Witan Pacific Investment Trust — Changes to the multi-manager line-up

Exhibit 2 (LHS) shows the absolute and relative performance of Asian equities over the last five years. Following a multi-year period of underperformance, over the last 12 months Asian equities have outperformed global equities. Earnings revisions in the region have been positive, in contrast to several prior years, where earnings forecasts started the year too optimistically and had to be revised down. Japanese equities have participated in the Asian stock market rally and have been particularly strong over the last few months (since early September 2017, the Nikkei 225 index is up by c 16%). Policies implemented under Prime Minister Shinzō Abe have led to an improving economic outlook and there is an increased focus on corporate governance in the country, potentially making Japan more appealing to international investors. Despite the near-term relative outperformance of Asian equities, on a forward P/E multiple basis they remain relatively attractively valued. As shown in Exhibit 2 (RHS), Asian equities are currently trading at a 10.8% discount to world equities, which compares with a 10.0% average discount over the last five years.

WPC aims to generate capital and income growth from a diversified portfolio of Asia Pacific equities. In May 2005, the trust adopted a multi-manager investment approach and Witan Investment Services (WIS, a subsidiary of Witan Investment Trust) took on an executive manager role reporting directly to the WPC board. Funds were initially allocated equally between Aberdeen Asset Management and Nomura. In April 2012, the Nomura funds were reallocated to Matthews International and Gavekal Capital. In September 2017, Gavekal was dropped and two new managers were hired: Dalton Investments and Robeco Institutional and the portfolio was reallocated. At end-September 2017, WPC’s portfolio was split as follows: Aberdeen (25%), Dalton (10%), Matthews (40%) and Robeco (25%). WPC is the only investment trust with a broad Asian remit that includes Japan, Australia and India; it is benchmarked against the MSCI AC Asia Pacific Free index (in sterling terms). Since the adoption of the multi-manager strategy to the end of H118, WPC’s NAV annualised total return of 10.3% compares with the benchmark total return of 9.8% pa.

We met with WIS’s investment director, James Hart. He says that Asia is participating in the global economic recovery, with corporate earnings picking up for the first time in four to five years. He also notes that government initiatives across the region to promote wage growth are now coming to an end, enabling corporates to keep a growing share of the growing pool of profits. There has also been an improvement in shareholder rights and corporate governance in Asia, which is generating more money for shareholders. This is evident at Samsung, which is owned by three of WPC’s four external managers, with the company returning cash to shareholders via higher dividends and share repurchases. Hart comments that Asia is an attractive region; it is home to 60% of the global population and is growing faster than most of the developed world.

Hart reports that on the board’s latest trip to Asia in February 2017 the directors spent some time in Japan, where they gained the impression that, for the first time in many years, there was a feeling of optimism among investors. While Prime Minister Abe’s policies have been slow to take effect, the benefits are now coming through and GDP growth is sustained, albeit at a low level. Hart says that Japanese businesses are integrating more with other Asian markets, including locating factories in China, which is leading to a significant increase in external demand. He believes these actions will allow Japanese corporate earnings growth to move closer to that seen across the wider Asian region. Hart’s view is that Japan has been ignored by many investors over a long period due to its lack of economic growth, so WPC’s broad mandate that includes the country has been seen as unfashionable. However, Hart believes that Japanese companies can compete for capital on a global scale and since mid-2013, the performance of Japanese equities is broadly comparable to equity markets across the rest of Asia.

WPC aims to generate long-term growth in capital and income from a diverse portfolio of Asian equities and outperform its benchmark MSCI AC Asia Pacific Free index (£). The geographic remit is broad and includes exposure to Japan, Australia and India. The board is responsible for monitoring and hiring external managers as well as allocating capital between them. The directors travel to Asia every two to three years to meet with existing and potential new managers.

In September 2017, WPC appointed two new external managers, aiming to broaden the trust’s opportunity set: Dalton Investments and Robeco Institutional Asset Management (see Exhibit 3 for details of their management styles), while reducing exposure to incumbent managers Aberdeen and Matthews and dropping Gavekal. Dalton is an independent investment boutique established in Santa Monica, California in 1999; it has c $3.3bn in assets under management. Robeco is owned by Tokyo-listed financial services company ORIX Corporation. Its Asian equity team has been in place since 1990 and has c $7bn in assets under management, run out of its Hong Kong office.

All four external managers are benchmark agnostic, they select stocks on a bottom-up basis, so the trust’s geographic and sector exposure is a residual of the investment process. No manager may hold more than 10% of their portfolio in any one company, but in aggregate, WPC is unlikely to have more than 5% of its portfolio in a single company. The managers may hold a percentage in cash, but are expected to be at least 80% invested in equities. They have active shares between 80% and 90%, which combines to 71% for WPC. This is a measure of how far a portfolio deviates from the benchmark, with 0% representing full replication and 100% representing no commonality. The board is excited by the new multi-manager line-up, which offers diverse exposure to the Asia Pacific region both geographically, by sector, and across the market cap spectrum.

