A divine performance from the Saints

The Scottish American Investment Company did not hold up well in the crisis, but the fund has rebounded strongly this year. Looking ahead the portfolio’s manager has an optimistic outlook.

Baillie Gifford took over management of the Scottish American Investment Company, also known as Saints, from First State Investments on January 1, 2004. At Baillie Gifford, under the watch of fund manager, Patrick Edwardson, the investment trust has outperformed its benchmark and delivered dividend growth of about 60% – until 2008.

In the second half of 2008 the fund was poorly positioned for the maelstrom of panic that engulfed markets following the collapse of Lehman Brothers, and performance took
a battering.

Edwardson decided to stick with the holdings in the portfolio: “On the whole we thought what we owned in the portfolio was good and was going to deliver good results in the long run”. He said that the markets’ valuation of the fund’s investments spoke more about fear and panic than of any fundamental change in their prospects. This judgement paid off: the fund has rebounded strongly so far in 2009.

Wins Investment Companies (Wins), in a research piece on September 3, says it does not believe the events of last year have changed the investment rationale of Saints. It concludes: “With a current yield of 5.6%, we believe this fund is an attractive vehicle for investors looking for a diversified source of income and the potential for capital growth”.

Saints has a long history dating back to 1873, making it one of the oldest investment trusts still in existence. Initially the trust invested solely in bonds issued by North American railroad companies – hence its name – and over time the investment portfolio broadened out to include shares as well as bonds.

Today, Edwardson’s objective for Saints is to increase capital and grow income to be able to deliver real dividend growth over time. “Our strongly held view is that income growth equals capital growth in the long run – they are two sides of the same coin,” he says.

Edwardson admits that he did not see the crisis coming, or at least the ferocity of it. When Lehman Brothers defaulted in September 2008 the fund was too fully invested and owned assets that did not hold up well, notably its bank stocks, which included RBS and HBOS. Its corporate bond and commercial property portfolios also fared badly.

The fund had invested in corporate bonds during the first half of 2008 because spreads above gilts had widened to attractive levels, explains Edwardson. He stands by that assessment for the long run. However, he admits that the fund invested in corporate bonds far too early.

Moreover, the portfolio still had substantial investments in commercial property, even after reducing its exposure to the sector by about one third in the first half of 2007. This was another source of losses.

The fund’s gross assets of about £340m include a single fixed-rate bond issue of about £88m, set for redemption in 2022. This provides a cheap source of funding, says Edwardson. If he feels confident about the outlook, he will use the money for interesting investments that can meet the cost of that borrowing. Alternatively, if he cannot find enough interesting things to invest in, the fund will hold a diversified portfolio of investment grade bonds of similar maturity and characteristics to the debenture, with the aim of removing the drag on performance.

Wins recent report states that the fund’s debt is not as expensive as it appears as much of it was issued at a premium.

Essentially an equity fund, Saints’ usual position is to be 100% invested in equity markets. It has 91.5% of its net assets (or shareholders funds) in equities, of which about 38% is invested in British equities and about 53% in overseas equities. This reflects Edwardson’s bullish view on the outlook for markets. The fund also has 4.5% of net assets in a UK-listed forestry fund and 2.9% in various property funds, (mostly UK listed, but whose portfolios are outside of the UK).

Besides these holdings, the fund has commercial property holdings (about 10% of net assets). “We are beginning to see capital gains in that portfolio again, so we believe we have reached the bottom of valuations there,” says Edwardson.

The fund’s exposure to corporate bonds is currently about a quarter of net assets. It also has a small amount of cash and a small unquoted investment.

The equity portfolio is managed as a single global portfolio, without paying attention to the geographical weightings of its benchmark (a 50/50 split between the FTSE All-Share index and the FTSE World ex UK index). “We look more at the prospects of individual companies we are invested in and the prospects of their industries,” explains Edwardson.

Edwardson has a positive view of the outlook for markets, stemming from confidence that the monetary and fiscal measures taken by governments around the world will work.

He expects a solid, rather than fast, recovery for the global economy. The main impetus will come from the emerging markets. He is gloomy about the outlook for the British and American economies but “very enthusiastic” about the prospects for emerging markets.

Edwardson has about a quarter of the equity portfolio invested in Asia and emerging markets. His favoured positions include Baidu.com, a Chinese internet search engine, and Brambles, a distributor of pallets and containers listed in Australia. Baidu.com, the Chinese Google, does not yield much but offers great potential for capital gains, he says. He bought Brambles in March this year when the stock was trading way below what he considered the business was worth.

In terms of sectors, the portfolio has big positions in tobacco stocks offering “reliable and attractive income growth”. It also favours oil and gas service stocks. This is on the expectation they will be the main beneficiaries of the enormous amounts the oil industry will have to spend in the medium- to long-term to bring to market the oil needed by the developing world. Of banks, the fund owns Barclays, Development Bank of Singapore and HSBC, and also holds some bank bonds.