Witan Investment Trust — Global equity exposure via specialist managers

Exhibit 2 (LHS) shows the performance of global and UK equities in sterling terms over the past 10 years. UK shares kept pace with global stocks for more than half of the decade, but since late-2014, overseas equities have performed considerably better, led by the US, which makes up more than 60% of the MSCI World index. Global stock markets have experienced increased volatility in 2018, as investors have focused on a series of macro issues including rising US interest rates, the US/China trade dispute and Brexit uncertainties, which has bought equity P/E valuation multiples back down to a level more in line with longer-term historical averages. Corporate earnings generally remain robust across a variety of sectors, so unless there is a significant slowdown in economic activity, more attractive valuations could provide an opportunity for equity investors, particularly those with a long-term, patient approach to stock selection.

Launched in 1909, WTAN is one of the oldest investment trusts; it has been listed on the London Stock Exchange since 1924. It is also one of the largest, with more than £2bn in assets under management. The trust has employed a multi-manager strategy since 2004, aiming to maximise returns while reducing performance volatility that may arise from a single manager. At that time, WTAN also became self-managed and appointed its first CEO. The trust seeks to generate long-term growth in capital and income, and to grow the annual dividend at a rate higher than UK CPI (the trust’s yearly distribution has increased in each of the past 43 consecutive years). WTAN typically employs around 10 specialist external managers, which are selected for their unconstrained, high-conviction approaches, and up to 12.5% of the portfolio may be invested directly by the trust’s executive team – up to 10.0% in specialist funds and up to 2.5% in niche or newly established managers. Gearing of up to 20% of net assets is permitted, typically in a range of 5–15% (although a cash position may be held when considered appropriate); at end-October 2018, net gearing was 11%. Derivatives may be used, such as exchange-traded futures, to quickly adjust exposure to a particular region without interfering with the strategies of the external managers. Over time, WTAN’s benchmark has evolved to reflect where the board and executive team believe the best opportunities lie for a global investor. The benchmark is a composite of indices: 1 September 2004 to 30 September 2007 – 50% FTSE All-Share and 50% FTSE World (ex-UK); 1 October 2007 to 31 December 2016 – 40% FTSE All Share and 20% in each of FTSE All-World North America, FTSE All-World Asia Pacific and FTSE All-World Europe (ex-UK); and since 1 January 2017 – 30% FTSE All-Share, 25% FTSE All-World North America, 20% FTSE All-World Asia Pacific, 20% FTSE All-World Europe (ex-UK) and 5% FTSE Emerging Markets.

WTAN’s investment director James Hart says that there are macro issues for investors to consider, such as escalating trade tensions and the normalisation of interest rates in response to rising inflation. However, with inflation under control, he remains constructive on the outlook for global equities as the world economy is still growing at a healthy pace and corporate earnings remain positive, if less robust, than in recent years.

The director comments that in Europe, concerns about the Italian budget have created headwinds, especially for active stock pickers in terms of increased share price volatility. However, WTAN’s European managers remain sanguine on the outlook for equities in the region. While there has been a rise in nationalism in Europe, Hart says that so far, recent elections have ‘gone the right way’ and he believes that events in Italy will not structurally destabilise Europe, as the country has shown strong support for the region and the euro.

Turning his attention to the US, Hart says that President Trump has achieved some of his stock market-friendly ambitions, such as lowering corporate tax rates. However, following the outcome of the mid-term elections, where the Democrats gained control of the House of Representatives, it will be more difficult for Trump to get his policies enacted. The director believes this should alleviate investor concerns about more draconian tariffs, and he says that the imposition of Iranian sanctions has been a bit of a ‘fudge’ as some countries have been granted waivers, such as China and India. These exemptions have contributed to a lower oil price, by alleviating fears about a global economic slowdown due to higher commodity costs, which is positive for equity markets. Hart also believes that if there are signs of weakness in the US economy, the Federal Reserve will be less likely to raise interest rates.

For the UK, the director says that Brexit is a big uncertainty. WTAN has a relatively high UK weighting, but Hart observes that many UK stocks within the portfolio have a high degree of foreign earnings. He says that UK equities are pricing in Brexit risks, so are very attractively valued if there is a positive resolution to the negotiations, particularly those companies with domestic operations.

