Despite a great deal of market noise and a notable spike in volatility, the first half of 2018 has delivered negligible returns for most UK equity investors.
Even so, the average discount rating in the investment companies sector remains tight by historic standards and it is difficult to identify particularly compelling investment opportunities at present.
Meanwhile, in the value versus growth debate, the growth camp continues to deliver, as demonstrated by the stellar performance of Baillie Gifford’s Scottish Mortgage Investment Trust, which has increased its net asset value by circa 17 per cent year to date.
The Unicorn Mastertrust holds sister fund, Monks Investment Trust, which has also performed well and has recently published its annual results.
The managers noted the significant performance contribution from a relatively narrow range of technology and internet companies and they have started to harvest some of the gains among their technology and US cyclical holdings “where progress is well recognised by the market”.
While Monks will remain firmly in the growth camp, it was interesting to see that much of the focus in recent months has been on portfolio diversification.
For investment trust followers, the portfolio typically features some household names but I also include more specialised trusts which might not readily fit into a conventional portfolio but offer alpha generating potential.My contrarian tendencies have, however, led me to tilt my portfolio towards more value oriented trusts, such as Aberforth Smaller Companies, which resolutely employs a value style.
Aberforth’s portfolio will never have the pizzazz of a growth fund and will, by its very nature, always look attractive relative to the wider market. But the current undervaluation is extreme by past comparisons.
The managers’ preferred metric, the ratio of enterprise value to earnings before interest, tax and amortisation (EV/Ebitda), places their portfolio on a multiple of nine times the 2019 forecasts compared to 11.3 times for their tracked universe of UK smaller companies and 16 times for UK smaller company growth stocks.
They contend that many growth businesses are being valued as if they were the next Amazon and note that few businesses succeed in retaining high stockmarket valuations for extended periods.
Brexit uncertainty and the poor perception of the UK market on the part of global investors are contributory factors to the lowly rating of Aberforth’s portfolio, but with cash rich private equity investors looking to deploy capital at higher multiples I can’t help thinking that further merger and acquisition activity will occur in the fullness of time.
In the meantime the underlying companies on average offer reasonable yields of around 3 per cent, with high dividend cover and robust balance sheets.
Other value names within Mastertrust’s portfolio include Fidelity Special Values, which has produced excellent performance under the guidance of Alex Wright, who started managing the trust in 2012 having built a strong record managing the Fidelity UK Smaller Companies fund since 2008.
I would tend to add to this position during periods of market stress if the discount to net asset value drifts out, but with the shares now trading at a modest premium I’m happy to sit on my hands.
In a similar vein to the managers of Monks, I have been concentrating on diversification.
The current portfolio is deliberately flat, with the largest weighting accounting for less than 3 per cent of the assets, as I want to have the flexibility to take advantage of future investment opportunities as and when they occur.
For investment trust followers, the portfolio typically features some household names but I also include more specialised trusts which might not readily fit into a conventional portfolio but offer alpha generating potential.
These often come with greater stock or sector specific risk, they may also be illiquid and in some cases will have a chequered history.
However, I am reasonably happy to take on that risk within the context of a widely diversified investment companies fund, as the compensation is usually an attractive discount at the point of entry.
A case in point is Riverstone Energy, where I established a position in March this year at a discount of around 20 per cent.
After two years of negative performance by the US S&P Oil & Gas E&P index in 2016-17 it was perhaps inevitable that a discount would open up on the shares, despite the fact that most commentators hold the management team in high regard.
The Trust invests exclusively in the global energy industry, with the majority of its investments in Permian, Eagle Ford and Western Canada basins.
The macro environment for Riverstone’s activities has improved significantly over the past two years with coordinated global growth and a significant recovery in the oil price.
Coincidently, productivity in the US shale oil industry has been soaring due to new extraction techniques. This much improved environment should enable the Trust to make attractive realisations over the coming years.
It is to be hoped that part of the proceeds of any realisations will be used to address the discount.
Peter Walls is fund manager of the Unicorn Mastertrust
