The Bankers Investment Trust
Steady as she goes
20 December 2021
With the spectre of inflation stalking markets, investors are looking for ways to protect and prosper from this emerging trend that has been absent for so long. Crooke believes that these inflationary pressures are not transitory, and that moderate (c 2–4%) inflation and higher interest rates will be the order of the day over the coming years.
In this scenario, companies that can pass through higher input costs, are ‘price makers’ or use their economies of scale to mitigate these pressures will have a competitive advantage. Crooke and the BNKR regional specialists have positioned the fund in higher-quality cash-generative companies that should be well placed to grow earnings and dividends in a moderately inflationary and higher interest rate environment.
BNKR is designed as a ‘one-stop shop’ for diversified global equity exposure, yet despite its very low cost (ongoing charges of 0.50% in FY20), it is far from an index tracker. The trust is overseen by Janus Henderson’s co-head of equities, with its regional portfolios managed by specialists from across the firm, each of whom brings their own expertise and style tilt under the overall umbrella of ‘growth at a reasonable price’. With long-run annualised total returns of c 10–15% and a 54-year history of dividend growth, we would argue that BNKR could represent a worthwhile long-term core holding for small and larger investors alike.
Crooke argues that global markets are in a period of transition from prolonged accommodative central bank policy to a more normalised environment. Central banks have begun easing up on support with tapering in the United States having begun in November. Norway was the first G10 central bank to raise rates to 0.25% in September, while South Korea and Brazil had already done so. In the years following the global financial crisis there has been exceptional (in historical terms) pricing and availability of money. Crooke says that ‘the speed and of scale of tapering will be the number one factor affecting asset class and equity selection going forward’.
Since the global financial crisis, the world economy has seen monetary support on an extraordinary scale. Further widespread stimulus and expenditure has been provided through much of the COVID-19 crisis. The result has been ‘boom time’ for financial and other assets such as house prices. Inflation has generally been curiously absent given the scale and duration of the stimulus, however it has recently begun to appear in parts of the real economy. UK CPI reached 4.2% in October having increased sharply by 1.1pp over the previous month. The US has seen even higher inflation with 6.2% (CPI) recorded in October. Labour, transport costs, food, raw material and energy prices have all started to increase with the question being asked whether this is the beginning of a structural and engrained environment for higher inflation or something that will abate in the coming quarters.
Crooke is not in the transitory inflation camp, believing that the unwinding of central bank stimulus will take time to wash through the system. In the meantime, shortages of labour and other supplies, insufficient transport capacity together with tentative signs of the reversal of long-term trends such as offshoring to low-cost but distant manufacturing areas should be generally supportive of rising prices. This is a global phenomenon witnessed in the United States just as in post Brexit UK.
The manager believes that long-term inflation in the 2–4% rather than 0–2% range is likely, arguing that this provides a supportive environment for equities in that well placed companies will be able pass through price rises to customers without impairing profit margins. Crooke would be concerned if inflation rose above the 5% level, but 2–4% is in line with long-term historical parameters and could provide a route for central banks to inflate away the high levels of debt within economies. Based on these assumptions, Crooke has a reasonably positive outlook and is cautiously optimistic that equities should be able to perform relatively well.
Crooke’s role is to manage the asset allocation and allocate funds to regional specialists. Crooke has worked closely with the regional specialists over many years and they all ultimately report up to him either directly or via the heads of their respective teams. He is thus extremely familiar with the sleeve portfolio managers, their investment approaches and the resultant portfolios.
BNKR has a dual mandate of capital growth and income, so Crooke does influence the construction of the portfolio sleeves, often with the provision of income in mind. There will also be an element of ensuring that top-down ideas are suitably represented within the portfolio. This can only be achieved through allocation to the regional sleeves as there is no use of thematic/sector funds within portfolio construction, as these could lead to unintended biases within the portfolio. Crooke aims for a collegiate decision-making environment through regular and frequent dialogue with the portfolio managers. Ultimately, he aims to ‘foster debate with a view to arrive at consensual agreement and to add value to their thought process’ on positioning within and across the respective regional sleeves. Each sleeve typically holds 25–30 stocks, which Crooke feels is enough latitude for the managers to find interesting ideas that can have a meaningful impact on returns.
Incremental but deliberate change in terms of asset allocation is something that investors have become accustomed to with BNKR. The benchmark changed from a UK/global hybrid to a broad developed markets index in October 2017, and Crooke is mindful of this yardstick but is not beholden to it. For example, North America is c 60% of the benchmark and while the US element of BNKR has increased it is currently only 34.4% of the portfolio. Crooke says he would be hesitant about any one region accounting for more than 40% of the fund (Exhibit 1).
