Discount: % Mean Discount: -8.21% -2 St Devs -1 St Dev

29 Discount Control Mechanisms Fixed Wind-Up Dates Fixed Wind-up Resolution dates Discount Targets If breached over specific period, may trigger a continuation vote or tender offer Share buybacks Presence of arbitrageurs provides incentive to prevent discount from drifting too wide 29

30 Total Expense Ratios Expenses tend to be lower on Investment Trusts than on Unit Trusts Independent Board exerts pressure on management fees Lower administration costs due to lack of redemptions Although leverage costs (not included here) can add to Investment Trust expenses Total Expense Ratio (%) Investment Trusts Unit Trusts Global UK-focused funds 30

31 Equity Income Advantages Investment trusts can build up revenue reserves over the year to act as a cushion in bad times Fund Name Net Assets ( m) Revenue Reserve ( m) Revenue Reserve (% of NAV) Yield (%) Dividend Cover in Years % in BP City of London Dunedin Income Growth F&C Capital & Income Invesco Income Growth JPMorgan Elect Managed Inc Lowland M&G Equity Package Unit Merchants Trust Murray Income Trust Schroder Income Growth Securities Trust of Scotland Shires Income Standard Life Equity Income Temple Bar Troy Income & Growth Value & Income

32 Case Study Fidelity China Special Situations How do we make a meaningful assessment of this trust? 32

33 Fidelity China Special Situations - People Asian team of 22 PMs and 31 analysts Based in HK, Seoul, Singapore, Mumbai, Sydney Martha Wang FF China Focus Superior rated Bolton only committed to 2 years Minimal prior experience of investing in China (and doesn t speak the language!) Experienced investor generally who is familiar with management of closed-end vehicles Bolton invested substantially in fund at launch ( 2.5m), aligning his interests with his investors 33

34 Fidelity China Special Situations Parent Part 1 Fund line-up spans all asset classes, geographies aiming to be all things to all investors but means well-resourced Promotes through ranks can lead to higher than average manager turnover as they change focus Funds could be cheaper, given scale of AUM (approx 140 bn) Paid 0.5% trail to IFAs who promoted fund, despite being closed-end If no adviser involved, Fidelity keeps the 0.5% trail firm putting its own and advisers interests above those of investors 34

35 Fidelity China Special Situations Parent Part 2 Fund Board Board of Directors of Trust 5 non-execs 1 is director of another trust 1 is director of FIL 4 own shares in the trust (exception is director of FIL) Hemscott Guru! 35

36 Fidelity China Special Situations Parent Part 2 Fund Board cont d 36

37 Fidelity China Special Situations - Process What do we know from Fidelity Special Situations? Contrarian with value bias Searches down market-cap scale in mid/small-caps Uses analysts extensively Not afraid of tail in portfolio but clear capacity limit here of $1bn Driven by bottom-up fundamentals but macro aware Will it work in China where many individuals trade daily? 37

38 Fidelity China Special Situations - Price Under the Management Agreement the Investment Manager has agreed to provide investment management services for an annual fee equal to 1.5% of the NAV. In addition, the Investment Manager is entitled to an annual Performance Fee of 15% of any change in NAV attributable to performance which is more than 2% above the returns on the MSCI China Index subject to a maximum Performance Fee payable in any year equal to 1.5% of the arithmetic mean of the value of assets with valuation calculated at the end of each month during the year. Any outperformance above this cap will be carried forward. If the Company underperforms, such underperformance must be made good before any further Performance Fee becomes payable. FCSS Prospectus 38

39 Fidelity China Special Situations: Performance (since launch) Apr Apr May May May May May Jun Jun Jun-10 NAV (p) Mid Price (p)

40 Fidelity China Special Situations: Premium/Discount since Launch Jun Jun Jun May May May May May Apr Apr

41 Buying funds at a premium can be a questionable decision when cheaper alternatives may exist JPMorgan Chinese is currently trading at a 10% wider discount differential Apr Apr May May May May May Jun Jun Jun-10 FCSS JMC 41

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