Finsbury Growth & Income Trust — A further step-up in performance

As shown in Exhibit 2, left-hand side, the performance of UK shares has lagged that of the global market, partly due to sterling weakness following the UK’s European referendum in June 2016. Global markets have returned to more normal levels of volatility, following a particularly benign period in 2017, due to a series of macro developments. During 2018, there were concerns about the pace and magnitude of US interest rate increases, which by Q418 had developed into worries about slowing economic growth, in part because of the trade dispute between the US and China. Shares rallied strongly in Q119 as there was greater confidence in the prospect of a trade settlement and the US Federal Reserve adopted a more dovish monetary policy stance; however, this was followed by a pullback in May 2019 on wider tensions between the US and its trading partners. The UK market has not been immune to these issues, and has also suffered significant outflows from international investors due to the lack of a Brexit resolution. As a result, UK shares are looking relatively attractively valued. Looking at the Datastream UK index, the current 12.3x average forward P/E multiple is a c 15% discount to the world market. This valuation is a 2% discount to the 10-year average; conversely, global equities are trading at a 7% premium. UK equities also offer an attractive 4.1% dividend yield, meaningfully higher than the 2.6% yield on the world market. For those investors who are seeking UK equity exposure and have a longer-term perspective, these valuation differentials may provide an attractive entry point.

FGT was launched in January 1926, and is listed on the Main Market of the London Stock Exchange. Since 2001, the trust has been managed by Nick Train (a founding partner of Lindsell Train Investment Management), who has more than 35 years’ investment experience. He aims to generate long-term growth in capital and income from a concentrated portfolio of typically c 25–30 primarily UK equities, although up to 20% (at the time of investment) may be invested in companies listed overseas. Ordinarily, 50–100% of the fund will be invested in FTSE 100 companies, and comparable companies listed on overseas stock exchanges, and at least 70% will be invested in FTSE 350 companies or their overseas equivalents. Gearing of up to 25% of NAV is permitted; at end-May 2019 it was 1.2%. Up to 10% of the portfolio may be held in cash, although Train prefers to remain fully invested. Performance is measured against the FTSE All-Share Index, although given the manager’s unconstrained and highly concentrated approach, the trust’s portfolio composition is very different from that of the benchmark. FGT has a very strong track record, with NAV and share price total returns significantly ahead of the benchmark and peers over the last one, three, five and 10 years. The trust has grown rapidly due to capital appreciation and ongoing inflows, and Train regularly invests his own money in the fund, illustrating the importance to the manager of having ‘skin in the game’.

FGT’s performance has been particularly strong in recent months, building on the trust’s long-term positive results. Speaking at a recent conference, Train said he feels ‘bewildered’ about the quantum and consistency of FGT’s returns, suggesting that it is unlikely they will continue on the same trajectory. However, he has delivered the same message at the last several FGT AGMs, and so far is yet to be proved right.

The manager says there are three aspects that create the potential for ‘different’ performance:

Train stresses the importance of investing for the long term, hoping that FGT holdings turn into ‘100 baggers’ (shares that appreciate by 100 times), or 50 baggers or 10 baggers. He suggests that this outlook once seemed over-optimistic, but he now has increased confidence in the potential for these significant returns having read Christopher Mayer’s book 100 Baggers: Stocks that Return 100-to-1 and How to Find Them. The manager says that it is an ‘exhilarating book’, illustrating how relatively common it is for substantial US companies, ‘not speculative tiddlers’, to experience share price rises of up to 100-fold. Many of the companies identified could have been (or are) Lindsell Train investments, as they operate in the three areas that the manager favours, including Unilever (branded goods), Walt Disney (media) or Charles Schwab (stock broker).

The manager has analysed the share price performance of FGT’s holdings over the last 30 years. All of the companies are multiple baggers: 100x – Manchester United and Sage; 20–30x – AG Barr, Diageo, Heineken, Rathbones and Schroders; 10–20x – Burberry, DMGT, Euromoney, Hargreaves Lansdown, LSE, Unilever and Youngs; and 3–10x – Celtic, Fullers, Mondelēz International, Pearson, RELX and Rémy Cointreau. Train says that with patience, investors can generate considerable returns; he hopes to be running FGT for many more years and is confident that the number of the trust’s high-multiple baggers will rise.