BNKR has a 54-year history of year-on-year dividend growth. In normal market conditions the board and manager aim to cover distributions with revenue, although reserves were utilised given the exceptional circumstances for FY20. In FY20, the UK provided 36% of trust income, while the US sleeve contributed only 11%. Thus, while income is more generally available from a range of regions these days (the second and third largest income generators in the portfolio are Europe with 18% and Asia with 15%), there are consequences to any aggressive shift in the geographic asset allocation. Crooke sets an income target for each sleeve, which in the case of the United States may be lower which gives the regional manager latitude to run a lower yield portfolio allowing them to own some zero yielding stocks such as Alphabet and Amazon which have delivered strong capital growth.
Cyclicals have been increasing within the portfolio (Exhibit 2) as the portfolio managers take advantage of value opportunities. Crooke feels that the pendulum of market opinion is swinging back to cyclicals, citing that over 50% of IPOs this year are now trading below issue price. For him it is a question of finding cyclical, attractively priced growth as opposed to growth at any price, and this growth at a reasonable price (GARP) style is prevalent in many of the regional sleeves.
Cyclical stocks are typically affected by the ebb and flow of the economic cycle. This broad category of companies encompasses basic materials, consumer cyclicals, financial services and real estate and now represents around 43.5% of the portfolio from 40.4% five years ago. This compares to the index with 33.9%.
Real estate and basic materials contribute the smallest element of this bucket at around 8.3% of the fund, while the diverse consumer cyclical group of companies has trended down from 19.1% five years ago to 11.5% now, which is broadly in line with the index and peers. Holdings here vary from the largest position in US home improvements company Home Depot to internet retailer Amazon and Japanese car manufacturer Toyota. There are also smaller weightings to luxury goods retailers Burberry and Hermès and Whitbread at the other end of the expenditure spectrum.
The largest and an incrementally increasing element of the cyclicals allocation is financials (Exhibit 3). This group of companies includes asset managers, banks, credit and payment facilitators, financial data, stock exchanges and insurers. There has been an increase in the allocation to financials over the past five years from 17.3% to 23.7% now, which is considerably higher than the benchmark weighting of 15.5%.
There are material longstanding positions in the transactional/payment companies such as Visa and Mastercard, although through profit taking these have been trimmed. There are also holdings in stock exchanges such as CME Group and Intercontinental Exchange as well as Insurers like Munich Re and Swiss Re. In an environment with some modest (c 2–4%) inflation, Crooke likes insurers who are able to apply higher discount rates to long-term liabilities, and within insurers he has highlighted the European options as attractive and cheaper than similar companies trading in other geographic regions. Exposure to asset managers has also been increasing and is overweight versus the index. Here there are holdings such as the French asset manager Amundi and UK listed private equity specialist Intermediate Capital.
Apart from insurers, higher inflation and the associated increase in interest rates (and an upward sloping yield curve) are also supportive of bank margins. There are holdings in a number of regional banks, such as Lloyds, Austrian retail bank Bawag and Italy’s UniCredit, whose weightings have increased over time and are likely to continue to rise. Crooke wants to increase exposure to interest rate sensitive financials but feels there is time to build up exposure. He also feels that there is better value on offer in Europe where book values on a broad range of European banks are below one compared to the United States where they stand on 1.3x P/B.
Crooke and the sleeve managers have been taking profits from areas that have seen strong performance and where valuations are fairly fully priced, for example the technology weighting (Exhibit 4) has dipped a little recently to 15.5% and now stands below the level seen in the benchmark weighting of 22.1%. Holdings such as Microsoft, Apple and Adobe have all been trimmed over the past 12 months (to September 2021).
Another area that has seen a decline in the trust’s weighting over time is energy (Exhibit 5), which now sits at around 1%, well below the index weighting of 3.4%. Crooke acknowledges that energy is ‘difficult’, with the quoted sector struggling to reinvest cash flows into high returning areas as they transition to renewables.
In the following pages we lift the bonnet on three of the regional sleeves and discuss how Crooke uses the internal resource to deliver shareholder returns.
Taking a mildly contrarian stance, Crooke likes Europe because it is ‘perceived as low growth, which isn’t the reality at the corporate level’. For example, Hermès and Novo Nordisk’s earnings are little related to their French and Danish domiciles. There is a huge array of world leading companies domiciled in the region on attractive valuations. Performance of the wider European market has of late been held back by weakness in software, gaming and consumer stocks. The allocation to European equities in BNKR is 20% as at the end of October 2021, up from 14.6% five years ago. The current weighting is higher than the benchmark’s13.9%.
