The Brunner Investment Trust — A one-stop global equity shop for all weathers

Global stocks have performed considerably better than the UK market over the last decade (Exhibit 1, left-hand side). However, UK stocks have proved to be more resilient since the beginning of 2022, a period that has been characterised by high inflation, rising interest rates and above-average stock market volatility. The economic environment is uncertain as inflation remains elevated and the impacts of higher interest rates are feeding through, meaning investors are concerned about the risk of recession. Given this backdrop, it would seem prudent to take a longer-term perspective, focusing on high-quality companies with pricing power that are trading on reasonable valuations.

As shown by the Datastream World Index in Exhibit 1 (right-hand side), in aggregate, on a forward P/E multiple basis, global stocks do not look overvalued, as they are trading at a discount to their 10-year average. However, while earnings generally held up well in Q123, with deteriorating economic conditions, current earnings estimates may prove to be too optimistic, which reinforces the case for market participants to remain selective when considering potential investments.

Schneider refers back to when our last BUT report was published in November 2022, commenting that then all eyes were on inflation and rising interest rates. However, this year there is more discussion about risks to the economy and the potential for recession, given elevated inflation and higher interest rates. The manager notes that financing conditions are now more difficult, economic activity has declined and the war in Ukraine is ongoing, although inflation seems to be abating and central banks are more cautious about the risks to the economy from high interest rates. With cracks having started to appear in the US and European financial systems in March 2023 due to the failure of US regional banks Silicon Valley Bank and Signature Bank, and in Europe, UBS’s hurried acquisition of Credit Suisse, investors are concerned about what impacts these events will have on the wider economy. If there is a recession, there are question marks around its severity and duration. Schneider says that yield curves are implying that bond markets are now pricing in less aggressive rate hikes, as central banks are more wary about recession risks. The manager comments that while lower overall inflation is positive for the economy, some problem areas remain, such as in the services sector where higher wage rates are proving to be sticky. He suggests that central banks are concerned about a classic wage spiral; hence interest rates remain high despite elevated costs of living as central banks are trying to create some slack in the labour market.

Bishop emphasises that the managers do not take a macroeconomic view in terms of BUT’s portfolio construction. He suggests that the last few years have shown that this is a sensible approach as a pandemic, war in Europe and bank runs have ‘come out of nowhere’ and there has been ‘runaway inflation’. The manager says these unpredictable events demonstrate the benefits of having a robust portfolio, essentially an all-weather fund that can outperform regardless of the economic backdrop. This view is validated by BUT’s performance, as the fund has outperformed its benchmark for the last four consecutive financial years (ending in November) and is ahead in FY23 to date despite a range of stock market environments in the last five years. Bishop highlights that this outperformance has been generated from a fund of around 60 individual stock ideas, each of which has idiosyncratic risks, and a portfolio beta of close to one.

The manager says that many companies are reporting that sales growth is a function of higher pricing not increased volumes. A recent example is consumer products company Unilever, which reported strong organic sales growth led by higher pricing. Bishop comments that, in general, companies are surprised by how well the economy has held up despite inflation and higher interest rates. He explains that during the pandemic there was high demand for technology products as everything was moving online. However, subsequent growth rates slowed, and investor expectations were high, so technology stocks experienced a sharp correction in 2022. BUT benefited from this as it had no holdings in Amazon or Tesla, for example. Bishop reports that demand for technology products and services is stabilising. He comments that in the technology sector there is a lot of ‘buzz’ around artificial intelligence (AI).

BUT’s largest holding, Microsoft, has a significant stake in AI company ChatGPT, which the manager explains is helping Microsoft to deliver an improved proposition across all its product offerings. The company is very bullish on the prospects for both its cloud and on-premise products. Bishop comments that Microsoft has delivered outstanding results in an uncertain economic environment. He does not believe that the company is overvalued as it has so many good growth attributes. The manager explains that Microsoft’s products are deeply embedded in its clients’ businesses, which provides good growth opportunities. The company operates in an environment where there are barriers to entry, it generates high returns on capital, has no debt and is returning cash to shareholders; essentially, ‘it ticks a lot of boxes’, opines Bishop.

