Lazard World Trust Fund — Global opportunities with new 6% dividend policy

Global equity markets have performed strongly in the years since the financial crisis, and particularly so in the past two years, with the main US and UK indices hitting multiple all-time highs. While the recent spell of volatility may have brought 12-month forward P/E valuations back from extremely elevated levels, in aggregate they remain above long-term averages (Exhibit 2, right-hand table). However, while the US has led the global recovery, emerging markets – which arguably display better fundamentals, based on rising domestic demand and positive demographic factors – have lagged (left-hand chart). Against such a backdrop, a strategy that focuses on accessing emerging market growth at discounted prices could find favour with investors.

WTR was launched in 1991 as The World Trust Fund, taking on its current name in May 2016. It is incorporated in Luxembourg, listed on the London Stock Exchange and managed by the New York-based Discounted Assets team at Lazard Asset Management. Its shares are denominated in sterling and its financial reports are in US dollars and sterling. The fund aims to achieve capital growth from a portfolio of CEFs and holding companies that the managers believe are trading at unjustifiably wide discounts to the value of their underlying assets, and where the assets themselves are also undervalued. It has a particular focus on Asian and emerging markets, and uses the MSCI AC World ex-USA index as a benchmark, reflecting its general lack of US exposure. Having begun paying dividends in 2014, WTR adopted a higher distribution policy in 2016, whereby it paid out 3.0% of its year-end NAV in two instalments. This has recently been revised to 6.0% paid quarterly (the first tranche payable in August 2018), which the board and managers hope will help the strategy stand out in a rising interest rate environment.

WTR’s management team has a long-standing bias towards funds or companies investing in emerging rather than developed markets. This is partly informed by the pace of change in developing markets, where the greater growth opportunities are likely to be less well understood by mainstream investors, leading to valuation anomalies. However, even where investors are ‘up with events’ – as seen in the rapid growth of Chinese internet companies such as Tencent and Alibaba – WTR’s strategy has allowed it to gain exposure at a discount through holding companies such as Naspers, which has a large stake in Tencent; Altaba, a Yahoo! spinout with a significant investment in Alibaba; and Fidelity China Special Situations. Deng points out that while Altaba (currently WTR’s largest holding) still trades at a large discount to the value of its stake in Alibaba, the main purpose of spinning it out of Yahoo! was to eliminate this discount as fast as possible, so there could be significant near-term upside in the Altaba share price. Altaba’s discount widened by 500bp in the market volatility earlier in 2018, providing an opportunity for Deng to add to the holding.

The fund also has exposure to China through Morgan Stanley China A Share, a US CEF. While the team sees little attraction in investing in the domestic US stock market, which is currently highly valued, holding US CEFs is a good way to keep up a flow of income into the WTR portfolio, as CEFs must pay out 90% of their investment income and 98% of realised gains to shareholders. The flow of income and capital distributions from these funds is an important support for WTR’s own higher distribution policy. Deng says that having spent the past five years encouraging WTR’s portfolio holdings to introduce or increase distributions to create shareholder value, it made sense for the fund itself to follow suit. “WTR is a total return fund capitalising on opportunities around the world, with a fairly aggressive, high-dividend policy,” he adds.

WTR invests in listed funds or holding companies that offer capital growth potential but are trading at a discount to NAV or sum-of-the-parts valuation, and whose assets are also undervalued. The strategy is opportunity-based, with the managers taking a flexible approach to portfolio construction according to where they see the best return potential (either short- or long-term) at the most attractive valuations. The Discounted Assets team at Lazard Asset Management, led by Kun Deng in New York, runs WTR alongside other portfolios and is solely focused on this area of opportunity. The four portfolio manager/analysts, supported by a client portfolio manager and a dedicated trader, can also draw on the wider macro and industry views of the Lazard Asset Management group.

