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Investment Trust Watch: why I sold Perpetual Income

Investment Trust Watch: why I sold Perpetual Income
The sell-off in UK equity income trusts has continued with Edinburgh (EDIN) and Perpetual Income & Growth (PLI) investment trusts entering our table of ‘cheap’ trusts for the first time (see below).

That’s topical as they are both run by the same manager, Mark Barnett, who we highlighted earlier today with a look at the big backers of British American Tobacco (BATS).

It also follows neatly from last week’s column in which I highlighted Invesco Income Growth (IVI), run by Barnett’s colleague Ciaran Mallon, as a potential ‘gem’ in an increasingly cheap sector as trust share prices fail to keep up with the underlying value of their portfolios.

Perpetual Income vs Edinburgh

Several of you wanted to know why Perpetual Income, which Barnett has run since 1999, had gone off the boil since he took on Edinburgh nearly three years ago following the departure of Neil Woodford?

Strangely, despite its better track record it is Edinburgh that is currently cheaper, ranking sixth in Numis Securities’ first table, ahead of Perpetual Income in 14th spot.

In fact Perpetual Income does have the lower rating of the two. Its shares closed yesterday nearly 10% below net asset value, which is nearly double the discount on Edinburgh. However, because Edinburgh has traded at an average discount of just 1.2% in the past year, its current 5.4% discount is slightly more unusual than Perpetual Income on a 9.8% discount versus its one-year average of 3.6%.

That’s why Edinburgh emerges with a Z-score of -2.2 compared to -2 for Perpetual Income.

Just to recap, a Z-score is a measure used by analysts to tell whether an investment is trading significantly beyond its one-year range. A Z-score of -2 or below is viewed as ‘cheap’ (see first table) while a score of 2 or above is regarded as ‘expensive’ (see second table).

'Cheap' trusts Share price premium (- discount) to net asset value % 12-month average premium (- discount) % Z-score
Standard Life Equity Income (SLET) -9.6 -1.9 -3.0
Honeycomb IT (HONY) -1.6 2.2 -2.8
JPMorgan Mid Cap (JMF) -12.7 -4.3 -2.4
BH Global - £ (BHGG) -11.7 -7.8 -2.3
BlackRock Income Strategies (BIST) -12.8 -3.6 -2.3
Edinburgh IT (EDIN) -5.4 -1.2 -2.2
European Assets (EAT) -7.9 -1.0 -2.2
Majedie (MAJE) -15.9 -4.7 -2.2
Nimrod Sea Assets (NSA) -86.7 -70.3 -2.2
Merchants (MRCH) -10.1 -6.0 -2.1
BACIT (BACT) -1.5 3.9 -2.1
Drum Income Plus REIT (DRIP) 10.4 12.9 -2.1
Blue Capital Global Reinsurance (BCGR) -12.8 -8.9 -2.1
-9.8 -3.6 -2.0
Diverse Income (DIVI) -4.5 0.6 -2.0

Source: Numis Securities 27/10/16

Perpetual's exposure

By coincidence this week I attended a briefing with Peter Hewitt (pictured below), manager of F&C Managed Portfolio and an experienced investor in investment trusts.

Perpetual Income was previously a top-five holding for Hewitt but he revealed he had sold – or ‘top-sliced’ – some of the position as part of post-Brexit overhaul of both his Growth and Income portfolios.

Hewitt, who kept a smaller position in Edinburgh intact, explained that Perpetual Income was a bit more exposed to mid-cap and smaller stocks, areas of the market big, international investors are expected to avoid, particularly if the UK opts for a ‘hard’ Brexit.

He said Edinburgh also uses slightly more gearing – or borrowing – than Perpetual Income which, despite a higher interest rate bill, would have helped boost its overall returns.