At end-March 2023, BUT’s top 10 holdings made up 32.0% of the portfolio, which was a modestly higher concentration compared with 30.9% at end-March 2022.

The largest geographic changes in BUT’s portfolio in the 12 months to end-March 2023 were a lower North American weighting (-3.5pp) and a higher allocation to Pacific ex-Japan (+2.0pp). Although stocks are selected on a bottom-up basis, at end-March there was a notable 16.5pp overweight position in Europe ex-UK, while the largest underweight exposure was the UK (-5.9pp).

Looking at changes in BUT’s sector exposure in the year ending 31 March 2023, the largest decrease was consumer discretionary (-3.2pp), while the largest increase was financials (+2.2pp). Compared with the benchmark, there were notable overweight positions in industrials (+8.8pp), financials (+5.5pp) and healthcare (+5.2pp). The largest underweight exposures were consumer staples (-4.4pp), basic materials (-4.1pp) and consumer discretionary (-3.2pp).

Schneider and Bishop discuss recent transactions in the portfolio. In March 2023, the position in UBS was sold as the company was forced to buy Credit Suisse in a deal brokered by the Swiss government and the central bank, which changed UBS’s investment case. The managers say it is an admirable bank with a large wealth manager business, which has low capital intensity, and has a sticky customer base. However, UBS’s balance sheet is now two times the size of Switzerland’s GDP, making it too large to be rescued if there are future problems. As the bank is higher risk, it will likely be subject to increased regulatory scrutiny and higher capital requirements, resulting in lower growth in profit and cash returns to shareholders.

There is a new position in business services company Rentokil Initial. Most of its revenues are generated from pest control, which the managers explain is a non-cyclical business with long-term growth opportunities, helped by growth in population, the global middle class and climate change. Rentokil is a global company with operations in Europe, the United States and emerging markets, providing services to both commercial and residential customers. The company recently acquired Terminix, a US termite-eradication business, which doubled Rentokil’s US pest control market share. Schneider and Bishop believe that the combination should be margin enhancing, with initiatives including reducing the number of branches and increasing route density.

In February 2023, the managers initiated a new position in DNB Bank. The company is Norway’s largest bank, and among the best capitalised in Europe, with high market shares in corporate and consumer loans, and other services such as investments and insurance. DNB has built up a strong balance sheet and generates sector-leading returns on equity. At the time of purchase, the bank’s shares looked attractively valued given the potential for further upward earnings revisions, and DNB returns cash to shareholders via a healthy dividend.

There were three new holdings in December 2022. Admiral Group is the UK’s largest motor insurer, with a c 14% market share. It benefits from industry-leading margins due to a low-cost structure and the sector is in an upcycle with very strong premium growth. The managers consider that Diageo is a steady, high-quality growth company. It is a multinational alcoholic beverage firm with more than 200 brands including Smirnoff, Baileys and Guinness. The company is gaining market share thanks to fast-growing categories such as tequila and whisky, and is benefiting from premiumisation (people trading up to higher-quality products). Diageo was purchased on a share-price pullback due to macroeconomic concerns. US-based Arthur J. Gallagher is one of the world’s largest insurance brokers; these businesses are capital light. The managers say that the company has a good long-term growth record, helped by rising insurance premiums, and it generates high levels of cash flow, providing opportunities for strategic mergers and acquisitions.

Last December, five positions were sold as the managers found better opportunities elsewhere. Schneider considers that activity in the month led to a ‘quality upgrade’ in the portfolio. Four of the disposals were: Ashmore Group (a UK emerging markets investment manager); Ecolab (a US company that provides water, hygiene and infection-prevention services); International Flavors and Fragrances (a US company that, as its name suggests, produces flavours and fragrances); and Intuitive Surgical (a US company that manufactures robotic products for minimally invasive surgery). The fifth sale was Adidas, which the managers admit had not been a successful position. It operates in a market where there is good end-market growth, but the company experienced a perfect storm. The global COVID-19 pandemic meant shops were closed, it has a large business in China, which was negatively affected by the country’s zero-COVID-19 policy, and the firm experienced supply chain issues. Adidas’s previous management team underperformed; for example, it was slow to market with new products, unlike its competitor Nike. While the company’s management has changed, Schneider and Bishop anticipate that any turnaround will be costly and protracted.

