Outperforming in a volatile market

The Halifax Fund of Investment Trusts has topped the Global Growth tables for the last six months. Manager David Marchant explains how he keeps the 20-year-old fund number one.

Getting something that is worth more than they paid for it is a key motivation for many consumers. Even in the current climate of falling high-street sales there is no shortage of shoppers keen to pick up an end-of-season bargain.

The fact that many investment trusts trade at a discount to their net asset value, therefore, could be a distinct advantage for the Halifax Fund of Investment Trusts. Sadly (but temporarily) absent from this month’s Global Growth fund of funds performance table because of a change in the share class used to provide data, the fund has topped the sector over both one and three years in each of the last six months. But just as there is little point buying a massively reduced designer suit if it does not fit, building a portfolio of investment trusts cannot just be about the discount.

Manager David Marchant, of Insight Investment, who has run the 20-year-old fund for over a decade, says he looks at two considerations alongside the discount. First is what the trust invests in, such as property, private equity, hedge funds and so on, and whether he and his team like the asset class. Second is the long-term record of the manager – Marchant says that unless you look long-term it can be hard to distinguish those who really add value from the “coin-flippers”.

“Basically, we want funds on large discounts managed by good managers in asset classes we like – though it is not always possible to get all three at once,” he adds.

Interestingly, it is not the discount that is the most dispensable element of this trio, but arguably the asset class. Marchant says that two of his favourite trusts – Atlantis Japan Growth and North Atlantic Smaller Companies – have been more about accessing good-quality managers at wide discounts than any particular fondness for smaller companies, either in America or Japan.

“I like to buy on wide discounts as you have the option to do something to manage the discount,” he says. “We try to do that as we are quite large investors in the investment trust sector, so we have a reasonable amount of influence. We engage with trust managers and chairmen to encourage good corporate practice with initiatives such as share buybacks that should narrow the discount over time.” He adds that his long experience in the sector means he has got to know a lot of the trust managers and boards, which can help when trying to identify investment opportunities.

The fund does not aim to be a one-stop portfolio solution, but does mix in a macro overlay with its bottom-up fund selection to try to ensure the portfolio is not skewed too heavily towards any one asset class. “We are not slaves to a benchmark but we do feel the need for a macro view on top,” says Marchant. “We have the flexibility to invest in a wide range of assets – for instance, we have had quite a lot in private equity, where we have been able to pick up mature funds quite cheaply.”

He explains that private equity suffered in the aftermath of the TMT bubble when investors were nervous about valuations. “All the major private equity trusts were on discounts of 20%-plus. When the market rallied strongly in 2003 these trusts got left behind, as their valuations were based on the valuations of their underlying holdings, which were out of date as they were based on the companies’ accounts. With the market roaring and private equity valuations lagging you could get a 20% discount on something that was obviously undervalued. Discounts have now narrowed substantially and Electra, one of the major players, is now on a discount of less than 10%.” Electra represented 3.6% of the fund’s portfolio at May 31, with RIT Capital Partners, also partly a private equity play, the largest holding at 6.6%.

With smaller companies arguably looking less attractive after the April sell-offs, Marchant has turned his attention to Japan, where he has been topping up holdings in JP Morgan Japanese and Baillie Gifford Japan. He says Japan is defensive in that it has not had a consumer boom, so it is less at risk from a consumer slowdown, and it has seen restructuring. There has been no economic growth for some time, and a long bear market, and valuations now compare well in global terms. “Nissan is on 8x earnings and a yield of 3%, and there are lots of examples like that. It’s the first time we have been able to say that for years,” he adds.

A cash balance on the high side at about 7% is more a result of strong inflows to the fund than any bearishness on Marchant’s part; it also serves to offset some of the gearing in underlying funds.

Marchant rejects the idea that investment trusts are inherently any riskier than their open-ended counterparts. “The risk is that you buy a trust at asset value and then the discount widens, so you could argue that discount volatility makes them riskier,” he says. “But then you have lower management charges, greater diversity in terms of asset classes and funds that, being closed-ended, can take a longer-term view. Also, while you can be subject to a widening discount, I see the discount as a source of opportunity, which gives extra potential for outperformance.”