F&C Investment Trust — New name, same tried-and-tested approach

Exhibit 2 (LHS) shows the performance of UK and world markets, in sterling terms, over the last decade. While UK shares kept pace with overseas equities until late 2015, investors holding shares in international equities have enjoyed materially higher total returns in recent years. This may be due to both the Brexit overhang and better growth opportunities available outside our home market. Equities across the globe suffered significant weakness in Q418 due to the US central bank’s commitment to tightening monetary policy and an escalation in the US-China trade dispute; the pullback has led to more reasonable equity valuations. During 2018, on a forward P/E multiple basis, global equities (led by the dominant US market) reached a c 20% premium to their 10-year average. They are now more reasonably priced, albeit still trading at a premium, led by the US, emerging markets and Europe. While macro uncertainties exist, including the ongoing US-China trade dispute and Brexit negotiations, lower equity valuations could provide an attractive entry point for investors looking to invest for the medium to long term.

Launched in 1868, FCIT is the oldest investment trust. On 9 November 2018, the company’s name was officially changed from Foreign & Colonial Investment Trust to F&C Investment Trust (former ticker FRCL). Reflecting low manager turnover, current lead manager Paul Niven (since 2014) is only the 11th since the fund’s launch, and the third since 1969. FCIT has a distinguished dividend history, having paid a distribution every single year since launch, and the annual payment has increased for the last 48 consecutive years. Along with holding a broad selection of listed companies, the trust has invested in private equity since 1942.

Niven aims to generate long-term growth in capital and income, and attractive risk-adjusted returns, from a portfolio that is widely diversified by geography and sector (there are no limits on geographic or sector exposures for publicly listed equities). The trust is benchmarked against the FTSE All-World index, and while the manager is benchmark aware, he is not constrained by the index allocations. A maximum 5% of the portfolio, at the time of investment, may be invested in unlisted securities (excluding private equity) and requires prior board approval. Shareholder approval would be required to increase FCIT’s private equity exposure above 20%. At the time of investment, a maximum 10% of the portfolio is permitted in a single investment, and up to 5% may be in funds managed by BMO Global Asset Management (subject to board approval). Gearing in either sterling or foreign currencies is permitted up to a maximum 20% of NAV (net gearing was 7% at end-February 2019). Data from FCIT shows that a £100 investment made when the trust was launched in 1868 would now be worth c £12m.

Niven highlights that we are late in the investment cycle, given most of the developed equity markets troughed more than a decade ago following the global financial crisis. However, he says that the backdrop has changed over the last few months as the US Federal Reserve (Fed) has indicated that it has reviewed its stance on raising interest rates, after heightened levels of stock market volatility in H218, as the Fed raised interest rates and tightened liquidity. The manager suggests that the central bank’s more dovish stance could extend the market cycle through 2019, and maybe even into the following year. Niven expects another year of positive earnings growth in 2019, albeit at a lower rate than in 2018, and believes that the stock market correction at the end of 2018 has reduced many of investors’ valuation concerns. He says that stocks are now reasonably valued, and are broadly pricing in the macro risks, such as the US-China trade dispute. However, the manager does expect further bouts of stock market volatility, although he believes there is potential for upside surprises in 2019. In terms of individual regions, compared to 12 months ago, he does not see any standout opportunities. European valuations look reasonable, but growth in this area has been disappointing, and the valuation discount between emerging and developed markets has narrowed, although Niven suggests that the US ‘is still pretty interesting’. He expects growth stocks to continue to lead markets higher into the end of the cycle, and suggests that he could allocate more capital to FCIT’s newly established in-house US equity growth strategy.

The manager aims to generate long-term growth in capital and income from a portfolio of securities that is diversified by both geography and sector. He believes that FCIT’s c 8% allocation to private equity is a key feature of the trust, helping to reduce risk and limit the volatility of returns, and over the long term this asset class has produced superior total returns compared with equities. While FCIT is benchmarked against the FTSE All-World index, the manager does not follow its allocations (geographic divergences are shown in Exhibit 4). As illustrated in Exhibit 3, Niven has inputs from both BMO’s specialist teams and third-party managers; strategy allocations are regularly reviewed, and adjusted when deemed appropriate.

