Lazard World Trust Fund — Update 2 August 2016

The financial year to 31 March 2017 has so far seen WTR announce a range of new initiatives, many of them in response to feedback from shareholders, aimed at increasing the appeal and marketability of the fund. The main points are summarised below.

Lazard World Trust Fund (WTR), formerly The World Trust Fund, has been managed by Lazard Asset Management since its launch in 1991. It aims to achieve capital growth by investing in a global portfolio of closed-end funds and holding companies that its managers believe are trading at unwarranted discounts to their net asset value, and where the underlying assets are also undervalued. There is significant exposure to emerging markets. Incorporated in Luxembourg as a société d’investissement à capital fixe (SICAF) and listed in London, WTR is managed by Lazard’s mainly New York-based Discounted Assets Strategies team, led by Kun Deng. It has proposed (see above) to adopt the MSCI AC World ex-US Index as its benchmark, with the MSCI AC World Index used as an additional reference. If approved, the change will be backdated to 1 April 2016.

WTR lead manager Kun Deng sees the current market uncertainty as a source of significant opportunity for the fund, given unusually wide discounts on the kinds of funds and companies in which it invests. “The fund thrives when the world is consumed by fear,” he says, adding that “this is one of the most attractive periods in our history in terms of discounts”. Emerging market funds are close to their widest discounts in 20 years, he says, with Japan, Europe and, to a lesser extent, the UK and US also providing attractive discount opportunities. The manager has a ‘shopping list’ and currently has a small net cash position to allow him to take advantage of discount volatility.

Deng says investors globally are concerned about the economy, the possibility of recession, and interest rate increases. However, while discounts may continue to widen in the short term, the manager sees the global backdrop as broadly positive, driven by accommodative monetary policy, with even US interest rate rises pushed further into the future as a result of the UK’s vote to leave the EU. While Brexit has created uncertainty in the UK and Europe, WTR’s managers say underlying valuations remain attractive, and Deng is likely to invest more in these areas if discounts widen.

The manager also sees WTR’s high emerging markets exposure as a key differentiating factor, highlighting their greater growth potential in a generally sluggish economic environment. Over 13% of the fund is invested in China, which Deng says has been misunderstood by investors. While the drivers of the Chinese economy in recent decades – resources, construction and industrials – are in decline, WTR’s focus is on the growing areas of e-commerce, social media, education and healthcare. As well as the exposure to Tencent and other Chinese stocks through Naspers (see below), WTR owns several explicitly China-focused investments, including Fidelity China Special Situations.1 The fund also has investments in markets such as India, Vietnam and the Philippines.

As well as emerging markets, WTR also has significant smaller companies exposure. The manager points out that the closed-end structure of its holdings is more suited to owning less liquid assets like small-caps; JPMorgan European Smaller Companies Trust1 is a top 10 holding and has been a source of good performance in recent years.

WTR is managed by the largely New York-based Discounted Assets Strategies team at Lazard Asset Management. The six-strong team is led by Kun Deng and seeks to build a portfolio of discounted investments with identifiable catalysts for revaluation. The team also has access to the macro and industry views of the wider Lazard group globally. There are broadly four stages to choosing investments for the WTR portfolio:

Screening: the universe of closed-end funds, investment trusts and holding companies is monitored to identify those that are trading at discounts that are high relative to peers or to history, or situations where there may be opportunities from short-term volatility.

Macro analysis: potential investments identified through screening are assessed to see if market and economic conditions favour a narrowing of the discount.

Fundamental analysis: stocks that pass the first two screens are analysed to assess the competitive landscape and the quality of management and governance, and to gain an understanding of whether their underlying assets are also trading at an unwarranted discount.

Catalysts for revaluation: aiming to avoid assets that are ‘cheap for a reason’, potential investments must have an identifiable catalyst, such as a tender offer or restructuring or the potential for an asset class to return to favour. The team is willing to engage with the companies it invests in, in order to encourage initiatives that may help unlock value for shareholders. Examples of recent engagement with holdings include encouraging HarbourVest Global Private Equity1and VinaCapital Vietnam Opportunity Fund1 to move their listings to the Main Market of the London Stock Exchange, thus qualifying them for index inclusion and boosting liquidity. Normally an investment would be made with the expectation of a catalyst occurring within 12 months, although holdings may remain in the portfolio for the longer term.

Having identified suitable investments, the team will reaffirm the value opportunity and downside risk before investing. The managers may make use of hedging, usually by taking short positions in ETFs, in order to mitigate market risk. During FY16, WTR held short positions in ETFs linked to the NASDAQ Biotechnology and MSCI China indices. Currency exposure is not usually hedged.

At the FY16 year-end (31 March) WTR had 37 holdings. This is a slightly shorter stock list than its peers, but gives access to a diversified portfolio of 1,000+ underlying investments. The fund has a bias towards Asian and emerging markets, with c 44% of the portfolio (adjusted for cash) invested in these areas (including c 10% in Japan) at 30 June. Europe is the next-largest allocation, at c 29% (including c 7% in the UK). The US exposure, which has always been broadly less than 35%, has fallen most over the last 12 months to stand at 20% at 30 June (Exhibit 2). Given that under its new MSCI ACWI ex-US benchmark, the fund is informally limited to a maximum US allocation of c 20%, it is reasonable to expect this may fall further. Geographical exposures are on a look-through basis.

