Hansa Trust — Focus on long-term capital preservation & growth

After a year of low volatility and strong gains across most global equity markets in 2017, so far 2018 has seen a pick-up in volatility and, in some cases, a correction from all-time market highs. While the global economy is enjoying a period of synchronised growth, and company earnings are largely meeting or exceeding expectations, investors have increasingly focused on the risks they had been happy to put to one side in recent years, such as the possibility of trade wars, and the threat of rising inflation making missteps in central bank policy more likely. In such a climate, investors may prefer to hold a diversified portfolio of assets that are not completely correlated with global equity markets, or to focus on areas where the economic recovery has further to run.

Hansa Trust (originally Scottish & Mercantile Trust) was launched in 1912, and has been owned to a significant degree since the 1950s by the Salomon family, who have a long involvement in banking and finance. They remain majority owners of the 8.0m voting shares, but hold fewer of the 16m non-voting A shares. The Salomon family office, Hansa Capital Partners, is Hansa Trust’s investment manager, with portfolio manager Alec Letchfield also overseeing a portfolio of funds (Ocean Wilsons Investments, or OWIL) for UK-listed OWHL, in which Hansa has a longstanding strategic investment. OWHL in turn owns a majority stake in Brazilian maritime services company WSON. Exhibit 2 illustrates the ownership structure. Both Hansa Trust and OWHL trade at a discount to the underlying value of their assets; the look-through NAV (see Exhibit 3) is approximately 10.7% above the cum-income reported NAV as at 27 April 2018.

The OWHL investment (including WSON and OWIL) made up 31.0% of the Hansa Trust portfolio at 31 March 2018, largely reflecting the long-term success of WSON. The balance of the portfolio is invested in core regional funds, thematic funds in high-growth areas such as technology, healthcare and financials, diversifying assets such as hedge funds and fixed income, and direct holdings in global equities. The OWIL funds portfolio has a degree of overlap with the broader Hansa Trust portfolio, but also invests around one-third of its assets in private equity and private debt. The overall investment aim of Hansa Trust is to provide long-term preservation and growth of capital from a portfolio of assets that individual investors would be unable or unlikely to access.

Hansa Trust has recently moved to the AIC Flexible Investment sector. It has no performance benchmark but measures itself against a range of KPIs, including equity and bond indices and the rate of UK inflation. Gearing of c 10% of NAV is available but in practice is used mainly for short-term investment flexibility rather than to express an opinion on the direction of markets.

Letchfield comments that while the past three years have been all about getting Hansa Trust’s investment portfolio into its new shape, the process has now concluded – and is feeding through into decent performance numbers – with the last stage having been the transition in the direct equity portfolio from UK to global equities. Combined with the board and manager’s efforts to raise awareness of the strategy, the repositioning has helped to manage the discount. Although the discount remains wide in the context of peers, Letchfield views it as a ‘margin of safety’ compared with other trusts that may be trading close to or above NAV in a late-cycle equity market.

Although seeing the market as later-cycle, Letchfield retains a bias towards equities (both directly and via regional and thematic funds), reflecting robust economies, an improvement in corporate profitability and an absence of the normal excess associated with market peaks. He believes the current cycle will go on for longer than history suggests, because the recovery has been slow and there remains little sign of economic overheating or a real boom in corporate profits. Letchfield notes that there are clearly risks, from the length of the cycle to geopolitical worries, with inflation and the direction of interest rates also starting to worry markets. However, the trust’s allocation to defensive assets (mainly hedge funds) that has been in place since mid-2016 is expected to provide a degree of support in any market wobbles. “If markets keep going up, we will systematically increase the exposure to more defensive assets, but we are not in a rush to do so,” he adds.

Letchfield comments that WSON has been trading well in the context of a difficult market and Brazil’s struggles with corruption and political change and could do even better as the Brazilian economy continues to improve. “They have come to the end of a significant period of capex and that has implications in terms of cash generation and the ability to pay higher dividends,” he says. WSON’s two container ports play into rising global trade and favourable demographics, and its towage business has almost half of the tugboat market in Brazil. Meanwhile, says Letchfield, its offshore support vehicles business, which had been adversely affected by the oil price collapse and the Petrobras corruption scandal, has good scope for recovery against a backdrop of improving oil prices and a liberalisation in Brazil’s pre-salt oilfields, opening them up to foreign producers.

