Witan Investment Trust — Seeking to procure the world’s best stock pickers

Macroeconomics was a key driver of global equity market returns in 2016, overshadowing individual companies’ operational performances. This environment proved tough for active managers focused primarily on stock-picking. In addition, the natural propensity of active managers to underweight sectors with limited earnings visibility such as mining (where fortunes are in large part dictated by commodity price moves) proved a further handicap, as highly operationally geared mining companies saw their share prices bounce sharply. In this environment, WTAN’s benchmark returned 23.0% in 2016, supported by continuing low government bond yields, a sharply weaker sterling and sustained US equity market optimism following the Trump victory.

The charts in Exhibit 2 show how WTAN’s benchmark universe of stocks has advanced significantly over the last 10 years, both in absolute terms and relative to the FTSE All Share index. While the average forward P/E ratio of the Datastream world index does not appear cheap on an historic basis, one thing WTAN’s selection of high-conviction stock pickers is not doing, unlike a tracker fund, is buying the average. A global environment of tighter monetary policy may prove advantageous in relative terms to high-quality active managers able to navigate their way through tougher market conditions.

Witan Investment Trust (WTAN) was created in 1909 and listed on the stock exchange in 1924. It is now one of the largest UK investment trusts, with more than £1.8bn in net assets. In 2004, there was a change in strategy; WTAN became self-managed, appointed its first chief executive and adopted a multi-manager investment approach, with the aim of reducing the performance volatility that can arise from dependence on a sole manager. The fund seeks long-term growth in capital via investment in global equities and real dividend growth. External managers are selected for their high-conviction, unconstrained approaches, focusing on both value and growth strategies investing in developed and emerging markets. Up to 10% of WTAN’s portfolio can be invested in specialist funds, which includes private equity and lesser-known/newly established managers. Since 1 January 2017, the composite benchmark based on FTSE All-World indices is 30% UK, 25% North America, 20% Asia Pacific, 20% Europe ex-UK and 5% emerging markets. Gearing of up to 20% of net assets is permitted (typically 5-15%) and a small net cash position may be held when appropriate. The use of derivatives is allowed to implement investment policy; in recent years, exchange-traded futures have been used to gain exposure to a particular market index quickly without having to interfere with the strategies of the external managers.

WTAN’s managers suggest that they are optimistic on the outlook for 2017, but need to be vigilant. Global economic growth is improving and corporate earnings growth turned more positive in Q316, which is supportive for equity prices. In a low interest rate environment, demand for equities is likely to remain robust and the managers consider that shares in aggregate are fairly valued, although some sectors are looking expensive. However, given outsized stock market returns in recent years, the managers suggest that further gains may rely on continued earnings growth rather than valuation uplifts. Key risks are seen as political rather than economic, so any sharp setback in global share prices could provide good investment opportunities for WTAN’s external managers, who are all unconstrained, active stock pickers. Brexit negotiations present a risk to growth, but monetary and fiscal policy could limit any damage, while sterling weakness is acting as a ‘pressure valve’ for the UK economy. The managers also suggest that the UK stock market is less at risk than the UK economy.

Commenting on the energy sector, the managers suggest that over the long term, the oil price is in structural decline. This is a function of technical advancements and lower demand for petrol as alternative energy sources are more widely adopted. The oil price has rallied following the November 2016 OPEC meeting, where members agreed to cut production, but is likely to remain well below the peak of recent years. This stability at a lower level should be a positive environment for many of the world’s corporate and individual consumers. WTAN remains positive on the outlook for Asian equities, despite US president Trump’s talk of protectionism. The managers comment that a lot of WTAN’s Asian exposure is focused on domestic demand, which is expected to continue to grow due to higher disposable incomes and they believe that US threats of protectionism are probably exaggerated; any blanket imposition of tariffs would likely face a corporate backlash.

WTAN has employed a multi-manager approach since 2004. Should the executive team wish to add a new external manager, it first decides, in conjunction with the board, what type of manager is required. It then consults relevant databases and conducts internal research and due diligence, both qualitative and quantitative. This leads to having a final shortlist of at least three managers who present to WTAN’s board in London, a final decision is then made. External managers are reviewed by the board (including CEO Andrew Bell, and a number of individuals with significant investment management experience) at least annually. There is no set formula as to the duration of each manager’s tenure but, as Bell recently highlighted, the market backdrop is constantly shifting and changing circumstances can sometimes necessitate a change in manager. Other factors that can lead to termination are a change in personnel, style drift (when a mandated manager does not adhere to their stated investment methodology) or, more rarely, sustained underperformance.

Global managers manage around 45% of total assets, while Europe and Asian mandates account for 20% with the UK accounting for approximately 20%. Since February 2017, c 4% of assets have been invested in emerging markets. Around 10% of assets are managed internally in a direct holdings portfolio, which primarily comprises specialist investment companies trading on anomalous valuations. The direct investments portfolio has enhanced returns since being introduced in 2010: in 2016 its holdings in listed private equity funds, where discounts have narrowed across the board, performed especially well. Direct investments can also be made to access strategies that are too small to justify a separate mandate and too specialist to be accessed using derivatives. A recent example occurred in 2016 when WTAN invested in a small-cap emerging market OEIC managed by Somerset Capital Management.

