Seeking misvaluation in a niche

Rising concern over the pace of global economic growth, and developments in China in particular, have contributed to a volatile start to 2016 for world equity markets, which has left the MSCI World Index down nearly 7% year to date. As a result P/E valuations are lower and closer to long-term averages (the prospective P/E for the Datastream world index is 7% above and 10% below its 10- and 20-year averages respectively). Equity valuations therefore seem more reasonable than previously but do not appear to give a clear signal and market caution could be validated if earnings estimates come under increasing pressure. This suggests a challenging outlook for equity investors in the near term, although it should be remembered that global growth is continuing at a lower level and the central view of forecasters such as the IMF still steers clear of a renewed recession.

Exhibit 2 shows how the Morningstar investment trust (ex-3i) index has performed against the MSCI World Index and how the investment trust index’s discount to net asset value has evolved. The investment trust index has tended to lag the world index since mid-2011, probably reflecting a period of relative strength for the US market where investment trusts as a group are likely be underrepresented in comparison to the world index. At the same time, the discount to NAV for the investment trust index has mainly continued a post-crisis narrowing trend, although this has reversed at the beginning of the current year as market volatility has risen (a normal pattern). The right-hand chart demonstrates that discounts can be widely dispersed in the sector, in this case classified by market cap. Looking ahead, continued market volatility could be mirrored by fluctuating discounts and potentially a wider spread of discounts in the closed-ended universe.

This kind of uncertain market background may therefore create greater opportunities for a niche fund such as MIGO with its strategy of identifying valuation anomalies among listed investment companies. Its increasing allocation to companies pursuing less market-sensitive alternative strategies may also tend to increase its differentiation from mainstream equity funds.

Miton Global Opportunities was launched in 2005 as iimia Investment Trust, changing its name in 2010 (to Miton Worldwide Growth Trust) and again in January this year to provide a better reflection of the fund’s investment strategy. Nick Greenwood has been lead manager since inception, following an approach that seeks to earn returns above those available on cash by investing to exploit pricing inefficiencies among closed-ended funds. He characterises the portfolio as mainly consisting of special situations where discounts have become too wide, providing a measure of downside protection and significant upside that could be crystallised by a change in market sentiment or corporate actions.

Nick Greenwood has a cautious view of the outlook for equity markets, citing levels of debt globally, lower liquidity in markets generally and a danger of a rush for the exits in the event of further, more significant corrections.

Partly in response to this and as a result of the opportunities available, he has been adding exposure to companies investing in alternative areas. These include private equity, property, second-hand endowments (Alternative Asset Opportunities), two hedge funds, timber investments, marinas (Camper & Nicholsons) and champerty (Juridica). Taken together these account for over 40% of the portfolio. The manager highlights that of the 421 London-listed funds, 139 are invested in alternatives and 85% of new issues in the last three years have also been in alternatives. Greenwood sees the smaller funds in particular as providing a happy hunting ground for the diligent investor.

The valuation of assets in alternatives can in some cases be less transparent, providing opportunities for a manager to carry out in-depth research to identify potential upside from stated values. An example here would be the longstanding MIGO investment in Taliesin where the company’s extensive portfolio of Berlin residential apartment blocks is valued as rental properties, well below either replacement cost or their potential value as leasehold properties. Greenwood also has a positive view on the prospects for the property market in Berlin, where prices have been rising from a very depressed level and still stand significantly below Munich, for example. Given that Taliesin has the necessary permissions to sell apartments separately, it is well-placed to realise the upside between rental and leasehold valuation over a number of years.

Reflecting the uncertain background Greenwood currently has limited exposure to macro themes, with the exception of Japan, and even here scepticism towards Abenomics and a view that operational gearing in Japanese companies could be a negative factor in a less favourable economic environment has meant that these have been viewed as a source of funds for other investments.

Nick Greenwood has been managing portfolios of closed-ended funds for 20 years and in that time has refined an approach to identifying value that is a continuous process of idea generation, fundamental research, portfolio construction and implementation.

Ideas may be drawn from macro or thematic research and the recognition of unloved asset classes and individual funds. The manager undertakes an intensive programme of company meetings, employs a proprietary database to screen for anomalies and looks for potential corporate actions (such as tender offers, realisations or a change in manager). Once a candidate investment is identified fundamental research is undertaken, enabling an assessment of fair value and, where appropriate, a holding is built over time allowing greater confidence in the investment case to be established. Portfolio construction takes into account the level of conviction, liquidity, diversification and a comparison between investment opportunities. Positions may be trimmed or sold where discounts have narrowed substantially, but realisations remain the most common reason for exits in the portfolio; currently c 25% of the portfolio is in the process of liquidation.

Looking at the asset allocation shown in Exhibit 3, the main changes over a year at this level were the increase in equity funds held and a decrease in the level of cash. However, as noted earlier, the manager indicates that he has more recently been increasing exposure to alternatives including property and private equity, which together account for c 32% of the portfolio, with other funds investing in alternatives taking the exposure to over 40%.

