The Merchants Trust — Higher gearing to take advantage of opportunities

The Merchants Trust (LSE: MRCH)

Last close As at 23/05/2024

GBP5.82

−5.00 (−0.85%)

Market capitalisation

GBP871m

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Research: Investment Companies

The Merchants Trust — Higher gearing to take advantage of opportunities

The Merchants Trust (MRCH) is managed by Simon Gergel, chief investment officer of UK equities at Allianz Global Investors (AllianzGI). He highlights that the remaining £16m of the trust’s £42m credit facility has recently been drawn down, taking gearing from c 13% to c 15%. This indicates that the manager, and MRCH’s board, see good value in the UK market, particularly in the type of stocks that fit Gergel’s disciplined investment criteria. The manager continues to seek undervalued companies with solid fundamentals, aiming to generate a high and growing level of income and long-term capital growth. MRCH has a commendable performance track record, outperforming the broad UK market over the short, medium and longer term. It also ranks highly versus its peers in the 22-strong AIC UK Equity Income sector. The trust’s annual dividend has grown for the last 40 consecutive years.

Melanie Jenner

Written by

Mel Jenner

Director, Investment Trusts

Investment Companies

The Merchants Trust

Higher gearing to take advantage of opportunities

Investment trusts
UK equity income

20 December 2022

Price

550p

Market cap

£767m

Total assets

£751m

NAV*

540.5p

Premium to NAV

1.8%

*Including income. At 16 December 2022.

Dividend yield

5.0%

Shares in issue

139.5m

Code/ISIN

MRCH/GB0005800072

Primary exchange

LSE

AIC sector

UK Equity Income

Financial year end

31 January

52-week high/low

587.0p

483.0p

585.1p

485.7p

*Including income.

Gearing

Net gearing*

13.1%

*At 31 October 2022.

Fund objective

The Merchants Trust’s investment objective is to provide an above-average level of income and income growth, together with long-term growth of capital, through investing mainly in higher-yielding large-cap UK companies (up to 10% of the fund may be invested in overseas equities). The benchmark is a broad UK stock market index.

Bull points

Long-term record of outperformance versus the UK stock market.

Attractive above-market dividend yield and at end-FY22, revenue reserves equivalent to around 0.6x the last annual distribution.

Competitive fee structure.

Bear points

Relative performance is likely to struggle in a growth/momentum-led market.

FY22 dividend was not fully covered (albeit with strong reserves), although the trust’s income is improving.

Rising inflation and interest rates, and a slowing economy, increase the risk of profit warnings.

Analyst

Mel Jenner

+44 (0)20 3077 5700

The Merchants Trust is a research client of Edison Investment Research Limited

The Merchants Trust (MRCH) is managed by Simon Gergel, chief investment officer of UK equities at Allianz Global Investors (AllianzGI). He highlights that the remaining £16m of the trust’s £42m credit facility has recently been drawn down, taking gearing from c 13% to c 15%. This indicates that the manager, and MRCH’s board, see good value in the UK market, particularly in the type of stocks that fit Gergel’s disciplined investment criteria. The manager continues to seek undervalued companies with solid fundamentals, aiming to generate a high and growing level of income and long-term capital growth. MRCH has a commendable performance track record, outperforming the broad UK market over the short, medium and longer term. It also ranks highly versus its peers in the 22-strong AIC UK Equity Income sector. The trust’s annual dividend has grown for the last 40 consecutive years.

NAV outperformance versus the broad UK market over the last three years

Source: Refinitiv, Edison Investment Research

The analyst’s view

MRCH offers investors the prospect of both capital and income growth from a relatively concentrated portfolio (52 names) of primarily UK companies (c 95% of the fund, with c 5% held in overseas businesses). In aggregate, the portfolio has a below-market valuation (forward P/E multiple of 7.8x versus 9.2x). The trust’s income has recovered strongly following COVID-induced weakness, meaning the dividend may now be fully covered. Encouragingly, the manager is finding attractive opportunities in the UK market due to the wide dispersion in company valuations. MRCH has outperformed its benchmark over the last one, three, five and 10 years in both NAV and share price terms; this is despite growth stocks being favoured by investors for much of the last decade.