At end-October 2017, WPC’s top 10 holdings comprised 18.1% of the portfolio, which was a lower concentration versus 20.9% at end-October 2016; six positions were common to both periods.

WPC’s exposure to the financials sector has increased by c 6pp over the last 12 months, including the weighting in Japanese banks, which was increased in late-2016 in response to the changing outlook for global interest rates. In addition, Gavekal’s portfolio had very low Japanese exposure, while the two new managers have closer to benchmark exposure, thus lifting WPC’s overall weighting to Japan.

In H118 (six months to end-July 2017), WPC’s NAV and share price total returns of 10.5% and 12.8% were meaningfully ahead of the benchmark’s 9.6% total return. The trust also has good relative performance over the long term (as shown in Exhibit 7). Since adopting the multi-manager strategy on 31 May 2005 to end-July 2017, the trust’s NAV and share price annualised total returns of 10.2% are above the benchmark’s 9.8% annualised total return. However, as shown in Exhibits 6 and 7, over one, three and five years, WPC’s total returns lag the benchmark, although they are ahead over 10 years. The board acknowledges the short- and medium-term underperformance, which it is hoping will be addressed by the appointment of the new managers: Dalton and Robeco and the reallocation of WPC’s assets across the revised four manager line-up, which retains incumbent managers, Aberdeen and Matthews.

WPC’s share price discount to cum-income NAV remains persistently wide despite a recent acceleration in share repurchases (Exhibit 1). The current 13.3% discount is broadly in line with the averages of the last one, three and five years of 13.5%, 13.3% and 13.2% respectively.

The board considers it is in shareholders’ interest to repurchase shares when they are trading at a substantial and anomalous discount to NAV. So far in FY18, 1.7m shares (2.7% of shares in issue) have been repurchased at a cost of £5.2m. There is scope for the discount to narrow alongside a sustained improvement in WPC’s relative investment performance or if investor demand increases for a fund with broad Asian exposure, that offers a ‘one-stop-shop’ for investment in the region.

WPC is a conventional investment trust with one class of share in issue; there are currently 63.3m ordinary shares outstanding. It is registered with the FCA as a small UK AIFM under the Alternative Investment Directive; as a result it does not employ gearing. This status is reviewed periodically by the board to assess the costs versus the potential benefit that gearing could add.

The board aims to hold ongoing charges below 1% (excluding performance fees); in FY17, they were 1.03% versus 1.05% in FY16, with management fees paid to the external managers and WIS totalling 0.65%. External managers are paid a management fee between 0.20% and 0.85% of assets under management. The changes to the overall fees following the appointment of Dalton and Robeco are negligible. Aberdeen charges a lower base fee than the other managers, but is eligible for an additional performance fee based on performance relative to the benchmark (no performance fee has been paid since FY15). Effective 1 February 2017, management fees are charged 75% to the capital account and 25% to the revenue account, rather than 100% to the revenue account, which reflects the boards expectation for the long-term split of WPC’s returns between capital and income.

WPC aims to increase the annual dividend in real terms over the long term; it pays dividends twice a year in June and October. The regular dividend has increased in each of the last 12 years. In FY17, the annual dividend of 4.75p was 2.2% higher than in FY16, which is modestly lower than the 3.5% average annual growth over the last five years; the FY17 dividend was 93% covered by revenue. At H118 (July 2017), the revenue reserve was £11.3m, which is equivalent to c 3.7x the last annual dividend. The change in allocation of management fees noted above will result in a relative increase in revenue earnings available for distribution from the current financial year.

WPC is the sole member of the AIC Asia Pacific including Japan sector, so in Exhibit 10 we compare it to the weighted average of the AIC Asia Pacific ex-Japan sector and the open-ended funds in the IA Asia Pacific including Japan sector. WPC has underperformed the weighted averages of the closed- and open-ended funds over the periods shown. The board acknowledges that the trust’s performance has not met expectations and has taken steps to address this via the recent changes to the multi-manager line up and capital allocation between the four external managers. WPC has a competitive ongoing charge, although a performance fee is payable. Its dividend yield is higher than the open-ended peer group average, but lower than the Asia Pacific ex-Japan closed-end fund average.

There are five directors on the board of WPC. Chairman Susan Platts-Martin was appointed in July 2014 and assumed her current role in June 2017, following the retirement of Sarah Bates. Dermot McMeekin was appointed in May 2012, Diane Seymour-Williams in June 2010 and Andrew Robson in July 2014. The newest member of the board is Chris Ralph, who has served as chief investment officer at St. James's Place since 2009; his directorship commenced on 1 July 2017. He has over 30 years' experience in financial services, which includes over 15 years' experience of investment manager selection and monitoring. He has extensive knowledge and experience of the Asia-Pacific region and is chairman of the St. James's Place Asia investment committee. Ralph was involved in the selection of the two new external managers.