Finsbury Growth & Income Trust — Adding to positive performance track record

As shown in Exhibit 2 (LHS), both UK and global equities have generated particularly strong returns over the last couple of years. This is due to both robust corporate earnings growth and an upward revaluation of equities. Illustrated in the table below, on a forward earnings multiple basis, UK equities are trading towards the high end of their 10-year range and more than 10% higher than the average of the last decade.

In 2017, stock market volatility, as measured by the US VIX index, was particularly low at around half the long-term average. Volatility has increased in 2018 year to date, returning to more normal historical levels. This current investment backdrop of above-average equity valuations and higher levels of volatility may favour managers with a high-conviction, stock-specific approach, that have a proven ability to outperform the market.

FGT was launched in January 1926 and since 2000 has been managed by Nick Train, a founding partner of specialist investment company Lindsell Train Investment Management. He has more than 35 years of investment experience. The manager aims to generate long-term growth in capital and income from a concentrated portfolio of primarily UK equities, although up to 20% (at the time of investment) may be invested in companies listed overseas. At end-March 2018, UK exposure was c 80%, with the remaining exposure spread between the US, the Netherlands and France.

FGT generally has 25 to 30 holdings with a minimum position size of 1%, unless they are in the process of being built or disposed of. Typically, 50-100% of the portfolio 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-March 2018 it was 2.0%. The manager believes that a modest level of gearing should add value over the long term. Up to 10% of the portfolio may be held in cash, although Train prefers to remain fully invested.

While the manager adopts an unconstrained investment approach, FGT is benchmarked against the FTSE All-Share index for comparison purposes. The trust has a very strong performance track record, outperforming the benchmark over the last one, three, five and 10 years. Due to capital appreciation and regular investor inflows, the size of the trust has grown rapidly in recent years and assets under management are now c £1.3bn. Train regularly invests his own money in FGT, ensuring that all shareholders’ interests are aligned.

Train discussed the increase in stock market volatility so far in 2018, saying that there are several companies he has been following for a long time and considered buying, which have fallen by 10-20% over the last year. While he considers these moves important, he notes there are key holdings in the portfolio that have also fallen by a similar amount, such as Unilever and Diageo, so Train suggests that he may well add to these positions rather than initiate a new holding. Given the very long holding period of FGT’s investments, the manager says that the entry point arguably should not matter. However, given his value bias, he still prefers to initiate a position in a company that is distinctly out of favour, or where its share price has been weak for a prolonged period, such as when he purchased Rémy Cointreau in 2015.

The manager says that the volume of global mergers and acquisitions (M&A) remains high by historical standards, which he views as supportive for stock markets. Indeed, two of FGT’s holdings have been bid for, at meaningful premiums to their pre-bid share prices: Dr Pepper Snapple Group by US coffee specialist Keurig Green Mountain; and Fidessa by Ion, a financial software group backed by US private equity firm Carlyle. Train considers both bids are a disappointment, given he will be losing two holdings that he describes as having been “magnificent investments”. However, receiving the proceeds from a takeover bid does give him the opportunity to add to other selected portfolio holdings whose share prices have pulled back, such as Burberry, Sage and Unilever.

As a long-term, optimistic investor in primarily UK companies, Train is disappointed that the UK is no longer seen globally as one of the leading stock markets. He says that anecdotally, investors are reducing their UK exposure, but given the improving performance of some of its large firms, such as the major oil companies, perhaps there will be higher future demand for UK equities.

Similar to the renowned US investor Warren Buffett, Train aims to buy great businesses that have high quality management teams, to pay less than their perceived intrinsic worth and to own shares in those companies forever. He seeks firms with the following attributes:

FGT’s portfolio is very concentrated, with c 25 holdings, and average annual turnover is less than 5% pa. Manchester United was the latest addition to the fund (2017); the previous two new holdings were Rémy Cointreau (2015) and Heineken (2011). The most recent complete sales were Kraft Heinz (2018), Thomson Reuters (2016) and Marston’s (2013). FGT tends to invest in very well-established firms – the average age of portfolio companies is c 150 years and nearly half have high family ownership. Investments are concentrated in sectors where the manager believes the companies have long-term competitive advantages, such as global branded consumer goods, owners of media/software intellectual property, and retail financial services. Examples include Diageo, which is the world’s number one spirits and dark beer producer; Heineken, the leading international beer brand; Mondelēz, the largest global chocolate company; Pearson, the world’s number one educational publisher; and Hargreaves Lansdown, the UK’s leading investment services platform.

At end-March 2018, FGT’s top 10 positions made up 73.9% of the portfolio, which was broadly in line with 73.5% a year earlier; all 10 companies were common to both periods. The largest holding in the portfolio continues to be Unilever, which the manager describes as the world’s number one emerging markets fast-moving consumer goods (FMCG) company. It has grown its dividend at an average annual rate of 8% over the last 54 years.

In terms of changes in sector exposure over the last 12 months, there have been modest increases in financials (+1.8pp) and technology (+0.8pp), with lower consumer exposure: goods (-2.1pp) and services (-0.5pp), although these two sectors continue to dominate FGT’s portfolio (nearly two-thirds combined). The structure of the portfolio in terms of geographic exposure is broadly similar compared with 12 months ago, with c 80% UK and c 20% overseas exposure.