In terms of regional preferences, the director says that the outlook for equities in the rest of the world is better than for those in the US, unless there is a return to a narrow market led by technology, which is heavily represented in US indices. Hart is positive on the outlook for emerging market equities (especially in Asia), along with those in Europe and the UK, which are trading on more attractive valuations than US shares. One of WTAN’s external managers has commented that there is a complete disconnect between valuations and company earnings, especially outside of developed markets. Hart says that, in aggregate, equities are inexpensive, although there are some pockets of overvaluation where companies will have to beat consensus expectations to support their current valuations, especially as many of these firms are already generating peak earnings. WTAN’s portfolio has forecast earnings and dividend growth of c 10% and 7%, respectively, with a c 3% dividend yield, and is trading on a forward P/E multiple below 13x. Hence, the director believes that, barring a global recession, the outlook for the portfolio remains positive.

WTAN adopted its multi-manager approach in 2004, aiming to maximise total returns and reduce performance volatility. It currently has 10 external managers: three investing in the UK, three running global portfolios, two investing in continental Europe, one focusing on Asia Pacific and one emerging markets specialist (Exhibit 3). They are all selected for their high-conviction, unconstrained approach to stock picking. WTAN’s board actively manages the line-up of external managers; the fund with the longest tenure is UK manager Artemis (appointed in May 2008), while the newest managers are European managers, CRUX and S W Mitchell (both appointed in October 2017). Reasons for a variation in the multi-manager line-up include a change in key personnel or ownership, style drift, if an investment style is ‘long in the tooth’ or for asset allocation reasons. The external managers each hold between 15 and 65 positions, and, in aggregate, WTAN has c 380, an increase in recent months from c 350, due to several of the managers finding new investment opportunities in 2018. Witan’s executive team invests up to 10.0% of the portfolio (at the time of investment) in specialist funds, including private equity, and up to 2.5% in newly established managers or those running niche investment strategies. The trust’s board and executive team are also responsible for asset allocation and the use of gearing.

WTAN’s portfolio breakdown is shown in Exhibit 3. As at end-H118, all managers have outperformed their respective benchmarks since their appointment, with the exception of Pzena
(-1.4pp pa relative), which is the only firm that has a structural bias towards deep-value stocks. The three best-performing managers are Lindsell Train (+7.1pp pa), Lansdowne Partners (+5.0pp pa) and Artemis (+3.4pp pa). Hart says that the managers have struggled somewhat in the ‘risk-off’ environment prevalent in H218, given WTAN’s relatively low exposure to more defensive sectors, such as large pharma, telecoms and utilities, which have outperformed.

Hart says that there have been no changes to WTAN’s direct fund holdings, although the position sizes have been adjusted when appropriate. The trust’s largest holding is in healthcare specialist Syncona, which invests in early-stage businesses offering transformational treatments to patients, while generating superior returns for investors. The portfolio, which was initiated in late 2016, is maturing over time. In June 2018, one of its portfolio companies Autolus Therapeutics floated on NASDAQ, and is one of four ‘established or maturing’ companies which make up the majority of Syncona’s life sciences portfolio. A pipeline of developing technologies, together with significant capital resources held in funds, makes up the balance. Hart says that Syncona is a good example to illustrate how WTAN can access opportunities that are complementary to those available via its multi-manager strategy.

In H118 (ending 30 June), WTAN’s NAV total return of +1.1% was in line with the benchmark’s, while its share price total return was modestly higher (+2.0%). During the period, all external managers, with the exception of Lansdowne Partners and Pzena, outperformed their respective benchmarks. WTAN’s directly held investments also outperformed the trust’s composite benchmark (by 1.9pp – see Exhibit 3).

Exhibit 6 shows WTAN’s relative performance. A tougher period over the short term means that the trust is now modestly behind the benchmark over one year, modestly ahead over three years (in NAV terms), while clearly outperforming in both NAV and share price terms over five and 10 years.