Recent updates from portfolio companies are encouraging; the manager says that most of the fund’s underlying businesses are ‘doing very nicely thank you’, and he sees plenty of growth opportunities. Train says that it is implausible to describe Diageo as a young or tiny company; however, in 2018, its annual revenues were just 2% of global alcoholic beverage sales, and the firm is benefiting from the industry trend of lower volumes, but higher-quality alcohol consumption. Over the years, Unilever’s business has pivoted towards the beauty and personal care division. The company’s new CEO Alan Jope joined the firm 33 years ago when the personal care business was just 8% of total sales; this higher-growth division, which has above-average profitability, is now 40% of sales, and Jope comments that Unilever’s ‘deodorants will quadruple once we crack Asia’. Turning to stock market proxies, Train highlights a McKinsey report that says there is $88.5tn of assets under management globally, growing at double-digits per year, which suggests there is plenty of available capital for both passive and active fund managers. He says Schroders has just 0.5% of the global asset pool, and has good growth opportunities given its Asian distribution platform. Its stock price has appreciated by more than 20x since 1990, over which period the FTSE All-Share Index has not even quadrupled.

The manager highlights FGT’s position in Irn-Bru maker AG Barr, suggesting its recent annual results were perfectly satisfactory, with sales up just under 6% year-on-year (above-market growth), along with robust levels of free cash flow. He comments that AG Barr’s annual dividend rose by 7%, ‘following on from a proud history’. Train says that this company was one of the first ‘wonderful investments’ he bought when he took over running FGT in 2001. That year the beverage company’s average share price was 77p; it is now trading at c 950p per share, which the manager deems an ‘exceptionally pleasing return’. He suggests that there is no reason why the shares should not continue to deliver good returns for patient investors. Train says that AG Barr is an archetypal investment for FGT that can be owned for ‘years and years’.

Train aims to buy great businesses with long-term growth potential, run by high-quality management teams, and which are trading at a discount to their intrinsic value; he then aims to own these shares ‘forever’. The manager seeks companies with the following attributes:

The three broad themes within the portfolio are global consumer brands, owners of media/software intellectual property, and capital market proxies. FGT is invested in just four of the 10 industry sectors (consumer goods, financials, consumer services and technology), and has no exposure to the other six, which together make up more than 45% of the index. In spite of its broadly large-cap focus, the trust’s portfolio has an active share above 90% (a measure of how a portfolio differs from its benchmark, with 0% representing full index replication, and 100% no commonality). Another of FGT’s key features is its low portfolio turnover, averaging less than 5% pa (just 2.5% in 2018). The manager tends to invest in very well-established businesses; the average age of portfolio companies is 152 years, and 11 out of the 20 holdings are family owned.

Train explains that if he were to start running the fund with a blank page, likely position sizes would be 6–7% in major liquid companies, 3–4% in less liquid firms, and 1–2% in smaller, exceptional businesses. He says that FGT’s current portfolio weightings are a function of its winning positions getting bigger, and it can take time to build up holdings in less liquid companies. The manager is keen to stress that he allows successful positions to run, rather than trimming them.

The consistency of FGT’s portfolio is illustrated in Exhibit 1; at the end of May 2019, the top 10 holdings were the same as a year before. However, it is interesting to note that the fund has become more concentrated, with the top 10 representing 81.7% of the total, compared with 74.6% at the end of May 2018. The trust has 20 primarily UK-listed holdings, with overseas positions in US-listed Mondelēz International and Manchester United, Netherlands-listed Heineken, and France-listed Rémy Cointreau. Over the last year, there has been very little change in FGT’s sector exposure (Exhibit 3), with higher weights in consumer goods (+1.7pp) and financials (+1.2pp) at the expense of technology (-2.3pp) and consumer services (-0.6pp). Around half of the portfolio is made up of consumer goods stocks, such as the two of the three largest positions Diageo and Unilever, which together are c 20% of the fund. In recent months the residual position in US soft drink company Dr Pepper Snapple was sold (the company is now a division of Keurig Dr Pepper). The other two disposals in 2018 were Fidessa (as a result of a takeover) and Kraft Heinz (a legacy position resulting from Kraft’s 2010 takeover of Cadbury). There have been no recent additions to the fund; the last new holding was Manchester United two years ago in 2017, following on from Rémy Cointreau in 2015 and Heineken in 2011.