Unchanged since 2007, the start of 2017 saw WTAN’s benchmark change – an emerging markets weighting of 5% was introduced to reflect the growing influence of emerging economies, while the North American weighting was increased by 5% to reflect the growing global dominance of US companies in technology and healthcare. From 1 September 2004 to 30 September 2007, the benchmark comprised 50% All-Share and 50% World (ex-UK). From 1 October 2007 to 31 December 2016 it was 40% All-Share, 20% All-World North America, 20% All-World Asia Pacific and 20% All-World Europe (ex-UK). Since 1 January 2017 the UK has reduced further, with the weightings at 30% All-Share, 25% All-World North America, 20% All-World Asia Pacific, 20% All-World Europe (ex-UK) and 5% Emerging Markets. According to Bell, the composite index reflects “where we think the opportunities are evolving over time for a global investor”.

In February 2017, WTAN allocated 4% of its net assets to GQG Partners. GQG is an emerging markets specialist recently set up by experienced active manager Rajiv Jain, who has a record of managing unconstrained portfolios. Apart from the addition of emerging markets, geographic weightings remain broadly unchanged since our last report in July 2016.

WTAN continues to advocate a high-conviction investment approach as a prerequisite for sustained outperformance. One measure of active management in a portfolio is known as ‘active share’, where a portfolio identical to the benchmark has an active share of 0%, while one with no holdings in common with its benchmark has an active share of 100%. The active share of WTAN’s combined portfolio was c 70% at the end of 2016 (2015: 66%). This suggests that, even with the diversifying effects of the multi-manager structure, WTAN's portfolio retains an active approach.

All the external managers set out in Exhibit 3 were in place throughout the year. Pzena and Tweedy, Browne had the strongest performance of the five global managers, benefiting from a broadening of investor interest to areas favoured by value managers, while Lansdowne had a relatively weak year (with a return of 14.4%), underperforming significantly during the first half of the year and improving a little in the second half of the year. In the UK, Heronbridge marginally outperformed the market. However, Artemis and Lindsell Train materially lagged the UK market, after four years of significant outperformance. Similarly, European manager, Marathon, underperformed. It is worth noting that the longer-term performance of all the managers that lagged in 2016 remains ahead of their benchmarks.

While the performance of the majority of external managers lagged in 2016, the executive management team’s direct holdings portfolio outperformed. Also, the deployment of gearing added 1.7% to NAV returns, while share buybacks added a further 0.6%. This boosted the total NAV return so that it ended the year broadly in line with its benchmark. Over the long term, WTAN’s track record is robust, as shown in Exhibit 6; it has now outperformed its benchmark over one, three, five and 10 years.

WTAN’s shares traded at an average discount to cum-income NAV of 5.8% in 2016, compared with an average 0.1% premium in 2015; the current discount is 3.8%. It remains the board and executive management team’s long-term objective to create sustainable liquidity in WTAN’s shares at or near asset value by issuing shares when trading at a premium to NAV and buying back at a discount. In doing so, the trust is both facilitating liquidity and enhancing NAV for continuing shareholders. During FY16, 18.9m shares were repurchased at a cost of £142.1m and in FY17 to date (4 April), 1.8m shares have been repurchased at a cost of £17.0m.

WTAN currently has 179.4m ordinary shares in issue. In October 2016, WTAN repaid its 8.5% debenture, which brought the average cost of its fixed borrowings down to 4.6%. Gearing is managed by WTAN; external managers are not allowed to employ gearing, but may hold cash. The level of gearing reflects the managers’ assessment of market conditions and was 11.0% at the end of February 2017, compared to the general range of 5-15% over the last five years.

WTAN’s ongoing charge for FY16 was 0.75% compared to 0.76% the previous year. When performance fees paid to external managers are included, the FY16 ongoing charge was 0.65% (1.04% for FY15). The lower figure including performance fees arose because accruals for performance fee liabilities at the end of 2015 were reduced owing to the underperformance of some external managers in 2016.

Along with capital growth, WTAN seeks to provide real dividend growth; it pays dividends quarterly in March, June, September and December. In FY16, the dividend was increased by 11.8% to 19.0p vs FY15 (17.0p), outstripping the 1.6% rise in the Consumer Price Index. WTAN’s revenue reserve is c 1.5x the FY16 dividend and the manager has confidence in the current year dividend outlook.

WTAN is one of the 24 trusts in the AIC Global sector. Exhibit 9 shows the 11 largest trusts, which all have market caps above £500m. Over most time horizons, WTAN finds itself towards the top end of the wider peer group in terms of NAV total return rankings. Of the peers shown, it was, until Alliance Trust followed suit, the only multi-manager trust in the selected group. However, unlike Alliance Trust, WTAN now has a well-established, 12-year-long record in multi-manager investing. The two trusts currently trade on similar levels of discount.

There are nine members of the board at WTAN; eight are independent and non-executive. Chairman Harry Henderson was appointed in 1988 and became chairman in 2003. The other seven independent directors with year of appointment are Tony Watson (senior independent director, 2006), Robert Boyle (2007), Catherine Claydon (2009), Richard Oldfield (2011), Suzy Neubert (2012), Jack Perry (2017) and Ben Rogoff (2016). The executive member of the board is WTAN’s CEO Andrew Bell (2010). As well as selecting external managers, the board also sets guidelines for the executive team to follow in the day-to-day management of the portfolio and this includes setting parameters on gearing levels. Hence, WTAN’s board has a somewhat broader remit than that of most other investment company boards, in overseeing the selection of external managers, as well as selecting its own executive team.