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Idiosyncratic Returns

1st March 2024

Investments capable of marching to the beat of their own drum, independent of the waxing and waning of economic factors and other financial assets are great things to own at the best of times, bringing lovely diversification benefits to multi-asset portfolios. With global equity markets increasingly concentrated and performance seemingly reliant on a small cohort of expensive US growth stocks (the top 10 stocks in the US account for 32% of that index whilst US equities are now almost 70% of MSCI World), we believe investments that possess idiosyncratic drivers of return are more attractive today than ever.

Investment trusts can act as a source of differentiated returns for a number of reasons. Firstly, the fixed capital structure makes them perfect vehicles for accessing less liquid alternative asset classes which will often possess risk-return profiles that differ to those exhibited by traditional equity and bond markets. This structural attraction is complemented today by a more cyclical feature where the prevailing confluence of historically wide discounts and increasing corporate activity has resulted in an exciting set of opportunities for experienced sector investors who are willing to spend some time sorting the wheat from the chaff and engaging with investment trust Boards to try and effect change.

As discussed in previous Crescendos, narrowing discounts, particularly from wide levels, can be a powerful driver of share price returns. Wide discounts when thinking about investment trusts as a source of differentiated performance are only one part of the equation, however, with rising corporate activity and an environment where Boards are increasingly open to engagement crucially important elements when thinking about catalysts for discount narrowing and the unlocking of shareholder value. Not all investment trusts are built equally when it comes to corporate governance standards, so it’s important to spend time thinking about the quality of the Board as well as any shareholder friendly provisions individual trusts might have in place which can help create each-way bets with positively asymmetric return profiles. These may include redemption facilities, tender offers, discount triggered buy-back programs and continuation votes, all of which can help accelerate the amortisation of discount narrowing. Redemption facilities (as well as some tenders) typically come at NAV less cost offering low risk arbitrage opportunities for investors to realise underlying value in a fairly mechanical way (albeit with exposure to movements in the NAV for those not hedging the underlying portfolio). Continuation votes meanwhile, and particularly those that coincide with an entrenched discount, tend to concentrate minds (the Boards) and can provide leverage to shareholders pushing for amended terms whether that be around fee arrangements or capital allocation where well communicated progress can act as a strong catalyst for share price recovery. A vote against continuation should lead to strategic review and in some cases a managed wind-down where the investment trust’s assets are sold with cash returned to shareholders. Understanding the liquidity of the underlying assets and the state of the transactional market are key considerations in determining the pace and efficacy with which capital is returned, but where there is reasonable confidence in the NAV, the managed wind-down of a trust trading on a wide discount can result in returns that are relatively predictable and, for alternative asset classes, independent of moves in traditional markets.

Investment trusts are, and always have been, an incredibly important part of our multi-asset portfolios and we are deeply immersed in the sector which leaves us well placed to try and identify some of the inefficiencies the market has to offer. We are also happy to roll up our sleeves and to try and drive change in cases where discounts have become entrenched. Engagement can be a time-consuming business but also a rewarding one given the outsized, uncorrelated returns that can result. The weighted average discount of the investment trusts we own in our Funds is around 26% and in most cases, there are identifiable catalysts for discount narrowing, whether that be due to external factors or as a result of our own proactivity. We wrote last month about some individual examples of the discount opportunities and inefficiencies we’ve identified and where our engagement is starting to bear fruit (here), including cases like RM Infrastructure Income and Tufton Oceanic.

The investment trust sector is undoubtedly facing a number of headwinds at the moment with misleading cost disclosure rules and wealth manager consolidation resulting in a difficult technical backdrop, which has led to a marked de-rating and a broader acceptance of the need for action to address stubborn discounts. For patient investors this confluence of factors presents an enviable combination of margin of safety, potential catalysts for the realisation of shareholder value and ultimately the opportunity to harvest attractive and wonderfully differentiated returns.

Ben Mackie – Senior Fund Manager

For professional advisers only. This article is issued by Hawksmoor Fund Managers which is a trading name of Hawksmoor Investment Management (“Hawksmoor”). Hawksmoor is authorised and regulated by the Financial Conduct Authority. Hawksmoor’s registered office is 2nd Floor Stratus House, Emperor Way, Exeter Business Park, Exeter, Devon EX1 3QS. Company Number: 6307442. This document does not constitute an offer or invitation to any person, nor should its content be interpreted as investment or tax advice for which you should consult your financial adviser and/or accountant. The information and opinions it contains have been compiled or arrived at from sources believed to be reliable at the time and are given in good faith, but no representation is made as to their accuracy, completeness or correctness. Any opinion expressed in this document, whether in general or both on the performance of individual securities and in a wider economic context, represents the views of Hawksmoor at the time of preparation and may be subject to change. Past performance is not a guide to future performance. The value of an investment and any income from it can fall as well as rise as a result of market and currency fluctuations. You may not get back the amount you originally invested. FPC2475.

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