WTAN is currently trading at a 1.7% discount to cum-income NAV, which compares with the 1.6% to 7.0% range of its averages over the past one, three, five and 10 years. The board actively manages the discount, aiming to ensure that WTAN’s shares trade close to NAV. Renewed annually, the trust has the authority to repurchase up to 14.99% and allot up to 10% of shares in issue. So far in FY18, there have been minimal shares repurchases (0.2m at a cost of c £2.3m).

WTAN is a conventional investment trust, with one class of share. There are currently 178.2m ordinary shares in issue. The trust has structural gearing of £170m with an average rate of interest of 4.3% (reduced from 4.6% following the issuance of a £30m, 2.74%, 37-year private placement note in August 2017). It also has a £125m short-term, variable-rate borrowing facility. Gearing is managed at the corporate level and the external managers may hold cash, but are not allowed to employ gearing. At end-October 2018, WTAN’s net gearing was 11%. At end-FY17, base fees levied by the external managers ranged from 0.25% to 0.80% pa, with a weighted average of 0.52% (0.49% at end-FY16). Two managers are entitled to a performance fee (four at end-FY16), but they charge lower base fees than the other eight managers. The majority of base fees incorporate a taper, so the percentage fee is reduced as the size of the managers’ portfolios increases. Ongoing charges in FY17 were 0.76% (1bp higher than in FY16), and 0.78% including performance fees (0.65% in FY16 – lower than the ongoing charge excluding performance fees due to the underperformance of some of the external managers).

The board seeks to increase WTAN’s dividend at a rate higher than UK inflation, as well as delivering long-term growth in capital. Dividends are paid in March, June, September and December. Barring unforeseen circumstances, the board’s policy is to pay three interim dividends equivalent to a quarter of the prior years’ annual distribution, and a fourth, historically higher variable, interim dividend. The 19.0p per share dividend paid for FY17 was 10.5% higher year-on-year and, over the past five years, the dividend has grown at an average rate of 9.7% pa, which is considerably higher than the rate of UK inflation over the period. WTAN has significant revenue reserves; at end-FY17 (after allowing for the fourth interim payment) they were equivalent to more 1.5x the annual dividend, which will provide a buffer for years where revenue growth is lower. The trust has a distinguished distribution history; annual dividends have risen for the past 43 consecutive years, and WTAN currently offers a yield of 2.2%. Having already declared the third interim dividend, the board is confident that it can grow the total dividend again in FY18, fully funded by current year revenue earnings, while also adding to revenue reserves. Hart says that the dividend growth rate may moderate slightly in coming years, as there have been a few years of very strong dividend growth, as a result of solid corporate earnings, while a trend towards international companies increasing their distributions reduces WTAN’s historical reliance on UK equities to generate the trust’s income.

WTAN is a member of the AIC Global sector, which comprises 21 trusts. Exhibit 9 shows the 11 largest (with market caps above £600m). In terms of performance, WTAN ranks fourth out of 11 funds over 10 years. Its NAV total returns are below average over the periods shown; however the averages are skewed by the significant outperformance of Scottish Mortgage. WTAN’s ongoing charge is higher than average and it is the only trust in the selected peer group with a performance fee, although this was negative in FY16. It has a higher-than-average level of gearing and its dividend yield is 0.5pp above the mean. The trust trades on a narrower discount than Alliance Trust (the only other trust in the sector with a fully multi-manager investment strategy).

Following the retirement of Robert Boyle and Catherine Claydon, and the appointment of Paul Yates in May 2018, there are eight directors on the board at WTAN; seven of whom are non-executive and independent of the manager. The chairman is Harry Henderson, who was appointed to the board in 1988 and assumed his current role in 2003. The other six independent directors and their years of appointment are: Tony Watson (2006), Richard Oldfield (2011), Suzy Neubert (2012), Ben Rogoff (2016), Jack Perry (2017) and Paul Yates (2018). The non-independent director is Andrew Bell, CEO of WTAN, who joined the board in 2010. On 5 December 2018, the board announced that Harry Henderson will be retiring at the May 2020 AGM. A committee, under the leadership of senior independent director Tony Watson, will commence a search for a chairman designate, who will be appointed in 2019.