Hansa Trust’s investment approach is based on blending a number of ‘silos’ to create a diversified portfolio, with the flexibility to move dynamically from higher-risk to more defensive assets in response to market conditions. Fund manager Alec Letchfield, a multi-asset investment specialist, joined Hansa Capital Partners from HSBC in late 2013 and began reorganising the portfolio (previously made up mostly of UK equities plus the strategic stake in Ocean Wilsons/Wilson Sons) from early 2014. In early 2017, John Alexander, who had managed the UK equity portfolio, retired. Investment manager Rob Royle, who joined from Smith & Williamson in late 2016, now runs the trust’s direct equity exposure, which has transitioned from a UK to global portfolio. In addition to overall responsibility for the Hansa Trust portfolio, Letchfield also manages the OWIL portfolio, to which Hansa Trust is exposed through its strategic holding in OWHL.

Letchfield’s aim is to build a portfolio of assets that individual investors would otherwise be unable or unlikely to access and seeks to invest with third-party managers offering a similar focus on capital preservation and alignment of interests. This may include other family offices (such as the Ritblat family office vehicle DV4, a property fund that is one of Hansa Trust’s top 10 holdings), or boutique fund management groups where the founders have invested significant sums of their own capital.

The overall emphasis on preservation and growth of real capital leads Letchfield to have a natural bias to equities, although there is a defensive allocation to hedge funds (in place since mid-2016), currently c 11% of the portfolio, which could be increased if equity market valuations become more extended. Asset class and regional exposures across the portfolio are the product of top-down allocation, although individual investments are selected on a bottom-up basis as a result of detailed fundamental analysis. In the direct equity portfolio, Royle seeks to invest in cash-generative businesses that have improving prospects and are able to invest for long-term growth. Some of the directly held equities may also be holdings in funds in the Hansa Trust portfolio, reflecting the managers’ greater conviction in what would otherwise be very small underlying positions. Letchfield aims to blend the exposures in the various silos so that investments complement each other and, in the case of the diversifying assets, possess lower correlations.

At 20 February 2018, Hansa Trust had 54 holdings. These included 16 core regional funds, four UK and 18 global direct equity holdings, three thematic sector funds, 12 diversifying funds (including the OWIL funds portfolio as one) and the strategic stake in WSON. The top 10 holdings at 31 March 2018 made up 61.5% of the portfolio (30.5% for the top nine excluding OWHL), broadly unchanged on 62.0% (31.3% ex-OWHL) a year earlier.

As shown in Exhibit 4, on a look-through basis (excluding WSON but including OWIL) the largest sector exposure at 31 March 2018 was to information technology, through specialist funds such as GAM Star Technology, regional funds like Findlay Park American, and directly in companies such as Alphabet (Google). Financials and consumer discretionary stocks were also major areas of focus. Geographically, North America was the largest exposure, but was a significant underweight versus the MSCI AC World index. Europe was also below the index weighting, with all other regions, including the frontier markets, Asia and Japan, being overweight.

In silo terms, the core regional allocation increased by 2.6pp over 12 months to 31 March 2018, while the global equity allocation was broadly unchanged, at 16.5% versus 16.6% a year earlier. The thematic & diversifying silo and the WSON weighting also remained broadly stable, while the level of net cash reduced from 2.1% to 0.2%. The period saw the equity holdings transition from a UK to a global portfolio following the retirement of John Alexander and the recruitment of Rob Royle. Those UK stocks that remain in the portfolio, such as property firm Hansteen Holdings and Hilton Food Group, have been retained on merit within the context of the global allocation.

