Investment trusts with strength to shrug off the downturn

Investment trusts had a tough time in 2011, not least because their closed-end format encourages them to focus on less-liquid sectors - such as smaller companies and emerging markets - and these suffered badly from the collapse in risk appetite in the second half of the year.

Trusts that employed gearing also turned sour in the second half, as gearing exacerbates downturns as well as enhancing upturns. To add to the pain, discounts widened as investors lost confidence in the economic outlook.

Despite these challenges, our experts managed to pick at least one trust in each of our three categories that defied the odds.

In the UK category, Charles Cade of Numis Securities scored a winner with Troy Income and Growth Trust (TIGT), which achieved an 8% share-price total return, compared to a 3% fall in the FTSE All-Share index. As with the top performers in the other two categories, it is profiled below.

In the Overseas category, John Newlands of Brewin Dolphin and James Burns of Smith & Williamson both backed SVM Global (SVG), which managed to hold its own on a share-price total return basis, compared to an 8% fall in the FTSE World ex UK index.

In the High Risk category, Newlands and Burns once again came good with attractive gains on two private-equity trusts. Newlands achieved the most dramatic uplift, with a 42% gain on Northern Investors (NRI). This was largely because the trust's decision to wind down its portfolio helped to slash its discount to 16.4%.

However, selling its portfolio of small unquoted UK companies could be a slog in current markets, so it is hard to get excited about buying into the shares now, following last year's uplift.

Burns backed F and C Private Equity Trust (FPEO), which achieved a 13% share-price gain, thanks to a 5% uplift in its net asset value (NAV) per share and a modest tightening in its discount. With the discount still above-average compared with other funds of funds in the private equity sector, F&C Private Equity has more long-term potential than Northern Investors, as we detail in the box below.

Among the tips from our other experts, Jean Matterson of Rossie House Investment Management did comparatively well with her UK and overseas choices of Herald Investment Trust (HRI) and Baillie Gifford Japan (BGFD), but was disappointed with Caledonia Investments (CLDN).

Herald had the best portfolio returns of the three technology specialists in 2011 despite its smaller company focus, and its wide discount offers decent scope for accelerated returns when it comes back into favour.

It has far less US exposure than Polar Capital Technology (PCT) and RCM Technology (RTT), which will be a disadvantage if the dollar continues to strengthen. On the other hand its wide spread of smaller company holdings could attract predatory interest from across the pond this year, potentially leading to a useful uplift in the NAV per share.

Baillie Gifford Japan was, as so often, one of the top-performing Japan trusts.

James Brown of Winterflood Securities was the only expert to pick a European trust for his overseas selection. This was not particularly clever in terms of regional asset allocation, but Brown had the satisfaction of seeing Jupiter European Opportunities (JEO) outperforming most of its rivals over the year at both the share price and NAV level.

JEO has by far the best NAV returns in its sector over three and five years, but does not enjoy a premium rating. Brown says that if the worst proves to be over in Europe, JEO should be a great way to play the recovery.

The most disappointing of the UK selections were Fidelity Special Values (FSV), picked by James Burns, and Throgmorton Trust (THRG), selected by John Newlands. Managed since January 2008 by Sanjeev Shah, the Fidelity trust's three-year NAV returns are now among the weakest in the UK growth sector, its discount has widened and its share-price performance has been grim. Shah's contrarian approach has not been working well, but Burns reckons that this could be the wrong time to sell.

Throgmorton was disappointing in that it did not fully use its ability to short the market to better protect its portfolio. However, its 2011 returns were relatively resilient, and its three-year NAV returns are now the best in the sector - better than those of Standard Life UK Smaller Companies (SLS) which trades on a 5.6% discount. On that basis Throgmorton's current discount looks unjustifiably wide.

UK: Troy refocused for caution

Troy Income & Growth has been transformed since Troy Asset Management took charge in August 2009. Formerly known as Glasgow Income Trust, it no longer has any gearing, its dividend has been slashed to a level where it is hoped to achieve steady growth, and its portfolio has been refocused on around 40 mainly UK blue-chip companies.

The manager at Troy is Francis Brooke, who has achieved top-decile returns for the open-ended Trojan Income fund over the past seven years. As he makes every effort to limit the downside in difficult markets, the unit trust has tended to underperform in strong markets but has more than made up for it in difficult times, and the trust seems likely to follow a similar pattern.

Reflecting Brooke's cautious outlook, the trust has around 6% in cash, and two-thirds of its portfolio is invested in FTSE 100 companies, headed by the likes of Royal Dutch Shell (RDSB), British American Tobacco (BATS) and BP (BP.). 10% is in companies listed overseas, mainly in the US, where Brooke recently bought into Microsoft (MSFT) because of its formidable balance sheet, strong brand, rapidly growing dividend and comparatively low share-price valuation.

The trust is a core UK recommendation from Charles Cade at Numis Securities. The yield may be below-average for the UK growth and income sector, he says, but there is more scope to grow it than is the case for the yield produced by most of its peers, thanks to good dividend cover and revenue reserves.

He adds that the portfolio is conservatively invested and the board has adopted a zero-discount policy which should protect investors from a nasty fall in the premium rating. This is achieved by buying-in shares if the discount falls below NAV, or issuing more if the premium starts to escalate.

Overseas: Positioned to gain

SVM Global is a globally-oriented fund of funds which has been managed since its 1991 launch by Colin McLean and Donald Robertson.

It has a great 10-year record but suffered severely in 2008 due to its exposure to emerging markets and resources shares, but recovered strongly in the two years to the end of September.

The trust holds many specialist trusts that were badly knocked by the loss of risk appetite in the last quarter of 2011, but James Burns and John Newlands believe it has the potential to perform relatively well again this year.

One of the aspects they like is that SVM Global's more adventurous holdings in sectors such as emerging markets are offset by those with a lower stockmarket correlation, such as hedge funds.

Another positive is that the average discount on its holdings has been hovering at 25% or more, and in some cases is nearly twice that.

With more than 30% of the trust invested in trusts where corporate activity has already been taking place, or where it seems likely to emerge, there is scope for some very rewarding revaluations in 2012, such as that enjoyed last year on its holding in Northern Investors.

High Risk: Opportunity from discounts

F and C Private Equity Trust (FPEO) is a modestly-sized private equity fund of funds, managed since September 2001 by Hamish Mair. It holds stakes in around 70 underlying funds, and has an international remit. However, over half its portfolio is in Europe, with a third in the UK, and only 7% in North America, and 6% elsewhere. More than two-thirds of the portfolio is in mid-market buyout funds.

The trust capitalised on the boom years for private equity with a 153% gain in NAV per share over the five years to the end of June 2008, but its share price fell steeply during the crash because of fears it would have difficulty raising sufficient funds to meet its forward-funding commitments.

The discount has halved from its March 2009 nadir of 84%, but James Burns believes the market is too cautious about the trust's prospects.

"Hamish Mair is a sensible fund manager with a sound long-term record, and has been achieving a steady flow of realisations," he says. "The portfolio is conservatively valued. I believe fears that the trust is dangerously over-committed [to funds raising cash] will prove overdone."

Looking for an all-round guide to investment trusts? Get expert advice from industry insiders and even some tips to help you increase your returns with our focus on investment trusts.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

This article was taken from the February 2012 issue of Money Observer.