Exhibit 3 shows FCIT’s strategy allocations (from mid-2018, UK exposure is now included within Europe, having previously been separate). In recent years, exposure to the UK has declined from c 30% to the current c 5% level. The manager explains that the move to a pan-European strategy brings a higher focus via a reduction in the number of stocks in the combined portfolio; in addition, BMO’s pan-European strategy total returns have exceeded those of the individual UK and European portfolios. During FY18, the manager closed FCIT’s multi-manager global strategy (launched in 2014), as it was not adding value after taking costs into consideration (the global income and smaller companies strategies remain in place). The closure has led to increased portfolio concentration and lower costs. FCIT’s multi-manager strategy was c 8% of the fund (c £250–300m), and the proceeds were: allocated into the global smaller companies portfolio; funded a BMO US growth strategy that was launched in December 2018 to complement external manager T Rowe Price’s portfolio; added to an existing BMO US value strategy; and the manager paid off some of the trust’s short-term debt. The in-house US growth and value strategies allow increased flexibility without allocating more to the external managers; Niven believes that it is appropriate to diversify FCIT’s US exposure.

The manager has initiated a £100m long sterling hedge (in two tranches). He explains that the vast majority of FCIT’s assets are non-sterling, which brings a risk for shareholders if there is a good Brexit outcome and sterling rallies. The position was initiated in November 2018, when sterling was very weak versus the US dollar (exchange rate of c $1.275) due to concerns about a ‘hard’ Brexit. Niven believes that there are still four possible Brexit outcomes: a deal in the next few months, another referendum, a general election or no deal. He says that if sterling weakens further, he will increase the trust’s exposure to the currency.

Niven explains that FCIT’s private equity exposure is diversified, with broadly 40% in North America, 40% in Europe and 20% in the rest of the world. During FY18, historic holdings HarbourVest and Pantheon realised £69m from maturing investments and delivered a 20.1% return, while the trust’s newer direct private equity investments also performed strongly, despite their relative immaturity, including life sciences fund Syncona (c 8% of the private equity exposure), which appreciated by 34% over the year. The manager says that there was close to £200m in new commitments in FY18 spread across primary and secondary funds and co-investments. Looking across all of FCIT’s new direct private equity commitments, 28% were made in 2016, 15% in 2017 and 57% in 2018. Niven says there is potential for the trust’s private equity exposure to increase from the current level of c 8% (historical range of 5% to 15%).

In terms of FCIT’s geographic exposure, while the weighting to North America has risen over the 12 months to end-February 2019, the trust retains a modest underweight exposure versus the benchmark FTSE All-World index. Pan-European exposure has been reduced, as the manager believes that there are better investment opportunities available in other regions.

As shown in Exhibit 5 (RHS), FCIT has delivered solid absolute returns over three, five and 10 years, with average annual NAV and share price returns in ranges of 12.7–14.7% and 14.5–18.7% respectively. In FY18, the trust generated a NAV total return of -3.3% and a share price total return of -0.6%, which were modestly ahead of the benchmark’s -3.4% total return. The outperformance of FCIT’s share price compared with its NAV led to a decline in the discount (Exhibit 6). During FY18, the standout performing asset was private equity with a 19.7% return, building on its long-term record of outperformance. In terms of regional strategies, the US and emerging markets outperformed their respective performance benchmarks (the US was the only region in positive territory), while the European (which now includes the UK) and Japanese strategies underperformed. Within the US, both growth manager T Rowe Price and value manager Barrow Hanley outperformed their respective growth and value performance benchmarks. FCIT’s combined global strategies modestly underperformed their underlying benchmark during FY18.

Exhibits 7 and 8 show FCIT’s relative performance. It has performed broadly in line with its benchmark in NAV terms over the last one, three, five and 10 years, while its share price has outperformed over these periods, particularly over three and five years. The trust has strongly outperformed the FTSE All-Share index over three, five and 10 years in both NAV and share price terms, highlighting the potential benefits of investing overseas.

As part of FCIT’s 150th anniversary celebrations, it has increased its engagement with existing and potential investors. This includes a programme with schools and other educational establishments, aiming to attract the next generation of investors. These efforts appear to have been successful, as the trust has continued to re-rate, and now regularly trades close to NAV, having traded at a c 15% discount following the UK’s European referendum. Until recently it had not traded at a premium since 1995.

During FY18, the trust reissued 100k shares from treasury (Exhibit 1); this was the first issuance since 1959, and the first time that it was undertaken at a premium (so far in FY19, a further 1.4m shares have been reissued – c 0.25% of the end-FY18 share base). There were no share repurchases in 2018 (the first year since 2002 that there were no buybacks) and, while there is no longer a hard discount control policy, the board is committed to buying back shares in response to a sustained widening of the discount.