As with all of the regional sleeves, this part of the portfolio is managed by a Janus Henderson fund manager, Jamie Ross. Ross took over from long-time incumbent Tim Stevenson in July 2018, and also manages Henderson EuroTrust and the Janus Henderson Horizon Pan European equity fund.
The portfolio has a focus on companies with high free cash flow generation, capital efficiency and superior capital management strategies. This sleeve is managed in a GARP strategy, blending the higher growth but more expensively rated stocks such as Dutch chip maker ASML with the cheaper, higher-yielding names such as reinsurer Swiss Re. In aggregate the management believes that the portfolio has higher-quality characteristics for a slight discount in valuation measures than the wider market. While there is significant commonality between Henderson EuroTrust and this sleeve, there is more balanced stylistic approach to the European sleeve, with less invested in higher-growth names, more in large cap and a more valuation-aware approach than is employed within his unconstrained portfolio. This is not a surprise given the core nature of BNKR and the nod to income generation throughout the various regional sleeves. As of the end of October 2020, the European sleeve delivered 18% of the trust’s income (FY19: 16%).
Ross manages this portfolio purely from a bottom-up basis and so the country weightings are a direct result of where he is finding opportunities. There are key positions in Faurecia, a French auto parts company, Swiss food and drink conglomerate Nestlé and Netherlands-listed health, nutrition and bioscience firm DSM. This sleeve has a geographic bias to the more internationally focused northern European countries such France, Switzerland and the Netherlands, with around 65% invested in these areas. There is less in southern Europe where companies can often be more domestically focused.
The cyclical bias in the sleeve has also been built from the bottom up, and is now a significant overweight versus the regional index or peers. This is a trend that has been increasing over the past five years. Financials make up around half of the current allocation, with material positions in a range of asset managers, banks and insurers. Austrian retail bank Bawag Group is the largest single European holding, with German reinsurer Munich Re next biggest. While financials is the largest element of the cyclical bucket, the diverse consumer cyclicals group of companies has been increasing over time, with packaging provider SIG Combibloc and luxury consumer fashion brands Hermès and Moncler being material positions within this area. There are significant underweights in energy and industrials.
Performance of the European sleeve has been good over the past five years compared with the regional index, returning 82.4% versus 62.8%. Although Ross was only appointed to this sleeve in July 2018, the trend of outperformance has continued. Both sector and stock selection over the past five years has been good, with stock selection in the financials sector (particularly Swiss private equity firm Partners Group) a notable driver of positive performance. However, the region has not been without challenges, with European exporters being viewed as especially sensitive to any perceived slowdown in Asian growth.
Crooke likes Japan because it is ‘all about the stocks’ despite a relatively low growth economy. In aggregate the market is attractively priced on a one-year forward P/E of 15.1x versus global stocks on 17.6x. Japan is home to some good-quality companies that are well managed, lowly indebted and have good returns on capital. As an example, he cites Toyota as well placed to capture the secular growth and resultant earnings driven by the transition from fossil fuels to electric vehicles, while standing on a lowly valuation of c 9.8x 2022 earnings, compared to Tesla’s forward P/E of c 159.2x. The allocation to Japan has gradually increased over the last five years to 11.9% as at October 2021, which is significantly higher than both peers and the benchmark. Crooke has also been using gearing to build up the Japanese exposure.
The sleeve has been managed by Junichi Inoue since he joined Janus Henderson July 2016. Inoue has also been the named manager on the Janus Henderson Japan Opportunities and Janus Henderson Horizon Japan Opportunities funds since April 2019. The portfolio focuses on growing companies generating excess free cash flow and with high-quality management. Compared with the regional index and peers, the portfolio is slightly larger in average market cap, marginally more fully valued but also with better quality and growth prospects. The Japanese sleeve has a very significant overlap (81% commonality) with the other portfolio that Inoue manages.
Cyclical companies account for around 30% of the BNKR Japan sleeve and defensives 20%. The remainder of the portfolio is invested in sensitives, sectors deemed neither defensive or cyclical such as communication services, industrials and technology. As with all of the sleeves, the sector positioning is a result of the stock opportunities, but the Japanese sleeve is significantly more represented in technology via names such as conglomerate Sony and automation sensors and optics specialist Keyence. Tech exposure has always been quite high within this sleeve and is above that of competitors and the index. The weighting has increased moderately over the last five years.
An honourable mention goes to consumer cyclicals, which now account for 16% of the sleeve through investments such as Toyota, internet search engine Z Holdings and home furnishings company Nitori Holdings. There is also an overweight position in consumer defensives via names such as brewing and food business Asahi Group. The portfolio is zero weighted in the real estate, utilities and energy sectors. Japan represents a dividend growth story rather than an initial high headline yield, but this sleeve still contributed c 12% of the overall BNKR portfolio income in FY20 (FY19: 10%).
