Investment Trusts

And Schroder Oriental Income Fund Ltd (SOI)

Caricature of Sir Philip Rose, Vanity Fair 1881, courtesy Wikipedia.

Sir Philip Rose founded the first investment trust in 1868 for investors of modest means. He called it The Foreign & Colonial Government Trust and it specialised in investing in Government bonds. In 1891 it changed its name to The Foreign & Colonial Investment Trust and it first started investing in equities in 1925. Today it has assets of £2.6 billion.  

Investment Trusts (ITs), whose shares are traded on the stock market like companies, have long been recognised as appropriate vehicles for illiquid investments in assets such as property, unlisted companies and infrastructure. Open Ended Investment Companies (OEICs, including Unit Trusts) and Exchange Traded Funds (ETFs), where investors may withdraw funds from the underlying assets, are not as suitable for such asset classes.

While ETFs have captured the largest share of managed equity funds, ITs hold certain advantages for equities over both ETFs and OEICs for the discerning investor. A major reason is that ITs generally perform better than either ETFs or OEICs in equity markets, according to an Investors Chronicle article (27 July 2012). This is confirmed by performance data, updated monthly, at http://www.theaic.co.uk/aic/statistics/aic-stats

The following table covers 10 years' performance to May 2012 by sector.

Sector	Investment trusts	Oeics/Unit trusts	Benchmark
Global	174.1	140.2	148.4
Global equity income	187.3	NA	148.4
UK equity income	165.2	146.8	144.1
UK	178.3	150	158.1
North America	139.1	122.6	142.6
Europe ex UK	173.2	143.4	147.2
Global emerging markets	398.9	298.7	325.6
Asia Pacific ex Japan	286.7	247.1	282.2

Source: Investors Chronicle 27 July 2012.

 ITs perform better than OEICs and ETFs for equity investors because:

·         The fees and expenses incurred by ITs are substantially lower than those charged by OEICs, though they are somewhat higher than ETFs.

·         IT managers can leverage their gains with borrowed funds.

·         IT managers follow long-term investment strategies, knowing that funds cannot be withdrawn from their portfolios. Managers of OEICs feel constrained by quarterly reporting and the fear that funds will be withdrawn if they perform below their benchmarks. As a result, OEICs sometimes become high cost index trackers.

·         ITs are never forced to buy or sell in their chosen markets. OEICs and ETFs are forced to do so as investors buy or sell their units. The ebb and flow of funds also increases the trading costs of OIECs and EFTs.

·         The price of OEICs and EFTs is linked exactly to the underlying fund's net asset value. Meanwhile ITs trade at a discount or premium to net asset value. This enables ITs to buy back their shares when they trade at a discount and to sell them when they trade at a premium to net asset value (NAV).

·         On average, IT managers add 'alpha' - they do better than their benchmarks.

Investment Trust investors will note that:

1.       The first step is to chose a theme - growth or income, geographical region, asset class etc. - and then review the available ITs listed at Morningstar or similar websites.

2.       The opportunity of buying assets at a discount to NAV should not be ignored. But there is usually a good reason for a high discount. INVISTA EUROPEAN REAL ESTATE IT trades at an 87% discount to NAV, but its borrowings are almost 6 times the value of assets and it is capitalised at only £7 million pounds. This is only for speculative investors. Evidently buying into an IT at a premium to NAV is best avoided, unless the investor has a compelling reason to do so.

3.       Unlike OEICs, ITs provide considerable information on their finances and investment strategies. This helps investors to find a manager who shares their investment criteria.

4.       As in any investment, it is a positive sign when managers own a substantial stake in their companies.

5.       While most ITs do not gear their investments by more than 10 to 15%, some do. This adds an element of risk, which in a downturn could hit the value of its shares.

6.       Small ITs, say with a free float of less than £50 million, are best avoided. Their shares can become illiquid and their bid to offer spread widen in a selloff.

-----------------------------------------------------------------------------------------

 

Schroder Oriental Income Fund Ltd (SOI)

Sydney International Airport, courtesy Wikipedia

After a year when equities in the Asia Pacific region (excluding Japan) have recorded a net loss, compared to the substantial gains in the developed markets of the USA, Japan and Europe, it does not take much of a contrarian to take an interest in this region of the globe. When regions or asset classes are out of favour, the share price of investment trusts specialising in these areas often move to a discount. This is the case with Schroder Oriental Income Fund Ltd (SOI), which currently trades at a 5% discount to net asset value (NAV).

SOI Share price premium/discount to Net Asset Value, courtesy Investors Chronicle, click to enlarge

SOI was founded in July 2005 to "provide a total return for investors primarily through investments in equities and equity-related investments, of companies which are based in, or which derive a significant proportion of their revenues from, the Asia Pacific region and which offer attractive yields." (Company factsheet).

SOI has consistently beaten its benchmark, the MSCI Asia Pacific ex Japan Index:

Annualised Returns %	1 YEAR	3 YEAR p.a.	5 YEAR p.a.	Since 2005 p.a.
SOI - Net Asset Value	-6.7%	7.6%	22.4%	11.2%
MSCI Asia Pacific ex-Japan  GBP	-7.0%	0.8%	15.2%	9.6%

 

Matthew Dobbs has managed SOI since its launch in 2005. According to FE Trustnet, he has outperformed his  peer group of managers by 77% in the past 10 years.  SOI has 68% of its funds invested in Australia, Singapore, Hong-Kong and Taiwan, with the remainder invested in China, South Korea, Thailand, New Zealand, Indonesia and the Philippines. Larger investments include Fortune Real Estate (Hong Kong), Taiwan Semiconductor, Sydney Airport, China Petroleum and Chemical and HSBC. The total number of holding is 72, which is not large for an IT with £400 million invested.

At its current price of 164p, SOI yields 4.5% and it is on a price earnings ratio (based solely  on revenue) of 19. The IT has a net gearing of just 3.3%. Seven institutional investors each own more than 3% of the fund's shares.

SOI has a good trading record. Consider:

1.       Revenue earnings per share (excluding capital gains and losses) and dividends have grown by 7% cumulatively per annum since 2007.

2.       SOI has returned a total gain on NAV of 148% since launch, 30% better than the benchmark return of 118% over the same period.

3.       Total charges amount to 0.93% per annum, about half the charges of a comparable OEIC.

4.       The fund issues or buys back shares to ensure that its share price does not move far from its NAV. By selling when the share price moves to a premium and by buying when it falls to a discount, shareholder returns are improved.

5.       The lead manager, from Schroder Investment Management, has been with the IT since its launch. Continuity, with a good performing IT, is important.

 

Using the dividend discount model, SOI would be valued at between 160p (discounting at 12%) and 260p (discounting at 10%), which compares to its current share price of 164p. This assumes that dividends continue to increase by 7% per annum indefinitely, though values beyond 20 years become tiny.

 

Main risks are:

 

Ø  The fund is highly dependent on what happens in China. Chinese gross public debt to GDP is estimated at 200% and for the first time public bodies have been allowed to default on their debts. Political risks in the region, both in North Korea and with Chinese claims in the East and South China Seas, are a concern.

Ø  The fund invests in a wide range of currencies, none of which are tied to sterling.

Ø  There is fear among investors that we may be on the brink of a financial crisis in the region.

 

 

Note: the next article will appear around 5 April.