Acceleration in share issuance

There continues to be high demand for MRCH’s shares, which is illustrated by an acceleration in its share issuance and, unlike most of its peers, the trust regularly trades at a premium. In FY22, MRCH’s share count increased by 5.6%, and so far in FY23 a further 9.2% has been issued. The trust is trading at a 1.8% premium to cum-income NAV, which compares with a range of an average 0.8% premium to a 1.8% discount over the last one, three, five and 10 years.

Market outlook: Re-rating potential given low sentiment

UK stocks have been out of favour with global investors since the Brexit vote in 2016 (Exhibit 1, left-hand side). The discount to the world market started to narrow at the end of 2021 but has since widened during a period of economic and political uncertainty in 2022. Looking at the valuation metrics in Exhibit 1 (right-hand side), the Datastream UK index is currently trading on a forward P/E multiple of 10.3x, which is a c 24% discount to its 10-year average and a c 26% discount compared with the Datastream World index. While the outlook for economic growth in the UK looks unappealing compared with other G7 countries in 2023, over time, with investor sentiment towards UK stocks so low, perhaps there is potential for a relative re-rating. The UK market offers a wide selection of global and domestic businesses, many of which have interesting long-term growth opportunities, and it is well established with robust legal and regulatory frameworks. There is potential for a pick-up in merger and acquisition activity as well-financed overseas companies take advantage of being able to acquire attractively valued UK businesses; this could be supportive for the performance of UK stocks.

Exhibit 1: Valuation of UK equities

Valuation versus global market (last 10 years)

Valuation metrics (at 19 December 2022)

 

Last

High

Low

10-year
average

Last as % of
average

UK

P/E 12 months forward (x)

10.3

15.7

9.4

13.5

76

Price to book (x)

0.9

1.9

0.7

1.2

74

Dividend yield (%)

3.7

6.4

2.7

3.5

103

Return on equity (%)

8.6

15.4

1.8

9.1

95

World

P/E 12 months forward (x)

14.0

19.9

11.4

15.4

91

Price to book (x)

2.1

2.5

1.4

1.9

111

Dividend yield (%)

2.5

3.4

1.8

2.4

102

Return on equity (%)

13.5

14.0

7.3

11.0

122

Source: Refinitiv, Edison Investment Research

The fund manager: Simon Gergel

The manager’s view: Past ‘peak fear’ on interest rate concerns

Gergel says that we are in a very challenging economic environment because of the spike in inflation, especially in energy prices, which has been exacerbated by the war in Ukraine. This is putting cost pressures on consumers and companies and squeezing their profitability. He suggests that we may already be in recession, so it is a difficult time for businesses. Supply chain disruptions continue, and inventories are high because companies overordered in response to these supply constraints, while currency movements are also adding to earnings volatility. However, the manager opines that a significant amount of these problems is already factored into share prices.

According to Gergel, the UK market is very modestly priced and there is a huge divergence between company valuations. He says that cyclical stocks have derated significantly; however, the outlook for these companies should improve over time. The oil price has come down, freight rates are back close to pre-pandemic levels, while other commodity prices have moderated, so inflationary pressures should ease, although the manager notes that labour costs are rising.

Gergel comments that interest rate expectations have risen in 2022, and the outlook for the pace of higher rates has accelerated. However, the manager suggests that we could be past ‘peak fear’ on interest rate concerns. In response to the former prime minister Liz Truss’s mini budget on 23 September 2022, UK mortgage rates rose above 6% but are now moderating. The UK 10-year government bond yield spiked at c 4.5% on fears that inflation would spiral out of control, but markets are now calmer, and the bond yield has come down to c 3.5%. Gergel suggests that on a six-month view, the investment backdrop could look very different, with talk of when interest rates will be reduced rather than raised. In such an environment, he believes that cyclical stocks could perform relatively better.

The manager says that coming into 2022, global investors were looking more favourably on the UK market given its modest valuation, robust corporate governance structure and being home to a good selection of global businesses. However, the UK’s political instability this year has been a deterrent. Gergel suggests that if the political environment stabilises, there could be more interest in the UK market. Also, given low valuations, the manager anticipates an uptick in the number of acquisitions of UK businesses by overseas companies as economic uncertainty abates.

So far, reports the manager, there has not been the anticipated widespread earnings downturn. He notes that there have been some weaker trading statements from companies in the building sector, with volumes declining but pricing remaining firm. Gergel suggests that investors are essentially waiting for the bad news to hit following a benign Q322 earnings reporting season.