Performance of this sleeve has been good over the past five years to the end of October 2021 with a total return of 48.5% versus 34.3% for the regional index. Returns have been driven by both sector and stock positioning, with the technology overweight proving particularly helpful. Allocation to healthcare and the stock selection therein was the biggest driver of overall returns, with pharma company Daiichi Sankyo being especially strong.
Crooke appreciates the Asian region for its ‘growth characteristics and attractive dividends’, often coming as a result of the family-owned corporate culture in the region. A valuation aware approach can often be successful here and the current allocation to both developed and developing Asia (ex Japan) is 14.8%, which has increased from 12.1% over the past five years.
This part of the portfolio has been managed by Janus Henderson fund manager Mike Kerley since July 2007. Kerley also manages Asian income strategies via the Janus Henderson Asian Dividend and Horizon Dividend strategy and the Henderson Far East Income (HFEL) investment trust. The BNKR Pacific ex-Japan sleeve shares similarities with these other strategies in terms of style of investment approach, although it has less of an emphasis on income. Kerley has a consistent focus on investing in companies that can generate strong cash flow, sustainable and increasing dividends and a willingness to return excess cash to shareholders. This sleeve stands at a discernible discount to the Asia-Pacific ex Japan market on valuation metrics. This focus on value and dividends held performance back through 2020. Asian yield has been deeply out of favour and Kerley notes that it has rarely been as cheap compared with other regions and to its own history. While there is exposure to structural growth trends through the building blocks of the internet (chipmakers Taiwan Semiconductor Manufacturing (TSMC) and Samsung Electronics) there have not been positions in the pure internet plays of Tencent and Alibaba.
The portfolio is constructed from the bottom up but in terms of country and sector positioning it is far less exposed to Australia than the index, with Macquarie Group being the main position. Kerley views Macquarie as a play on renewables and green infrastructure investment rather than as a conventional bank. There is also more in South Korea via Samsung, Taiwan (TSMC) and Hong Kong via Citic Securities. A position in VinaCapital Vietnam Opportunity Fund is a rare example of the use of a third-party managed investment vehicle within a niche and specialist market.
From a sector perspective the sleeve is heavily exposed to financial services and technology, which together make up some 60% of this sleeve versus 52% for the regional index. There are holdings in Hong Kong listed life insurer AIA Group and Korean retail bank KB Financial Services, while in technology the above-mentioned chipmakers are augmented by Taiwan listed Quanta Computer.
All of the holdings within the BNKR Pacific ex-Japan sleeve are also held in HFEL, although the trust has a longer stock list and a greater focus on high-yielding names. The BNKR Asia portfolio is marginally less exposed to deeper valuation factors. It largely excludes China (there is a separate China A share sleeve), which accounts for 11.8% of HFEL, although Kerley can buy Hong Kong-listed and A shares in this sleeve such as ANTA Sports and Hengan International. The region is an important contributor to the overall income within the portfolio with some 15.5% of BNKR’s income for FY20 derived from the region (FY19: 16.5%).
The Asia portfolio has performed well over the last five years with a cumulative total return of 68.0% to the end of October 2021 versus the regional index return of 49.4%. Sector positioning in aggregate (especially the overweight telecommunications position) detracted from performance, but this was more than compensated by strong stock selection, particularly in the energy and technology sectors, with Star Petroleum Refining and TSMC being the most significant contributors to performance over this period. Despite a tougher 2020 and 2021 there are reasons to be optimistic for this element of the overall portfolio. The IMF expects Asian ex-Japan growth to be among the highest in the world in 2022. This tailwind also supports the region’s consensus earnings growth forecast in 2022, which is higher than other economic regions. This all feeds through to very high dividend growth compared with global peers, which could be a catalyst for a re-rating of the BNKR Asia portfolio and stronger relative performance.
Crooke believes that the direction and magnitude of corporate earnings and inflation will be the primary drivers for markets through 2022 and beyond. COVID-19 will continue to cast a shadow over society and economic activity. However, if the world is able to manage and effectively live more normally with the various mutations then this could unlock a wave of economic activity through pent up consumer demand, with positive effects on corporate earnings.
Inflationary concerns will be front and centre for central bankers whose actions will shape the speed and scale of any recovery. Their actions will also greatly influence which sectors lead the recovery. Crooke thinks that the recently seen price rises are structural rather than transitory and that central bank responses will be behind the curve, favouring growth over stabilising prices. The manager feels that this environment is supportive for equities, and as we have seen from the activity in the BNKR portfolio, he has been increasing the fund’s weighting to those areas (such as financials and high-quality consumer cyclicals) that can thrive in a world of rising interest rates and inflation.