In H119 (ending 31 March), FGT’s NAV and share price total returns of +2.9% and +2.4%, respectively, were ahead of the benchmark’s -1.8% total return. Positive contributors included Diageo, Mondelēz International and Sage Group, while the main detractors were Hargreaves Lansdown, Schroders and Manchester United.

FGT has generated very strong absolute and relative total returns over the long term. Over the last 10 years, in absolute terms, its NAV and share price total returns are +18.6% and +18.8% pa. The trust’s relative returns are shown in Exhibit 6. It has outperformed the benchmark over all periods shown, particularly over the last one, five and 10 years, helped by a very strong period of relative performance over the last three months, which is graphically illustrated in Exhibit 7. FGT has also outperformed the MSCI World Index over all periods shown, despite the outperformance of the dominant US market in recent years.

FGT’s shares tend to trade closely in line with NAV. The current 0.5% share price premium to cum-income NAV compares to the range of a 1.3% premium to a 0.5% discount over the last 12 months. Over the last one, three and five years, the trust has traded at average premiums of 0.6%, 0.5% and 0.5%, respectively. Since 2004, the board has actively managed the discount/premium, purchasing shares when the discount exceeds 5% (no shares have been bought back since FY10) and issuing shares at a small premium when there are unfulfilled buy orders in the market. There is healthy ongoing demand for shares, evidenced by regular share issuance (Exhibit 1); during H119, 14.4m shares (8.3% of the end-FY18 share base) were issued, raising proceeds of £112.8m.

FGT is a conventional investment trust with one class of share. There are currently 195.5m ordinary shares outstanding. The trust has a £75m multicurrency revolving credit facility with Scotiabank Europe, with an option to increase it by a further £25m (at a rate of Libor +1.05% pa); the facility expires in October 2019 and is expected to be renewed. Net gearing at end-May 2019 was a modest 1.2%. Train is not keen on taking on too much debt given the highly concentrated nature of FGT’s portfolio, and says that the trust’s attractive returns have been achieved without employing a lot of leverage.

Manager Lindsell Train is paid an annual management fee of 0.450% of FGT’s market cap up to £1bn and 0.405% of market cap above £1bn; no performance fee is payable. Frostrow Capital, the trust’s Alternative Investment Fund Manager, provides company management, secretarial, administrative and marketing services, and receives an annual fee of 0.150% of the trust’s market cap up to £1bn, and 0.135% of market cap above £1bn. In FY18, ongoing charges of 0.67% were 4bp lower than in FY17, and in H119 they were 0.70% (in line with H118).

FGT pays semi-annual dividends in May and October. It has a progressive distribution policy, aiming to grow the annual dividend at a rate higher than UK inflation. The 15.3p per share paid in respect of FY18 was +7.7% year-on-year (1.1x covered); this increase is broadly in line with the 7.8% five-year compound annual growth rate. For FY19, the first interim dividend of 8.0p per share is +11.1% year-on-year; this higher increase has been made to reduce the disparity between the first and second interim dividends. FGT focuses on total return rather than income, but currently offers a 1.8% dividend yield.

In Exhibit 9, we show the 13 largest trusts in the AIC UK Equity Income sector (25 funds), with market caps above £300m. FGT has a very distinguished performance record; its NAV ranks first over all periods shown, and is 14.1pp above the mean over the last 12 months, +31.7pp over three years, +54.1pp over five years and +234.6pp over 10 years. The trust is one of three that are currently trading at a premium. Its ongoing charge is modestly higher than the average, but no performance fee is payable. FGT has a below-average level of gearing and dividend yield, although the low yield is unsurprising given its focus on total return rather than income.

There are six directors on FGT’s board; all are non-executive. Anthony Townsend re-joined the board on 1 February 2005 and assumed the role of chairman on 30 January 2008. The other five directors are: David Hunt (appointed on 6 July 2006), Neil Collins (appointed on 30 January 2008), Simon Hayes (appointed on 29 June 2015), and Kate Cornish-Bowden and Lorna Tilbian (both appointed on 26 October 2017).