Current portfolio positioning

At end-October 2022, MRCH’s top 10 holdings made up 35.0% of the fund, which was a lower concentration compared with 38.0% a year earlier; six positions were common to both periods. The portfolio had 52 positions and its geographic exposure was c 95% UK and c 5% Europe ex-UK. In terms of market cap, the broad split was 60%, 25% and 15% between large caps, mid-caps and small cap/other/cash respectively.

Exhibit 2: Top 10 holdings (at 31 October 2022)

Company

Sector

Portfolio weight %

31 October 2022

31 October 2021**

Shell

Oil, gas & coal

4.6

3.6

British American Tobacco

Tobacco

4.3

4.4

GSK*

Pharmaceuticals & biotechnology

4.0

5.3

Imperial Brands

Tobacco

4.0

4.1

BP

Oil, gas & coal

3.8

3.9

IG Group

Investment banking & brokerage

3.3

N/A

Rio Tinto

Industrial metals & mining

3.0

N/A

BAE Systems

Aerospace & defence

2.8

3.3

DCC

Industrial support services

2.7

N/A

CRH

Construction & materials

2.7

N/A

Top 10 (% of portfolio)

35.0

38.0

Source: MRCH, Edison Investment Research. Note: *Formerly GlaxoSmithKline. **N/A where not in end-October 2021 top 10.

There were modest changes in MRCH’s sector exposure in the 12 months to end-October 2022. The largest increases were industrials (+2.4pp) and consumer staples (+2.3pp), while the largest reductions were utilities (-3.9pp) and consumer discretionary (-2.3pp). The trust’s portfolio is the result of bottom-up stock selection with the largest active weights versus the benchmark being industrials (+5.1pp) and healthcare and basic materials (both -4.4pp).

Gergel highlights one of MRCH’s energy holdings. Energean (ticker: ENOG, £2.2bn cap) is an international exploration and production company with a focus on natural gas. It has just started producing from a very large field offshore Israel that is expected to quadruple the firm’s gas production. Energean has very long-term contracts with downside caps and upside inflation protection, strong cash flow growth and is ramping up its dividend. The manager considers that Energean is a mispriced company that is not well known in the market.

Exhibit 3: Portfolio sector exposure vs benchmark (% unless stated)

Portfolio end-
October 2022

Portfolio end-
October 2021

Change
(pp)

Index
weight

Active weight
vs index (pp)

Trust weight/
index weight (x)

Financials

20.5

22.4

(1.9)

21.4

(0.9)

1.0

Consumer staples

17.0

14.7

2.3

16.4

0.6

1.0

Industrials

16.1

13.7

2.4

11.0

5.1

1.5

Consumer discretionary

12.9

15.2

(2.3)

10.5

2.4

1.2

Energy

11.7

10.5

1.2

12.4

(0.7)

0.9

Healthcare

6.8

6.6

0.2

11.2

(4.4)

0.6

Utilities

5.7

9.6

(3.9)

3.4

2.3

1.7

Basic materials

3.5

2.1

1.4

7.9

(4.4)

0.4

Real estate

3.0

1.5

1.5

2.6

0.4

1.1

Telecommunications

1.3

2.9

(1.6)

1.8

(0.5)

0.7

Technology

0.0

0.0

0.0

1.3

(1.3)

0.0

Cash

1.5

0.8

0.7

0.0

1.5

N/A

100.0

100.0

100.0

Source: MRCH, Edison Investment Research. Note: Numbers subject to rounding.

In September 2022, Gergel initiated a position in Grafton Group (ticker: GFTU, £1.78bn cap), which is a leading builders merchant and retailer in Ireland and a major UK distributor under the Selco brand. H122 revenues were split: 42% UK, 37% Ireland, 15% Netherlands and 6% Finland. The Irish economy is resilient, with a shortage of housing and ageing housing stock in need of modernisation. Grafton has a good history of capital allocation and at the time of purchase was trading on a modest 7x forward P/E multiple, with a third of its balance sheet held in cash, providing opportunities for further investment in a fragmented industry. The manager says that its stock price had declined significantly due to general economic concerns, which afforded him the opportunity of buying a very good business at an attractive valuation. MRCH’s remaining holding in HomeServe was sold as its share price approached the level of Brookfield Asset Management’s bid.

In August 2022, Gergel added NatWest Group to MRCH’s portfolio to increase its exposure to interest rate-sensitive stocks. Since the 2007–08 global financial crisis, the banking industry has become highly regulated and bank balance sheets are stronger. The manager explains that NatWest operates in an oligopoly and its legacy issues are being resolved. Gergel is not too pessimistic on the outlook for the UK economy and considers the bank well provisioned with a solid lending book, while it is benefiting from higher interest rates.