FCIT’s current 0.1% discount to cum-income NAV compares with the range of a 1.4% premium to a 3.1% discount over the last 12 months, and average discounts of 0.3%, 5.1%, 6.5% and 8.3% over the last one, three, five and 10 years respectively.

FCIT is a conventional investment trust with one class of share in issue. There are currently 543.7m ordinary shares in issue, with a further 18.1m held in treasury. At end-FY18, FCIT had the following debt: ¥6.6bn at 2.50% and $80m at 4.00% (maturing in 2019); €72m at 1.69% (2022); £25m at 2.80% (2028); £50m at 3.16% (2031); £75m at 2.92% (2048 – taken out in H118); and a £0.6m 4.25% perpetual debenture. The trust also has a £100m (with the option of a further £100m) revolving credit facility, which expires in December 2019; it is currently undrawn. Following a series of refinancings, the trust’s weighted average cost of debt has declined over the last five years from 7.10% to 2.85% at end-FY18.

On 2 April 2019, FCIT announced the issuance of fixed rate senior unsecured private placement notes in four tranches (funding date expected on 27 June 2019): €42m with a seven-year tenor (coupon of 0.93%); £57m with a 23-year tenor (coupon of 2.59%); £37m with a 30-year tenor (coupon of 2.69%); and £20m with a 40-year tenor (coupon of 2.72%). The notes offer a mix of medium- and long-dated fixed rate unsecured financing, which the board considers to be at attractive rates and will lead to a greater balance in FCIT’s debt maturity profile. Proceeds from the sale of the notes will be used for refinancing of existing debt, investment, and other general corporate purposes. The weighted average interest payable on the newly issued notes will be less than 2.3% and the weighted average interest on all structural borrowings following the transaction is expected to be c 2.5%.

FCIT is permitted to gear up to 20% of NAV; at end-February 2019, net gearing was 7%, which is at the lower end of the c 6% to c 16% range since 2008.

In FY18, the trust’s ongoing charges declined from 0.79% to 0.65%, which was helped by maturing private equity exposure (resulting in reduced fees to external managers) and a lower allocation to funds. Effective from 1 January 2019, FCIT’s management charges have reduced from a flat fee of 0.365% of market cap to a tiered structure (0.35% on the first £3bn market cap, 0.30% between £3bn and £4bn, and 0.25% above £4bn). In FY18, FCIT’s total costs (including interest expense and transaction charges) were 1.01%, 5bp lower than 1.06% in FY17.

FCIT has a progressive dividend policy; its annual distribution has increased for the last 48 consecutive years, and it has paid a dividend every year since the trust was launched in 1868. The proposed 11.0p dividend per share for FY18 (c 1.15x covered) is 5.8% higher than 10.4p per share paid in FY17, which compares to a 2.1% UK inflation rate over the period. Over the last 10 years, the trust’s annual distribution has compounded at an average annual rate of 5.5%, which is meaningfully higher than the 2.3% pa average rate of UK inflation. Following the final FY18 dividend payment, FCIT has revenue reserves c 1.2x the annual distribution.

Exhibit 10 shows the 13 members of the AIC Global sector with less than 25% UK exposure. FCIT is the second-largest trust, with a market cap more than double the selected peer group average. Its NAV total returns are below average over the periods shown; ranking eighth, ninth, seventh and seventh over one, three, five and 10 years respectively. However, data from FCIT suggest that the trust has better risk-adjusted returns compared with the majority of its peers. Its ongoing charge is in line with the mean, it has an above average level of gearing, and its dividend yield is modestly below the selected peer group average.

There are eight independent, non-executive directors on FCIT’s board: Simon Fraser (appointed in September 2009, chairman since May 2010); Sir Roger Bone (appointed in March 2008, senior independent director since November 2011); Jeffrey Hewitt (appointed in September 2010); Sarah Arkle and Nicholas Moakes (both appointed in March 2011); Francesca Ecsery (appointed in August 2013); Edward Knapp (appointed in July 2016); and Beatrice Hollond (appointed in September 2017). At the time of the May 2019 AGM, Fraser will have served nine years as chairman, and has announced his decision to retire at some point during this year. Led by the senior independent director, the board is undertaking a search for a new chairman.