Having looked at both trusts’ fact sheets I have to say the differences are quite small but combined perhaps they mean Edinburgh faces fewer headwinds from Brexit. Their top 10 holdings are identical, featuring familiar big FTSE 100 dividend payers. However, Edinburgh had slightly higher exposure to blue chips at the end of August, with 53% of the fund invested in the FTSE 100 compared to Perpetual Income on 48%. Also it had 10% in smaller caps and other investment trusts, less than 17% for its sister trust. Meanwhile, a 15% weighting in international stocks compared to Perpetual Income’s 11% is advantageous while the weak pound boosts overseas earnings.

All that could be enough to account for the recent gap in performance between the two. Over the past year, for example, Edinburgh’s total shareholder return has edged up 1.5%, while Perpetual Income’s has fallen 8.5%. The disparity between the underlying portfolio returns is narrower though: Perpetual's NAV has increased by 3% while Edinburgh's rose 8%.

'Expensive' trusts Share price premium (- discount) to net asset value % 12-month average premium (- discount) % Z-score
Damille Investments II (DIL2) -8.8 -16.9 2.8
Invesco Perpetual Enhanced Income (IPE) 5.2 2.8 2.8
Pacific Horizon (PHI) -7.3 -11.6 2.8
AXA Property (APT) -1.9 -12.6 2.7
Tiso BlackStar Group (TBGR) -36.8 -49.2 2.7
Vinaland (VNL) -19.8 -30.9 2.7
Doric Nimrod Air Three (DNA3) 35.3 25.7 2.6
Ashmore Global Opportunities - US$ (AGOU) -28.8 -33.0 2.5
Doric Nimrod Air One (DNA) 25.2 16.5 2.5
F&C Private Equity (FPEO) -7.6 -17.9 2.4
Monks (MNKS) -7.2 -11.0 2.2
Geiger Counter (GCL) -8.0 -22.6 2.1
Tetragon Financial (TFG) -43.2 -48.6 2.1
Investor AB (INVEB) -5.2 -15.2 2.1
Vietnam Infrastructure (VNI) -8.3 -26.0 2.0

Source: Numis Securities 27/10/16

Long-term shadows

Hewitt’s broader point – and the reason for reshuffling his portfolios – was that UK equity income trusts had generally delivered lacklustre performance in the past year and had also suffered growing investor caution towards stock market highs and overall UK prospects. As a result, discounts in the sector had widened from zero to 6% on average.

A similar trend had occurred in UK All Companies trusts with discounts this year widening from 6% to over 11%. He gave the example of JPMorgan Mid Cap (), this week’s third cheapest trust on a 12.7% discount and -2.4 Z-score. UK Smaller Companies trusts had seen discounts widen around 8% on average, despite their post-Brexit rally.

While he acknowledged this created investment opportunities in some good funds, he cautioned that it could be a while before they re-rated.

‘I’m very cautious about the UK – the trusts are good value but I don’t see their discounts moving in very much,’ he said.

Brexit buys and sells

Hewitt admitted that, like many investors, he had been wrong-footed by the Brexit vote. While he kept positions in UK trusts like Strategic Equity Capital (SEC) and River & Mercantile UK Micro Cap (RMMC), he had re-weighted his funds away from the UK towards Asia and emerging markets.

For example, for () he had bought new positions in Secure Income REIT (SIRE) and BlackRock Commodities Income (BRCI) as well as adding to Aberdeen Asian Income (AAIF), JPMorgan Global Emerging Income (JEMI), Murray International (MYI), 3i Infrastructure (3IN) and GCP Infrastructure (GCP).

In addition to reducing Perpetual Income he sold out of four UK trusts, Merchants (), Mercantile (MRC), Standard Life UK Smaller Companies (SLS) and Keystone (KIT) , Mark Barnett’s third remaining investment trust in the UK All Companies sector.

For his Growth () portfolio Hewitt bought into private equity trust HgCapital (HGT), RIT Capital Partners (RCP), Fidelity Asian Values (FAV), which this week released strong annual results, and Templeton Emerging Markets (TEM), which new manager Carlos Hardenberg appears to be turning round after succeeding Mark Mobius.

Among his sales were three UK trusts: Montanaro UK Smaller Companies (MTU), BlackRock Throgmorton (THROG) and Andy Brough’s Schroder UK Mid Cap (SMC).

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