The manager reports that, over the last few months, he has been increasing MRCH’s cyclical exposure due to the wide valuation dispersion within the UK market. Additions include to real estate, financials, construction and retail stocks.

Performance: Long-term record of outperformance

Exhibit 4: Investment trust performance to 30 November 2022

Price, NAV and benchmark total return performance, one-year rebased

Price, NAV and benchmark total return performance (%)

Source: Refinitiv, Edison Investment Research. Note: Three-, five- and 10-year performance figures annualised.

Exhibit 5: Five-year discrete performance data

12 months ending

Share price
(%)

NAV*
(%)

Blended benchmark (%)

CBOE UK All companies (%)

CBOE UK 100 Companies (%)

30/11/18

2.6

(1.7)

(1.8)

(1.8)

0.8

30/11/19

17.1

14.8

11.3

11.3

0.8

30/11/20

(13.0)

(14.2)

(11.2)

(11.2)

3.7

30/11/21

35.6

35.4

17.1

17.1

16.0

30/11/22

10.2

11.2

7.9

7.9

12.2

Source: Refinitiv. Note: All % on a total return basis in pounds sterling. *NAV with debt at market value.

MRCH’s relative performance is shown in Exhibit 6. Its NAV and share price total returns are ahead of the benchmarks’ over the last one, three, five and 10 years. The trust’s outperformance is particularly notable over the last decade.

Gergel comments that it has been difficult to beat the market over the last 12 months. MRCH has benefited from not having a significant underweight in energy stocks, which have performed well, while its overweight exposure in tobacco stocks has been an important contributor to the trust’s performance. Shares in Imperial Brands and British American Tobacco have appreciated due to the companies’ defensive qualities and attractive valuations. Also, Imperial Brands launched a £1bn share repurchase (c 5.5% of the share base), which was welcomed by investors. The manager also highlights that defence and mining stocks have performed well, and banks have done relatively well in a lacklustre market. Some investors have avoided these businesses on ESG grounds, but they are represented in MRCH’s portfolio. The largest detractor to the trust’s performance over the last 12 months was not having a position in AstraZeneca, which has benefited from pipeline successes. Gergel stresses that he must have a positive investment case on a company before it is included in the portfolio, and this was not the case for AstraZeneca.

Exhibit 6: Share price and NAV total return performance, relative to indices (%)

 

One month

Three months

Six months

One year

Three years

Five years

10 years

Price relative to blended benchmark*

(0.4)

1.2

(0.8)

2.1

16.0

27.4

82.5

NAV relative to blended benchmark*

0.2

0.7

(2.3)

3.0

15.1

18.8

72.9

Price relative to CBOE UK All Companies

(0.4)

1.2

(0.8)

2.1

16.0

27.4

30.2

NAV relative to CBOE UK All Companies

0.2

0.7

(2.3)

3.0

15.1

18.8

23.3

Price relative to CBOE UK 100

(0.4)

0.8

(2.0)

(1.7)

(3.5)

14.0

75.9

NAV relative to CBOE UK 100

0.3

0.3

(3.4)

(0.9)

(4.3)

6.3

66.7

Source: Refinitiv, Edison Investment Research. Note: Data to end-November 2022. Geometric calculation. *Blended benchmark is UK 100 Index until 31 January 2017 and UK All-Share Index thereafter.

Exhibit 7: NAV total return performance relative to the benchmark over 10 years

Source: Refinitiv, Edison Investment Research

Peer group comparison

There are 21 funds in the AIC UK Equity Income sector and in Exhibit 8 we show the 17 largest with market caps greater than £100m. MRCH has a commendable performance track record, with its NAV ranking first over the last five years, second over the last three years, third over the last 12 months and fifth over the last decade. On 19 December 2022, MRCH was one of five funds in the selected peer group trading at a premium to NAV. The trust has a competitive ongoing charge, ranking sixth and, in line with its peers, no performance fee is payable. MRCH has an above-average level of net gearing and offers the third-highest dividend yield in the selected peer group, 0.7pp higher than average.