While much of the portfolio has remained the same over the past six to nine months, there have been a few notable changes. Naspers, a South African-listed holding company, is a recent addition and is now the fund’s largest position. Naspers invests in tech and media companies and its largest holding is a 34% stake in Chinese internet giant Tencent. WTR’s manager notes that this holding allows the fund to access the growth in China’s new economy at a substantial discount. Based on 20 July share prices and exchange rates, Naspers’ Tencent stake was worth £57bn while its own market capitalisation was £52bn. Another new holding is Tetragon Financial Group (TFG), a UK-listed closed-end fund with a diversified portfolio of income-generating alternative assets. WTR has also increased its position in VinaCapital Vietnam Opportunity Fund (VOF); both TFG and VOF are now just outside the top 10 holdings.

The most significant recent exit was from BB Biotech1 previously the largest holding. WTR’s managers continue to favour the biotech sector (International Biotechnology Trust1 is a top 20 position), but sold out of the Swiss-listed specialist after it moved from a double-digit discount to a premium. Allianz Technology Trust was also sold in the second half of the 2016 financial year.

In absolute terms WTR’s NAV and share price total return performance has been positive over both the short and longer term (Exhibit 3), boosted by sterling weakness (the majority of underlying assets are non-UK) in the aftermath of the EU referendum. Relative to benchmarks – the MSCI World Index until 1 April 2010 and the MSCI AC World Index thereafter – the fund has lagged, although this perhaps says more about the choice of benchmark than WTR’s performance. The new benchmark, MSCI AC World ex-US, while still an imperfect comparator, is a better reflection of the fund’s low US and high emerging market exposure. As seen in Exhibit 4, WTR has comfortably outperformed the index over three and five years, and underperformance over some shorter periods has been marginal. Over most periods shorter than 10 years WTR’s performance has also been ahead of or broadly in line with the universe of investment companies.

As reported in WTR’s annual results, positive contributors to performance over the 12 months to 31 March came from stock selection – particularly in European smaller company specialists and frontier markets – and corporate actions and restructuring of some underlying holdings, while a general widening in investment company discounts was a negative factor. However, the managers point out that the unusually wide average discount on underlying holdings (28.1%, a level only exceeded in the last 20 years during the financial crisis of 2008/09) means there is significant value in the portfolio: adding WTR’s own 11.8% discount (at 1 August) to the portfolio discount means that each £1 invested effectively buys £1.58 worth of assets based on underlying NAVs.

WTR’s shares had broadly traded at a discount to cum-income NAV of 10-14% in recent years before widening in a climate of heightened risk aversion from the start of 2016 (Exhibit 5). Over one, three and five years the discount has averaged 13.7%, 12.7% and 12.0%, respectively. It reached a five-year high of 18.6% on 27 June 2016 in the immediate aftermath of the UK’s Brexit vote, although it subsequently narrowed sharply after the announcement of new initiatives including an enhanced distribution policy, and stood at 11.8% at 1 August. A tender offer for up to 10% of WTR’s shares has been proposed, at a 2% discount to NAV minus costs.

WTR is a closed-end fund (SICAF) incorporated in Luxembourg. It has one class of share, with 40.5m in issue at 1 August and 10.2m held in treasury without voting rights. A continuation vote is held each year, and the board may also propose a tender offer as a method of managing the discount, allowing shareholders to exit a portion of their investment at a price closer to NAV. There is a $25m line of credit with Citibank, which, if fully drawn, would equate to 14.8% gearing based on 31 March net assets. The manager is permitted to gear up to 15% but at 30 June 2016 had 4.1% net cash.

Lazard is paid an annual management fee of 0.75% of net assets. A performance fee may be paid on a sliding scale of between 5% and 20% of outperformance of the benchmark, measured over a two-year period. No performance fee has been paid in any of the last five years. Ongoing charges were 1.39% at the FY16 year-end.

WTR is focused on capital growth, but in response to investor interest it has, since FY15, paid out a significant portion of its investment income (net of fees) as dividends, with an interim payout in January and a final in August subject to AGM approval. The FY15 total dividend was 3.4p, rising to 6.4p (assuming approval of the 5.4p final dividend) for FY16. This represents a prospective yield of 2.2% based on the 1 August share price. Under a new policy announced in June 2016 (subject to shareholder approval), from FY17 WTR will pay a distribution equal to 3.5% of its opening NAV at the start of the financial year. Based on the NAV of 290.3p on 1 April 2016 (the first day of the financial year), the distribution for FY17 will be 10.2p per share, a prospective dividend yield of 3.6% (as at 1 August). Distributions under the new policy may be partly funded out of capital.

WTR is a member of the AIC’s Global sector but has few direct comparators, as the majority of trusts in the sector invest solely or largely in mainstream equities. Exhibit 6 below shows a selection of peers with broadly similar (mainly fund of funds-type) strategies. Three of the peers are in the Global sector, while two (Henderson Alternative Strategies Trust1 and Miton Global Opportunities1) moved to the new Flexible Investment sector when it was launched at the start of 2016.

Strong recent performance has propelled WTR close to the top of the group in terms of NAV total return performance over one, three years and five years. It also ranks first for risk-adjusted performance as measured by the Sharpe ratio over both one and three years. The discount to NAV and ongoing charges are both somewhat above average. WTR is currently ungeared. Including the recently declared dividend, WTR has the highest yield in the group, and this is set to rise further subject to approval of the new 3.5% distribution policy.

WTR has five directors, all non-executive and independent of the manager. Chairman (since 2010) Philip R McLoughlin has been a director since WTR’s launch in 1991. Duncan Budge joined the board in 2006, while James Cave was appointed in 2008 and Howard Myles in 2011. Tony Morrongiello became a director in 2014. Founding portfolio manager Alex Zagoreos has recently stepped down as an adviser to the directors, a position he had occupied since retiring from the board in 2014. The directors all have backgrounds in investment management.