When assessing potential investments, the managers look for catalysts for revaluation, not just for the fund or company itself but also its underlying investments. They also seek to reduce discounts proactively, such as encouraging the payment of a higher dividend or returning capital to shareholders, or, occasionally, a change of manager or strategy. The managers describe this engagement as quiet, behind-the-scenes activity, not high-profile public ‘activism’. The overall aim is to build a diversified but high-conviction portfolio with the potential to outperform WTR’s benchmark (MSCI AC World ex-USA) and peers in both rising and falling markets.

The investment process broadly has four stages:

WTR may take short positions in equity markets or hedge its currency exposure. There were no short positions or hedges in place at 30 April 2018.

At 30 April 2018, there were 33 holdings in the WTR portfolio, the same number as at the end of FY17 (31 March 2017). The top 10 holdings made up 50.9% of the portfolio, compared with 48.7% a year earlier, and the average discount to NAV for the top 10 holdings was 19.5% (30 April 2017: 20.7%). There were no short positions at either 30 April 2018 or 30 April 2017, and net cash stood at 2.0% compared with 0.6% a year earlier. There have been relatively few changes to the portfolio in FY18. Four new holdings – Templeton Dragon, Altaba, Wendel and Softbank – were added in H118, while General American Investors and Liberty All Star Equity (both US funds) were sold. The Templeton Dragon purchase was a tactical move to access a capital distribution (the fund was bought at a discount but the distribution was effectively at NAV), and the position was subsequently sold in H218. There were no other new investments or complete exits in H218.

The two major themes in the portfolio are technology (the largest look-through sector exposure at 21.5%) and China (also 21.5% at end-March 2018). These themes come together in new holdings Softbank (a Japanese holding company) and Altaba (a spinout from Yahoo!), both of which offer discounted exposure to Chinese e-commerce giant Alibaba, in the same way that previous largest holding Naspers is a proxy for the Chinese internet stock Tencent. Deng comments that China’s take-up of mobile payments is far higher than in the West, with Alibaba “at the forefront of creating a cashless society”. Altaba owns 15% of Alibaba (among other assets), a stake worth $75bn based on Alibaba’s 24 May share price, yet Altaba’s own market capitalisation is only c $62bn.

The majority of the top 10 stocks have a focus on Asian and emerging markets, with three of the largest (Altaba, Fidelity China Special Situations and Morgan Stanley China A Share) being mainly exposed to China. Deng comments that a period of volatility sparked by fears of a US/China trade war caused discounts to widen, presenting an opportunity to add to holdings at lower valuations. Compared with the benchmark, WTR is very overweight emerging Asia (including Vietnam and India as well as China), and very underweight developed Europe. The managers took profits in Eurazeo, previously a top 10 holding, after the discount narrowed substantially (reflecting a greater market appreciation of Eurazeo’s investment business), and topped up the holdings in Investor AB (where the discount widened on Swedish krona weakness) and French holding company Wendel.

Following the sale of General American Investors and Liberty All Star Equity, there is no explicit exposure to the US; however, on a look-through basis there are some US stocks in underlying funds such as International Biotechnology Trust, reflecting the fact that most of the biotech investment universe is US-listed.

WTR’s share price has posted strong gains over 12 months to 31 May 2018 (Exhibit 4), with a total return of 16.3% versus 6.9% for the benchmark MSCI AC World ex-USA index. However, the 5.5% NAV total return lagged the benchmark. The shares have also outperformed the blended benchmark over three and five years, while the NAV total return is behind the blended benchmark (including the US until 31 March 2016) over these periods, but ahead of the current ex-US benchmark (Exhibit 5). Over one year to 30 April 2018, the top contributors to NAV returns (adding a total of 5.7pp) were Naspers, Fidelity China Special Situations (FCSS) and Eurazeo. The top detractors (costing 1.8pp) were First Pacific, GP Investment and Jardine Strategic. More recent periods have been less positive in both relative and absolute terms, although there was an upturn in April. Year-to-date (to 30 April 2018), the top contributors (Fondul Proprietatea, FCSS and Morgan Stanley China A Share) added 0.8pp to returns, which was outweighed by a negative contribution of 1.7pp from the top three detractors, First Pacific, Wendel and Naspers. (Figures from WTR in US dollar terms.)