Exhibit 8: Selected peer group at 19 December 2022*

% unless stated

Market
cap £m

NAV TR
1 year

NAV TR
3 year

NAV TR
5 year

NAV TR
10 year

Discount
(cum-fair)

Ongoing charge

Perf.
fee

Net gearing

Dividend yield

Merchants Trust

767.0

0.4

13.7

32.4

105.0

1.3

0.6

No

111

5.0

abrdn Equity Income Trust

162.5

(0.3)

(4.3)

(6.6)

66.3

(0.5)

0.9

No

113

6.6

City of London

1,917.2

2.7

3.7

15.1

92.5

2.1

0.4

No

107

5.0

CT UK Capital and Income

311.6

(8.5)

(5.5)

10.0

88.1

(0.7)

0.6

No

107

4.0

CT UK High Income Units

106.4

(4.8)

(4.9)

2.7

61.8

(6.0)

1.0

No

101

4.9

Diverse Income Trust

327.4

(12.8)

7.7

9.5

137.0

(2.7)

1.1

No

100

4.2

Dunedin Income Growth

416.6

(7.1)

3.2

23.1

84.7

(2.6)

0.6

No

107

4.6

Edinburgh Investment

1,037.3

(1.7)

1.9

3.7

87.3

(7.8)

0.5

No

109

4.1

Finsbury Growth & Income

1,792.0

(4.9)

3.7

28.0

179.8

(4.5)

0.6

No

102

2.2

Invesco Select UK Equity

115.7

(7.3)

5.4

14.5

129.6

(9.3)

0.7

No

108

4.1

JPMorgan Claverhouse

415.0

(7.4)

(3.6)

10.1

98.8

0.3

0.7

No

109

4.6

Law Debenture Corporation

978.5

(5.4)

19.4

30.7

137.3

2.0

0.5

No

113

3.8

Lowland

322.9

(7.8)

(4.8)

(3.4)

74.7

(7.3)

0.6

No

113

5.1

Murray Income Trust

949.6

(6.1)

3.8

24.6

96.8

(6.2)

0.5

No

108

4.4

Schroder Income Growth

205.6

3.4

2.9

15.2

103.1

1.3

0.7

No

113

4.5

Temple Bar

681.3

(3.4)

(16.8)

(1.2)

62.8

(5.6)

0.5

No

107

3.8

Troy Income & Growth

192.8

(11.0)

(8.4)

5.8

78.8

(1.2)

0.9

No

100

2.9

Selected group average (17 funds)

629.4

(4.8)

1.0

12.6

99.1

(2.8)

0.7

108

4.3

MRCH rank

6

3

2

1

5

4

6

5

3

Source: Morningstar, Edison Investment Research. Note: *Performance to 16 December 2022. NAV with debt at par. TR, total return. Net gearing is total assets less cash and equivalents as a percentage of net assets.

Dividends: Four decades of consecutive annual growth

MRCH has grown its dividend for the last 40 consecutive years, compounding at a rate considerably higher than that of UK CPI inflation, and consistently offers a higher dividend yield than the broad UK market (Exhibit 10). Distributions are made quarterly in August, November, February/March and May.

Exhibit 9: Dividend history since FY17

Source: Bloomberg, Edison Investment Research

Gergel is encouraged by the improvement in the trust’s income following COVID-19 weakness. The FY22 dividend of 27.3p per share was 0.94x covered, whereas the FY21 dividend was just 0.68x covered, and the prospects for further improvement look bright. As examples, NatWest Group has recently announced a not-inconsequential special dividend of 16.8p per share and IG Group Holdings increased its dividend for the first time since 2018.

At the end of FY22, MRCH had 16p per share in revenue reserves, which is equivalent to c 0.6x the FY22 dividend. So far in FY23, two interim dividends of 6.85p per share have been paid, which are 0.7% higher year-on-year. Based on its current share price, the trust offers a 5.0% dividend yield.

Exhibit 10: Dividend record

Dividend growth above the level of UK inflation

Consistent above-market dividend yield

Source: MRCH, Edison Investment Research

Valuation: Regularly trading at a premium

MRCH’s 1.8% share price premium to cum-income NAV compares with a range of a 2.7% premium to a 2.2% discount over the last 12 months. Over the last one, three, five and 10 years, the trust has traded at average premiums of 0.8% and 0.6% and average discounts of 0.5% and 1.8% respectively.