The manager says that FGT’s total return of more than 20% in 2017 highlighted the importance within the portfolio of themes, which he expects to continue to generate shareholder value. The first theme is consumer brands that are great products. The best-performing stock in the portfolio in 2017 was Rémy Cointreau (+53%), which owns Rémy Martin, a world-leading producer of premium cognac. It has been observed that as global wealth increases, there is an increase in premium cognac consumption, meaning Rémy Cointreau is well positioned to continue to grow its revenues and earnings. Train says that there are plenty of companies in FGT’s portfolio that he believes have brands that are undervalued, including the trust’s newest holding in Manchester United, and A.G. Barr, the maker of the highly recognisable soft drink IRN-BRU, among others.

The second key portfolio theme is companies that are taking advantage of digital technology, such as online investment platform Hargreaves Lansdown, which was FGT’s largest single contributor to performance in 2017. The company continues to grow faster than its competitors, both in terms of gathering assets and increasing its number of customers. Train says that economies of scale make Hargreaves Lansdown tough to compete against and although its shares are not currently cheap, he believes the company is undervalued compared to its potential value over the next five to 10 years. The manager and his colleagues spend a lot of their time considering how companies are using digital technology to enhance their business performance. While Pearson’s shares have underperformed the UK stock market in recent years, Train says that he is pleased that he did not sell the position, as the shares have rallied meaningfully from the low point in Q317. He says that the jury is still out as to whether Pearson has been successful in responding to the technology pressures it has faced. However, recent trading statements have been more encouraging than those released a couple of years ago. The company is working hard to put its digital products and services into the hands of US educators and students. Train says that getting its US educational business right is critical in terms of increasing Pearson’s profitability and there is a huge benefit if a successful US business model can subsequently be exported around the globe.

Train is in his 18th year as manager of FGT and data issued by the company shows that over this period he has only underperformed the benchmark in three calendar years: by 4.3pp in 2016; 1.4pp in 2008; and a very modest 0.3pp in 2005. He has outperformed in all other years, including five years of double-digit outperformance: 10.7pp in 2015; 14.3pp in 2013; 11.3pp in 2012; 14.9pp in 2010; and 18.8pp in 2004. This is in spite of the trust’s heavily concentrated portfolio, which is currently invested in just four sectors. On an annualised basis, between 2001 and 2018, the trust has delivered total returns of 10.1% pa compared to 5.1% pa for the benchmark.

FGT’s enviable performance track record is shown in Exhibits 4, 5 and 6. The trust has delivered average c 15% pa NAV and share price total returns over the last decade and has outperformed the benchmark FTSE All-Share index benchmark in both NAV and share price terms over all periods shown. Its NAV has outperformed by 7.7% over the last 12 months and by an average of c 4.5%, c 6.0% and c 10.0% over the last three, five and 10 years respectively.

FGT’s shares trade closely in line with NAV. The current 0.4% share price premium to cum-income NAV compares to the range over the last 12 months of a 1.3% premium to a 0.4% discount. It is broadly in line with the average premiums of the last one, three and five years of 0.6%, 0.5% and 0.5% respectively. FGT’s board actively manages the discount/premium, purchasing shares when the discount to ex-income NAV exceeds 5% and issuing shares when there are unfulfilled buy orders in the market. There have been no shares repurchased since FY10 and there is healthy ongoing demand for shares, evidenced by regular share issuance (Exhibit 1).

FGT is a conventional investment trust with one class of share. There are currently 167.0m ordinary shares outstanding. The trust has a £75m revolving credit facility with Scotiabank Europe, with an option to increase it by a further £25m and the facility expires in October 2019. If the £75m was fully drawn down, gearing would be c 6%, which compares to 2% at end-March 2018.

The board introduced a stepped fee structure, which has been in effect since 11 October 2016. 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. The manager is not entitled to a performance fee. Historically, annual management fees were a flat 0.450% of market cap. Frostrow Capital is FGT’s Alternative Investment Fund Manager, providing company management, secretarial, administrative and marketing services. It receives an annual fee of 0.150% of the trust’s market cap up to £1bn, and 0.135% of market cap above £1bn. Previously Frostrow’s fees were fixed at £70,000 pa plus 0.15% of FGT’s market cap. In FY17, ongoing charges of 0.71% were 3bp lower than in FY16.

FGT pays dividends twice a year in May and October. The trust has a progressive dividend policy, aiming to grow annual dividends at a rate higher than UK inflation; over the last five years FGT’s total distribution has compounded at an annual rate of 7.7% pa. The FY17 annual dividend of 14.2p was 1.1x covered by revenue and was 8.4% higher than 13.1p paid in FY16. FGT’s dividend yield is lower than its peer group average, reflecting its focus on total return rather than income.

FGT is a member of the AIC UK Equity Income sector, a relatively large group of 24 funds with a variety of mandates. In Exhibit 8, we show the 12 largest trusts; FGT is the third-largest. The trust has a very strong performance record – its NAV total returns are first over one and three years (6.4pp and 17.7pp above average respectively), second over five years (34.4pp above average) and first out of 11 funds over 10 years (152.2pp above average). FGT is one of four trusts trading at a premium, its ongoing charge is average and, in common with most of the peers, no performance fee is payable. The trust has a modest level of gearing and, befitting its mandate to generate long-term growth in both capital and income, it has a below-average dividend yield.

There are six directors on FGT’s board; all are non-executive and independent of the manager. The chairman is Anthony Townsend, who rejoined the board in February 2005 and assumed his current role in January 2008. The other five directors and their dates of appointment are: David Hunt (July 2006), Neil Collins (January 2008), Simon Hayes (June 2015), and Kate Cornish-Bowden and Lorna Tilbian (both October 2017).