At 13 June 2018, WTR’s shares traded at a 3.3% discount to cum-income NAV. This was appreciably narrower than the average discounts over one, three, five and 10 years (7.8%, 11.3%, 11.6% and 11.4%, respectively), and follows a marked rerating since the latest continuation vote in August 2017. While this means the ‘double discount’ is lower than it has been, WTR’s managers stress that the primary opportunity is in owning discounted assets at the portfolio level. The discount may narrow further following implementation of the new 6.0% distribution policy, which the board and managers argue is a fairer way of returning cash to shareholders than periodic tender offers.

WTR is a Luxembourg-incorporated CEF (SICAF), listed on the London Stock Exchange. It has 35.7m ordinary shares in issue, with a further 10.9m in treasury. There is a continuation vote at the AGM each August. WTR only narrowly passed the 2017 vote, but the board and managers hope the revised dividend policy will be sufficiently well received by investors to ensure the fund’s future at the 2018 vote. A tender offer may also be proposed as a means of managing the discount to NAV and providing an exit opportunity at a predetermined price; the last tender was in 2016, since when the discount has narrowed substantially. Gearing is available via a $25m loan facility (c 12% of NAV based on 22 May exchange rates). However, the facility is currently undrawn and WTR has a small net cash position. Lazard is paid an annual management fee of 0.75%, and a performance fee may be paid on a sliding scale of between 5% and 20% of outperformance of the benchmark, measured over two years. No performance fee was paid in respect of FY17 or FY16.

The board of WTR recently revised the fund’s dividend policy for the second time in two years, in recognition of the attractiveness to investors of a high regular income. Under the previous policy (in place since FY17), a distribution equal to 3.5% of the previous year-end NAV was paid in two equal instalments. With effect from 1 April 2018 (the start of FY19), the distribution has been increased to 6.0% of NAV at the start of the financial year, paid in equal quarterly instalments. A second dividend of 6.4925p was paid on 8 June, bringing the total distribution for the year to 12.985p. It is intended the new quarterly dividends will be paid in August, November, February and May. While the first dividend for FY19 has not yet been declared, we anticipate (based on the 2 April NAV of 384.3p) that it will be c 5.7645p, being one-quarter of 23.058p, which is 6.0% of the opening NAV for FY19. Based on the current share price and the FY18 dividends, WTR yields 3.3%. The prospective yield under the new policy is 5.9%, which would make WTR one of the highest-yielding equity investment companies in the AIC universe. The current average dividend yield across all AIC sectors is 3.2%. Dividends may be partly funded from capital, although WTR’s managers point to a high level of distributions (either through dividends or share buybacks) from underlying holdings, meaning that the 3.5% dividend has been largely covered by income.

WTR is a member of the AIC Global sector; however, increasingly investment companies that follow a comparable strategy of investing in other CEFs are to be found in the Flexible Investment sector, launched at the beginning of 2016. Exhibit 8 below includes funds of funds from both sectors. WTR, British Empire and JPMorgan Elect Managed Growth are in the Global sector, while F&C Managed Portfolio Growth, Henderson Alternative Strategies, Miton Global Opportunities and Seneca Global Income & Growth are in the Flexible Investment sector. Within the group, WTR’s NAV total returns are broadly in line with the average over one and three years, ahead over five years and behind over 10 years. The discount to NAV and the level of gearing are also broadly average. Ongoing charges are higher than peers, and WTR also has a performance fee. The dividend yield is the second-highest in the group, and will be the highest by some margin under the new dividend policy.

WTR has five non-executive directors, all independent of the manager. The chairman (since 2010), Philip R McLoughlin, joined the board at the fund’s launch in 1991. Duncan Budge was appointed in 2006 and James Cave became a director in 2008. Howard Myles joined the board in 2011 and is chairman of the audit committee. The newest director, Tony Morrongiello, was appointed in 2014. The directors all have backgrounds in investment management.