Exhibit 11: Discount over three years (%)

Exhibit 12: Buybacks and issuance

Source: Refinitiv, Edison Investment Research

Source: Morningstar, Edison Investment Research

Exhibit 11: Discount over three years (%)

Source: Refinitiv, Edison Investment Research

Exhibit 12: Buybacks and issuance

Source: Morningstar, Edison Investment Research

The board’s policy is to issue new shares when MRCH’s shares are trading at a premium to NAV with debt at market value and to consider repurchasing them when they are at a sustained discount to NAV. As shown in Exhibit 12, share issuance has accelerated meaningfully in FY23; so far c 11.8m shares (c 9.2% of the share base) have been issued, raising c £65.5m.

Fund profile: High-conviction, diversified portfolio

MRCH was launched in 1889, and as such is one of the oldest investment trusts listed on the London Stock Exchange. Since 2006, MRCH has been managed by AllianzGI’s chief investment officer for UK equities, Simon Gergel, who has c 35 years of investment experience. He aims to provide an above-average level of income and income growth, together with long-term capital appreciation from a high-conviction portfolio of mainly higher-yielding large UK companies.

The trust’s portfolio is relatively concentrated, with c 40–60 stocks, and Gergel has a contrarian approach, seeking undervalued equities that can be held for the long term. MRCH’s performance is measured against the broad UK market (prior to the end of January 2017 it was versus the 100 largest UK companies). Investment guidelines are in place to mitigate risk. MRCH must have exposure in at least five of the 11 market sectors, with a maximum 35% of the fund in a single sector. Any holding may not exceed 15% of assets. Gearing in a range of 10–25% of NAV, at the time of drawdown, is permitted; at end-October 2022, net gearing was 13.1%.

MRCH has a distinguished dividend history: it has increased its annual distribution for the last 40 consecutive years, using reserves to supplement income when required. MRCH currently offers an above-market dividend yield of 5.0%.

Investment process: Three pillars

Gergel focuses on undervalued companies with strong fundamentals, aiming to generate a high – and rising – income stream and long-term capital growth. He says that there is compelling historical evidence that, on average, companies paying high dividend yields have delivered above-average total returns, not just a higher income stream. The manager is able to draw on the broad resources of AllianzGI’s investment team, which includes equity, credit and macroeconomic research analysts, ESG specialists, and the proprietary Grassroots market research operation.

Companies considered for inclusion in the portfolio undergo thorough fundamental research with a particular focus on the sustainability of a firm’s cash flows. Stock selection is centred around three pillars: fundamentals (focus on a company’s industry structure and competitive position, its financial metrics and ESG factors); valuation (in absolute and relative terms, along with dividend yield); and themes (industry and secular issues, the macroeconomic outlook, and the stage of the business cycle.) There are three investment categories represented in MRCH’s portfolio:

Classic value: companies that are unloved, under-owned or misunderstood. Fundamentally sound businesses without major structural risks. It is important to avoid ‘value traps’ (shares that appear inexpensive, but whose valuation is warranted due to structural challenges or disruptive threats to an industry). Typically, short/medium holding periods.

Franchise: quality companies with sustainable competitive advantages. Long-term growth potential to compound value. Buy at attractive valuations and do not overpay for growth. Typically, medium/long holding periods.

Special situations: unique situations with unusual share price drivers that are often uncorrelated with the economy or financial markets. These include turnarounds, workouts, spin-offs, balance sheet restructurings and countercyclical businesses. Holding periods are variable.

Positions may be sold if they become fully valued, there is a change in the investment case, or a better opportunity is identified.

MRCH’s approach to ESG

The consideration of ESG factors is fully integrated into MRCH’s research process along with more traditional operational and financial analysis. By understanding how a business interacts with the environment, treats its employees and deals with customers and suppliers, the manager and his team can gain valuable insights into its future prospects, and can assess long-term risks, which might not be evident in financial metrics. Companies with a low score on any ESG factor are sold or need a documented justification from the manager. The process is monitored by regional CIOs and AllianzGI’s sustainability team.

AllianzGI believes that it has an important duty to engage with the boards and management teams of MRCH’s investee companies and to regularly submit proxy votes. This is not purely about holding management to account, but also about influencing company strategy and promoting effective governance, to help improve long-term performance. Working with investee companies, sometimes in conjunction with other shareholders, helps engender real change and make a positive difference to society. AllianzGI sees ESG as a distinctly different philosophy from socially responsible investing, where investment universes are explicitly constrained to avoid ‘bad companies’ so that portfolios can be skewed toward ‘good companies’. It believes that ESG risk, once properly understood, should be considered in the context of risk/reward, like all other risks considered by the manager. Furthermore, AllianzGI believes that third-party ESG/SRI research is too dependent on limited company disclosures. Therefore, its analysts and managers challenge third-party research, developing their own conclusions based on material risks.