Hansa Trust conducted a strategic review in early 2014, following which it has progressively shifted to its new structure. Over this period the trust has delivered NAV total returns of c 6-7% pa over one, three and five years to the end of March 2018 (Exhibit 5). Share price total returns over the past 12 months were particularly strong, narrowing the discount to NAV. The recent equity market wobble has affected short-term performance versus UK government bonds and the rate of inflation (Exhibit 6), and a strong recovery in Brazil is not fully reflected given WSON only makes up c 20% of Hansa Trust’s portfolio. However, over six months to three years, the trust has beaten most of its KPI measures. Strong performance in 2017 (Exhibit 7) came from holdings such as GAM Star Technology in the thematic silo, Goodhart Hanjo in the core regional portfolio, and Hansteen Holdings, which returned almost half its market value in cash, in the direct equity allocation. OWHL was the largest single contributor, performing in line with its weight, at c 30% of the net portfolio return. Detractors were relatively few and their impact was limited.

At 27 April 2018, Hansa Trust’s A shares traded at a 28.9% discount to cum-income NAV. While high in relation to many investment trusts (the industry average is currently c 3.9%), this is close to or below the averages for the past one, three and five years (29.7%, 30.6% and 28.6%), following an appreciable narrowing over the past 12 months. OWHL also trades at a discount to the value of its underlying assets, so there is a look-through discount of c 34%. While Hansa Trust’s board is able to buy back the A shares to manage a discount, it has stated that it is unlikely to do so, as this would shrink the trust, reduce liquidity in the shares, inflate the size of the OWHL holding as a percentage of the portfolio, and reduce the manager’s investment flexibility by requiring him to hold more liquid assets. Instead, the board is focusing on improving investment performance and increasing demand for the strategy through marketing.

Hansa Trust has two classes of share. A majority of the 8.0m ordinary shares with voting rights are owned by or on behalf of members of the Salomon family. There are also 16.0m A shares that do not carry voting rights. A buyback authority permits the board to repurchase up to 14.99% of the A shares, although in practice this is not used. Gearing is permitted up to an informal limit, currently equivalent to c 12%. A £30m loan facility is in place with BNP Paribas, which is undrawn. The facility is intended to provide flexibility in the timing of investments, rather than as long-term strategic gearing; however, if fully drawn, it would represent gross gearing of c 9% based on 27 April 2018 net assets.

Hansa Capital Partners receives an annual management fee of 1% on net assets, after deducting the value of the stake in OWHL. There is no performance fee. Ongoing charges were 1.0% in FY17, compared with 1.2% in FY16.

Hansa Trust pays two dividends a year, in November and May. Since the start of FY15, the board has given guidance in the annual report on the expected level of dividends for the year ahead. So far these forecasts have consistently been achieved, with total dividends of 16.0p paid in each of the last four financial years, and 16.0p declared (8.0p paid so far) in FY18. Dividends have been partly uncovered by income in four of the past five years, but Hansa Trust’s revenue reserve at 31 March 2017 was equivalent to 75% of the annual dividend and the trust also has large distributable capital reserves, which can be used to top up the dividend in the event of an income shortfall. Based on the declared dividends for FY18, Hansa Trust’s shares currently yield 1.6%.

Hansa Trust has recently moved to the AIC Flexible Investment sector (which includes more absolute return-focused and funds of funds) from the Global sector. The peer group in Exhibit 9 below consists of those trusts that Hansa Trust’s board and managers deem most comparable. However, because of the trust’s unique structure, it is hard to draw direct comparisons with the peer group. Hansa Trust’s NAV total return performance is above average over one year (ranking first in the group), broadly in line over three and five years, and below average over 10 years. Ongoing charges are in line with the average, and there is no performance fee. Hansa Trust’s two share classes trade at the widest discounts to NAV in the group, while gearing is below average and the dividend yield is above average.

There are five directors on the board of Hansa Trust, four of whom are independent of the manager. Alex Hammond-Chambers has been a director since 2002 and was appointed chairman in 2004. Geoffrey Wood joined the board in 1997, and Jonathan Davie and Raymond (Lord) Oxford were appointed in 2013. William Salomon has been a director since 1999 and is deemed non-independent. He is the senior partner of Hansa Capital Partners and is also deputy chairman of OWHL and WSON. The directors have professional backgrounds in asset management, academia, capital markets and the diplomatic service. The portfolio manager and board regularly visit Brazil to ensure oversight of the large holding in OWHL/WSON.