Schneider and Bishop discuss BUT’s performance attribution so far in FY23. Stocks that have made a positive contribution include:

Stocks that have detracted from BUT’s performance in FY23 include: Charles Schwab (a US financial services company whose share price has been negatively affected by the concerns about US regional banks); UnitedHealth (a major US healthcare services firm that has suffered from stock market rotation, as its shares performed very strongly in 2022); and Agilent (a US life science tools company, which has been another victim of stock market rotation).

BUT’s relative returns are shown in Exhibit 7. Its NAV has outperformed the benchmark over all periods shown. Over the last three years, the trust’s share price has lagged its NAV performance, leading to a wider discount. It is interesting to note how well BUT has performed versus the broad UK market over the last five and 10 years, illustrating the potential benefits of investing overseas.

BUT is one of 13 funds in the AIC Global sector. While the peers follow a variety of mandates, with its balanced approach of aiming to generate both capital and income growth BUT can be considered a ‘core’ or ‘all-weather’ fund. Its portfolio of high-quality companies is straightforward, with no unlisted firms or derivatives, and the managers are much more likely to invest in long-term growth opportunities rather than hyper-growth, more speculative businesses.

Despite high levels of stock market volatility over the last 12 months, BUT has retained its solid relative performance record, with above-average NAV total returns over the last one, three and five years, ranking seventh, second and sixth, respectively. Considering this achievement, one may consider that the trust’s above-average discount is unwarranted. BUT’s ongoing charge is in line with the mean, its gearing is modestly below the sector mean and its dividend is below average, ranking seventh out of 13 funds.

BUT has a very distinguished dividend history; its annual distributions have increased for the past 51 consecutive years, at an average rate above the level of UK inflation. In FY22, the trust’s earnings per share of 22.7p were 11.3% higher than 20.4p in FY21. The annual dividend of 21.5p per share was 6.7% higher year-on-year. After the payment of the FY22 final dividend BUT had 25.9p per share in revenue reserves (4.9% higher than 24.7p per share in FY21), which is equivalent to c 1.2x the FY22 distribution.

An overhang in BUT’s shares was removed following Aviva’s sale of its residual holding in the trust in April 2021. BUT’s discount subsequently narrowed, but widened again in 2022 in an environment of rising interest rates and increased investor risk aversion. Over the last year, the trust has broadly traded in a 10–15% discount range. The latest 11.0% share price discount to cum-income NAV is not dissimilar to the 10.6% to 11.9% range of discounts over the last one, three, five and 10 years.

BUT is one of the oldest UK investment trusts (launched in January 1927) and is listed on the Main Market of the London Stock Exchange. Former lead manager Matthew Tillett stepped down in July 2022 and the trust now has two co-lead managers: Christian Schneider, who is deputy CIO of AllianzGI’s global growth team, and Julian Bishop, who was formerly a global equity portfolio manager with Tesco Pension Investment. Schneider and Bishop work closely with Marcus Morris-Eyton, who is a growth equity specialist and Simon Gergel, who is AllianzGI’s CIO UK Equities.

The managers aim to generate long-term growth in capital and income from a diversified portfolio of global equities, and BUT’s performance is measured against a composite benchmark (70% World ex-UK Index and 30% broad UK index, versus a 50:50 split until 21 March 2017). To mitigate risk, a maximum 10% of gross assets (at the time of investment) may be invested in a single holding, while the portfolio must contain at least 50 stocks. Gearing of up to 20% of NAV (at the time of borrowing) is permitted. BUT has a long-term record of dividend growth: its annual distribution has increased in each of the past 51 consecutive years, compounding at a rate higher than the level of UK inflation.