Within these broad categories there is a wide range of individual investment cases. Two in the private equity area are examples of this: Pantheon and Dunedin Enterprise. In the case of Pantheon, Greenwood sees the relatively mature fund-of-fund portfolio as likely to benefit from NAV uplift on realisations. In addition, MIGO’s exposure is through the redeemable share class, which is illiquid and trades at a wide discount that could be compressed in the event of a merger of share classes. Dunedin Enterprise has traded at a very wide discount, which Greenwood saw as too wide, given the potential for realisation of one or more of the leading investments. Recently, Dunedin has announced the sale of its largest investment, CitySprint, and that the board will seek approval for a managed wind-down of the company.

Among relatively recent changes have been the (re)purchase of a holding in Dunedin Enterprise, the addition of Boussard & Gavaudan (hedge fund) on a 20% discount and increases in the holdings of Taliesin and Phoenix Spree (also a Berlin residential property play).

Geographically (see Exhibit 1), MIGO’s differentiation from equity benchmarks is clear, with the largest exposures being to Europe, UK and Japan with North America standing at 7%.

As Exhibits 4 and 5 show, MIGO has delivered positive absolute returns over three, five and 10 years, which put its NAV total returns ahead of the cash return benchmark (Libor +2%) over three years, but behind over one, five and 10 years.

We have included NAV performance relative to equity indices in Exhibit 5 but these figures should be viewed in the context of the relative stability of returns over the same periods. This is illustrated by the markedly lower volatility of returns (as measured by standard deviation) compared with both the MSCI World and FTSE All-Share indices (Exhibit 4).

Our peer group comparison (page 8) shows that MIGO’s NAV total returns outperformed the overall group shown over three years and were modestly behind over one and five years.

At the time of writing (7 March 2016), MIGO shares trade at a discount of 10.9% to cum-income NAV, modestly above the five-year average of 9.8%. As Exhibit 7, shows the discount has been within a 6% and 13% band over the last three years, suggesting the market has on average tended to apply a habitual discount of around 10% to NAV. This discount may now be misplaced given that the historical selling pressure from funds managed by subsidiaries of Miton Group predecessor companies is no longer a factor. The prospect of a three-yearly opportunity to opt for a realisation share class in place of all or part of a holding may tend to limit the discount.

The changes allowing for the realisation opportunity were approved at the AGM in September 2015 and replaced a continuation vote that took place every three years. The first chance to exercise this option will be in 2018 at the time of the AGM. The arrangement means investors have a clear prospect of an opportunity to exit at NAV, but the manager is not forced to compromise his investment approach to provide liquidity more immediately for a tender or buyback. If the take-up of the realisation class means that MIGO’s net assets fall below £30m, the company would move to realise all its assets on a timely basis and return proceeds to shareholders.

We calculate a c 28% underlying discount for MIGO using the weighted average discount to NAV of the portfolio constituents (reported at the end of October last year), together with MIGO’s own discount. Potential crystallisation of the value identified in the holdings in the next two or three years, together with the approach of the realisation opportunity, could drive a significant narrowing of the combined discounts.

MIGO has one class of shares with 25.3m ordinary shares in issue. The company may buy back up to 14.99% and issue up to 5% of the issued share capital. Gearing of up to 20% of NAV may be used and, as at the end of December 2015, stood at 6.7%. The manager notes that gearing tends to rise following market corrections as he takes opportunities to add attractively valued holdings, but the borrowing is not seen as structural in nature.

Among the changes associated with the adoption of the realisation class option was the removal of a performance fee on the ordinary shares, but an increase in the management charge from 0.5% to 0.65%. If issued, the realisation class would incur a fee of 0.5% and a performance fee of 15% of cash raised subject to a hurdle of Libor +5pp from the date of the relevant AGM.

The company has not paid dividends since launch, as this allows the manager flexibility in pursuing the trust’s objective by investing where there are valuation opportunities without taking into account an income objective. Many holdings do not pay dividends, reflecting the emphasis on special situations in the portfolio. The revenue return for FY15 showed a small surplus (of 0.41p), while there was a small deficit in the first half of FY16 (0.75p).

MIGO lacks direct comparators given its profile, fund-of-fund approach and absolute return objective, but in Exhibit 8 we have set it in the context of its AIC peer group, the newly formed Flexible Investment sector and included two, arguably closer peers: British Empire and World Trust Fund. Previously we identified Cayenne Trust as the closest peer, but this company announced last year that it would wind up following the departure of one of its managers and the prospective retirement of the other. Compared with the Flexible Investment sector average NAV total returns, MIGO lagged slightly over one and five years, but outperformed over three years. MIGO’s performance is above the overall average for three years. Otherwise, the table shows that MIGO is among the smaller companies in the sector and has higher gearing compared with the sector average and its closer peers.

The MIGO board has four members, all of whom are non-executive and independent. Chairman Anthony Townsend, James Fox and Michael Phillips all joined the board at the trust’s inception in 2004. Hugh van Cutsem was appointed in 2010. Michael Phillips founded iimia Investment Group which eventually became Miton Group, leaving the company in 2008. All directors have significant experience in the investment company sector.