With a lot of talk about value rotation, investors will be forgiven for thinking that few others matter. Yet history suggests that it remains wise to keep the portfolio balanced. Market sentiment is often fickle and can be distracting. Staying focused on the fundamentals of investing, while relating them to one’s assessment of sentiment and long-term outlook, is the key to successful portfolio management over time. And now it’s no different.
The portfolios benefited from their overweighting in growth companies. They will continue to seek out the many entrepreneurial directions and companies that embrace existing and emerging trends and technologies. However, the past year has seen a reduction in the magnitude of this overweighting to ensure a better balance between the two approaches. The logic is well established.
The disparity in valuations between the two, the increasingly obvious determination of governments to stage a strong economic recovery, the prospect of artificially low interest rates and the attendant risk of higher inflation, all indicate that these companies less. fashionable but still of good quality benefit disproportionately. But maintaining a balance within this now more important “value” component remains just as important as ensuring the balance of the portfolio in general.
For the reasons outlined in “The Case of Commodities” (July 10, 2020), last year most of the nine true investment trust portfolios managed on the website www.johnbaronportfolios.co.uk, including the two regularly featured in this column, introduced and then added to their exposure to commodities. BlackRock World Mining Trust (BRWM) and CQS Growth and Income of Natural Resources (CYN) were bought at prices between £ 3.38 and £ 4.00 in the first and £ 0.73 and £ 0.86 in the second.
We remain positive on the outlook for commodities. However, due to the extent of the outperformance of BRWM and CYN, including that of BlackRock Energy & Resources Income (BERI), the sector exposure has become disproportionate. BRWM has therefore been sliced or sold in recent months at prices between £ 6.41 and £ 6.89 when it was on a net asset value (NAV) premium, knowing that exposure to the sector remains significant.
Another consideration for some of the portfolios is the requirement of a reasonable or high level of income. Due to the good performances of BRWM, CYN and BERI, their returns have fallen considerably. Other “value” sectors which have lagged behind the commodities sector therefore perhaps offer more potential.
The commercial real estate sector is one example. It had to go through a torrid time because of an unprecedented economic shock involving arrears of rent, higher vacancy rates and lower dividends. However, the prudence of managers and therefore their lack of exposure to development, their focus on income and diversification, and the lack of investment and therefore the shortage of supply, are just some of the positive points. The sector in general is well positioned to benefit from the economic recovery. In addition, the sector offers attractive income opportunities.
Standard Life Property Income (SLI) has a long-term history of good strategic and efficient asset management thanks to Jason Baggaley, its senior manager. The focus on quality assets and the judicious allocation of sub-sectors helped. After a 20 percent dividend cut last year, a 25 percent quarterly dividend increase this year suggests a yield above 5.1 percent. SLI believes that this dividend is sustainable given the current levels of rent collection. The portfolios therefore increased holdings at prices of £ 0.67 and £ 0.70 when they stood at a haircut of around 20%.
A portion of the funds raised through the portfolios’ exposure to commodities was also used to increase exposure to other sustainable sources of income.
For example, the Winter portfolio has been added to GCP Asset Backed Income Fund (GABI) priced at £ 1.01 The company seeks attractive risk-adjusted returns by investing in asset-backed loans in social infrastructure, real estate, energy, infrastructure and asset finance . A disciplined approach to portfolio construction and a focus on defensive assets has meant that all interest due has been collected in 2020. A slight discount to net asset value and a 6.4% return on purchase are added to the investment file.
Trade of the decade
Meanwhile, for reasons discussed in last month’s column (“Trade of the Decade?”), Portfolios further increased their exposure to the UK, which also supported income levels.
Examples include City of London (CTY) and BMO UK High Income (BHI) at prices of £ 3.92 and £ 0.94 respectively. CTY has a proud record of dividend growth, under the leadership of its respected manager, Job Curtis – for whom she is recognized by the Association of Investment Companies as a “Dividend Hero”. Recent data suggests that relative performance is improving as the rotation to value stocks continues. An increased dividend and a potential yield of 4.9% on purchase strengthens the investment case.
In recent years, BHI has quietly built up a good track record, again against its goal of “value”. Strong income reserves and a continued movement by the manager to reposition the portfolio to companies with lower yields but with greater potential for dividend growth helped the company to increase its distributions again last year. This search for sustainable dividends led to a non-FTSE 100 bias representing more than 60% of its portfolio. Reasonable discount and 5.6% return on purchase add to the attraction.
Meanwhile, Edinburgh Investment Trust (EDIN) was added for £ 6.28. EDIN recently appointed Majedie Asset Management and is looking for companies in UK with strong business models and good management. Managers take a high conviction approach, while Majedie’s UK portfolio has outperformed the FTSE All-Share by 3% p.a. on average since 2006. A new manager with a good long-term track record, a modest discount to the net asset value and return on purchase suggests patient investors will be rewarded.
Artemis Alpha Trust (ATS) was recently introduced to the Thematic Wallet for £ 4.54. The company takes a “no-holds-barred and opportunistic” approach that best suits the portfolio’s higher risk / return mission. The company’s portfolio is concentrated and deviates significantly from the index. This will increase volatility. However, its performance has been good – for example, last year its net asset value rose 10% while the benchmark, the FTSE All-Share Index, was down 9.8%.
Meanwhile, the website’s portfolios also increased their exposure to UK small businesses. The commentary article “The Future is Small” (February 10, 2021) explains our long-standing positive outlook which has been reflected in the makeup of portfolios over the years. However, the future looks particularly bright as the economy recovers.
Aberforth Split Level Income Trust (ASIT) and Invesco Perpetual UK Smaller Companies (IPU) were introduced in some wallets. ASIT is a split capital investment trust where the zeros represent approximately 33 percent indebtedness. Aberforth are value investors who buy shares of companies they believe are selling below their intrinsic value. Long-term performance has been respectable given the emphasis on value, but has improved markedly in recent times as the rotation to value continues – with returns aided by the gear.
The IPU has a strong track record and a proven investment approach. Unfortunately, the board of directors made the mistake last year of abandoning the company’s stated policy of paying a dividend equal to 4 percent of the share price. It was not well received, and the remission has broadened considerably – such overt policies are useless if dropped on the first shot. The Council accepted its mistake and the policy was recently reinstated. The discount has reduced accordingly, but has not yet fully recovered.
This rebalancing of the value component of portfolios – from commodities to UK equities and commercial real estate – has now largely run its course. However, portfolios will remain nimble to capitalize on opportunities that offer good long-term prospects for the patient investor.
For more portfolios and commentary from John’s company, please visit his website at johnbaronportfolios.co.uk. John Baron has joined a team that forms a separate Baron & Grant discretionary management firm.
January 1, 2009 – May 31, 2021
Portfolio (%) 426.6 289.2
Baseline (%) * 203.0 151.8
Year on May 31, 2021
Portfolio (%) 6.8 5.7
Baseline (%) * 6.6 4.6
Efficiency (%) 2.6 3.1
* MSCI PIMFA Growth and Income benchmarks quoted (total return)