The managers aim to generate long-term capital growth and a growing level of income from a portfolio of global equities that is diversified by geography and sector. BUT’s portfolio currently consists of 60 stocks, with 85% invested in companies with market caps greater than $10bn and is selected from an investible universe of c 6,000 securities. Positions may be sold if there is a change in the investment case, on valuation grounds or if a better opportunity is identified. Portfolio turnover is running at c 15% pa, implying around a seven-year holding period. The BUT investment philosophy is based on three pillars:

AllianzGI’s investment team is very well resourced, and along with portfolio managers and analysts focusing on fundamental research includes ESG specialists, the proprietary Grassroots market research platform and online discussion platform Salesforce Chatter.

BUT’s managers employ an integrated ESG strategy. This approach aims to incorporate material ESG risk considerations into BUT’s investment process, seeking to obtain a better risk/return profile for the fund. An analytical framework is used to manage tail risks and/or weaknesses in a company’s ESG profile. The integrated ESG approach does not restrict the investment universe, but BUT’s managers are required to monitor ESG risks for each portfolio holding. ESG analysis is considered an integral part of BUT’s fundamental research process and AllianzGI believes that there is a link between integrated ESG analysis and enhanced long-term shareholder value.

Every stock researched is considered in terms of its ESG credentials. If the managers are considering initiating a position in a company with a low ESG rating, they need to understand the issues and be able to justify the purchase (some low ratings relate to a lack of disclosure rather than bad behaviour). BUT’s managers regularly engage with investee companies, which has multiple benefits including enriching investment analysis and decision-making and helping to assess a firm’s leadership and culture. These meetings are not just about holding managements to account, but also about influencing company strategy, maybe in conjunction with other shareholders, and promoting effective governance, to help improve long-term performance. In particular, there is a focus on the sustainability of companies’ business models and factors such as the environmental impact of their operations, social policies and capital management.

BUT’s capital structure improved significantly following the repayment of two high-cost (11.125% and 9.25%) debentures in 2018. It now has £25m of fixed-rate 30-year 2.84% loan notes (repayable on 28 June 2048), a £10m short-term revolving credit facility (RCF) and £450k of 5% cumulative preference shares. The RCF is fully drawn down, its interest rate is set each month and is made up of a fixed margin plus SONIA. Under this agreement £10m was rolled over on 27 December 2022, with a maturity date of 27 June 2023. The repayment date of the revolving facility is the last day of its interest period, and the termination date is 27 June 2025.

AllianzGI is paid an annual management fee of 0.45% of gross assets minus short-term liabilities, excluding any funds managed by AllianzGI; it is charged in a 70:30 ratio between the capital and revenue accounts. In FY22, ongoing charges were 0.63%, which is in line with FY21.

BUT is a conventional investment trust with 42.7m ordinary shares in issue. Over the last 12 months, the trust’s average daily trading volume was c 37k shares. Although c 29% of BUT’s share base is owned by the Brunner family, there are multiple owners within the family, some of whom trade their shares.

At end-FY22, BUT’s shareholder base was split as follows: investment platforms 31.4% (vs 28.0% at end FY21); direct holdings including Brunner family members 29.4% (vs 29.5%); wealth managers 23.5% (vs 24.1%); financial institutions 12.6% (vs 15.8%); and other 3.1% (vs 2.6%). There is further increased retail demand for the trust’s shares as evidenced by the higher weighting on investment platforms, while demand from financial institutions continues to decline. Higher retail ownership has been helped by AllianzGI’s efforts to promote the trust to a wider audience.

BUT’s board has five independent, non-executive directors. It aims to have board members with backgrounds in investment, accountancy and law and a director with commercial expertise, who has a connection to the Brunner family, in order to provide a balanced line-up; Jim Sharp is connected to the Brunner family by marriage.

Elizabeth Field was appointed as an independent, non-executive director on 1 December 2022. She was a corporate lawyer for 35 years, gaining extensive experience of advising public and private companies on a wide range of corporate transactions across a variety of sectors, including investment trusts.

Peter Maynard retired at 2023 BUT’s AGM, which was held on 31 March. He had served on the board since October 2010, staying beyond his planned retirement date to provide continuity during the global COVID-19 pandemic.