Recent ESG discussions include with power generator Drax Group about its sourcing and use of biomass following a Panorama investigation. Meetings with IG Group Holdings have centred around corporate governance and the company’s capital allocation, having asked investors for their input. IG Group has subsequently issued a clear policy on returning cash to shareholders, which includes a progressive dividend and share repurchases; this development has been well received by shareholders, including AllianzGI. Discussions with tobacco companies include environmental issues such as the control of deforestation, and the use of children on tobacco farms, with a commitment to eradicate the practice at farms supplying British American Tobacco by 2025.

Gearing

At end-FY22, MRCH had c £93m of debt with an effective interest rate of c 3.7% (considerably lower than 8.5% at end-FY17). Net gearing at the end of October 2022 was 13.1%, which is within the board’s policy range of 10–25%.

Recently, the remaining £16m of MRCH’s £42m revolving credit facility was drawn down, which increased its net gearing from c 13% to c 15%. This indicates that Gergel sees good value in the UK market and illustrates the board’s confidence that the manager will be able to generate annual total returns above the trust’s low single-digit cost of debt.

MRCH’s active share issuance, in response to high investor demand, has reduced the trust’s net gearing over time. As a reminder, at the end of January 2020, gearing was reduced to c 15% by repaying £16m of MRCH’s revolving credit facility. Bringing the trust’s net gearing back up to this level enhances MRCH’s potential income generation and provides the board with extra flexibility in terms of the trust’s own dividend payments.

Fees and charges

AllianzGI is paid 0.35% pa of the value of MRCH’s gross assets (minus current liabilities, short-term loans and any funds within the portfolio managed by AllianzGI). The management fee is allocated 65% to the capital and 35% to the revenue accounts respectively, which helps to boost the trust’s level of income, and reflects the board’s expected split of long-term returns between capital and income. MRCH’s FY22 ongoing charge was 0.55%, which was 6bp lower than 0.61% in FY21.

Capital structure

MRCH is a conventional investment trust with one class of share; there are 139.5m ordinary shares in issue and its average daily trading volume over the last 12 months is c 237k shares.

Exhibit 13: Major shareholders

Exhibit 14: Average daily volume

Source: MRCH. Note: At 31 October 2022.

Source: Refinitiv. Note: 12 months to 19 December 2022.

Exhibit 13: Major shareholders

Source: MRCH. Note: At 31 October 2022.

Exhibit 14: Average daily volume

Source: Refinitiv. Note: 12 months to 19 December 2022.

The board

Exhibit 15: MRCH’s board of directors

Board member

Date of appointment

Remuneration in FY22

Shareholdings at end-FY22

Colin Clark (chairman since September 2019)

June 2019

£39,750

10,000

Sybella Stanley (senior independent director)

November 2014

£26,500

3,114

Mary Ann Sieghart

November 2014

£26,500

1,000

Timon Drakesmith*

November 2016

£32,250

15,000

Karen McKellar

May 2020

£26,500

8,000

Source: MRCH. Note: *Chairman of the audit committee.

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This report has been commissioned by The Merchants Trust and prepared and issued by Edison, in consideration of a fee payable by The Merchants Trust. Edison Investment Research standard fees are £60,000 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

General disclaimer and copyright

This report has been commissioned by The Merchants Trust and prepared and issued by Edison, in consideration of a fee payable by The Merchants Trust. Edison Investment Research standard fees are £60,000 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2022 Edison Investment Research Limited (Edison).

Australia

Edison Investment Research Pty Ltd (Edison AU) is the Australian subsidiary of Edison. Edison AU is a Corporate Authorised Representative (1252501) of Crown Wealth Group Pty Ltd who holds an Australian Financial Services Licence (Number: 494274). This research is issued in Australia by Edison AU and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. Any advice given by Edison AU is general advice only and does not take into account your personal circumstances, needs or objectives. You should, before acting on this advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If our advice relates to the acquisition, or possible acquisition, of a particular financial product you should read any relevant Product Disclosure Statement or like instrument.

New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

United Kingdom

This document is prepared and provided by Edison for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

United States

Edison relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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