The Bankers Investment Trust — Global outperformer on track for 53rd divi increase

Despite significant risk factors from geopolitics and slowing economic growth, global stock markets – once more led by the US – have posted good gains so far in 2019, with the FTSE World Index up 21.6% in sterling terms from 1 January to 30 November. Even UK equities – for most of the year one of the least favoured asset classes among global investors – have produced total returns of 15.3% (measured by the FTSE All-Share), close to double the 10-year average of 8.2% pa. Admittedly these above-average returns are partly due to a flattering starting point, following the sharp sell-off in Q418. However, investor sentiment recovered through the year following a return to more supportive monetary policy measures in the US and Europe, with liquidity boosted by a return to bond purchasing at both the Federal Reserve and the European Central Bank (ECB). But while this may have mitigated risks to an extent, safeguarding the US from an overtightening-induced recession, we still have to contend with the ongoing US-China trade dispute, the mechanics of what now looks like a near-certain Brexit, and US elections in November 2020. Furthermore, after a decade-long bull market in most regions, valuations (Exhibit 2, right-hand side) look somewhat stretched relative to historical averages. While recent history has shown that what goes up can easily go up some more, investors with a focus on not overpaying for growth may be better rewarded in the long term.

Launched in 1888, The Bankers Investment Trust (BNKR) is one of the UK’s oldest investment companies. Alex Crooke, co-head of equities at Janus Henderson Investors (JHI), has been BNKR’s fund manager since 2003. The trust invests globally with the aim of achieving capital and income growth from a portfolio of equities. Crooke, in conjunction with the board of directors, sets the level of gearing and the geographical allocation. The portfolio is managed on a regional basis by specialists from across JHI’s global equity teams, each of whom runs a relatively concentrated selection of stocks chosen with a broad bias towards value and income. The regional portfolios are UK, North America, Europe, Japan, Pacific (excluding Japan and China) and China A-shares. BNKR measures its performance versus the FTSE World Index and is a member of the Association of Investment Companies’ Global sector. The trust may invest up to 20% of its assets in fixed income securities, but in practice does not tend to do so. Gearing is permitted up to 20% of net assets, with borrowings coming from a mixture of low-cost long-term loan notes (£50m), a debenture maturing in 2023 (£15m) and a flexible bank loan facility (£20m).

As well as seeking to achieve capital growth in excess of the FTSE World Index, BNKR also aims to grow its annual dividend (paid quarterly) ahead of the rate of UK RPI inflation. It has the joint-longest record of year-on-year dividend increases for an investment company, having increased its dividend every year since 1966.

Crooke explains that while he is not bearish on the medium-term outlook for markets, he feels the prudent approach in the current environment has been to take profits in a number of BNKR’s holdings and move from a geared to a net cash position. ‘Year-to-date, markets have gone up quite a bit – the US is up more than 25% in sterling terms, and Europe is up 20%,’ he says, adding that market earnings growth expectations have been downgraded, although they are not yet negative. ‘I don’t believe we are facing Armageddon and a US recession, but we are seeing estimate downgrades and companies are getting hit hard on the back of them,’ says Crooke. ‘I believe gearing should be used actively, not permanently. I think of it as being like sails – you take them down in poor weather,’ he adds. ‘I still see uncertainty – the Fed cuts rates when it sees weakness in the economy, and that is wrapped up with uncertainty on how the US-China trade talks will conclude.’

The manager says that while monetary easing around the world has buoyed equity markets, this is a secondary effect rather than an explicit intention. In the US, mortgages are normally fixed-rate and are priced based on long-term bond yields, so a flatter yield curve reduces housing costs. ‘The Fed is trying to force the banks to lend money and not hoard it, but the appetite to borrow is lacking,’ he explains. Meanwhile, the European Central Bank is doing what it can to avert an economic slowdown, but outgoing ECB chief Mario Draghi has warned that governments in the region also need to help out with fiscal policy measures. Lower rates and the return of quantitative easing have put further pressure on banks, although Crooke says he and the regional portfolio managers are still finding opportunities in the sector. ‘It is tough for banks – deposits are not earning anything – but that is reflected in their share prices.’ He adds that banks’ low valuations are more to do with investor sentiment than fundamental issues of over-borrowing, such as in 2008. ‘European banks are in a pretty dark place, but they have lots of capital,’ the manager explains. ‘The likes of Credit Agricole and ING are pretty safe beasts, but the market is very negative on the outlook.’

Crooke admits he may have been a little optimistic in his view (published in our last note) that the road ahead would be clearer by the second half of 2019. ‘I thought we would have more clarity on the trade war and Brexit by now, but both are getting pushed out’, he explains. China has actually been one of the best-performing areas of the BNKR portfolio, with the manager having slightly increased the allocation in late 2018 and early 2019 during the global market sell-off. ‘What we own in China is not the market,’ says Crooke. ‘We are particularly focused on consumer angles as we think China can continue to see wage growth, and people want a more ‘Western’ lifestyle. What we own is things like brewers, distillers, airports, duty free shops and air-conditioning unit makers, rather than exporters. Trade tariffs aren’t affecting us at the moment but they will if it feeds into job losses and very poor sentiment.’

Regarding Brexit and the political outlook in the UK, Crooke said of the market ahead of December’s general election: ‘At these levels of low expectations, the UK is ridiculously good value – it’s off the scale on a P/E relative basis versus the MSCI World; back to 2008/9 or 2003 levels.’ While a disorderly Brexit (which looks quite unlikely at present) might be another leg down of misery, the manager points out that any significant weakening of sterling would actually be positive for overseas investment returns. However, he stressed he was not positioning the portfolio for any specific Brexit or election outcome: ‘Trusts like this are supposed to take a longer-term view and not whipsaw from quarter to quarter.’

In summary, the manager says that he is still optimistic on an 18-month view that there will be some clarity on trade discussions, there will be GDP upgrades in 2021, and that Federal Reserve rate cuts will have a beneficial effect: ‘Looking beyond next year you can be a bit more optimistic.’ Meanwhile, he adds, ‘investors have had a great year, but markets could pull back a bit and give us a chance to get more active at cheaper valuations.’

Lead manager Crooke is responsible for BNKR’s overall strategy and geographical allocation, as well as deciding the level of gearing in conjunction with the board. The portfolio itself is split into six regional segments, each run by specialists at JHI. Although the overall stock list is relatively long at c 180 names, Crooke’s ambition is that each regional portfolio should have c 30 holdings, making BNKR in effect a sort of fund of funds investing around the world on a fairly concentrated basis. The overarching investment approach is founded on bottom-up stock picking with a tilt towards value and income, although individual styles may differ somewhat from one regional manager to another. As befits a trust with over half a century of year-on-year dividend growth, there is a bias towards cash-generative companies with strong balance sheets and growing dividends. Portfolio turnover is relatively low, at 26.4% in FY18 and 15.0% in H119, implying an average holding period of around three to four years.

The key details for each sub-portfolio at end-September 2019 are shown below, along with 12month total return (TR) performance relative to local indices (all in sterling). We have excluded the non-Asian emerging markets allocation, as it is below 1% of the total following the departure of the previous management team. While Janus Henderson has hired a new US-based emerging markets team from Putnam Investments, Crooke is removing the allocation for the time being, on the back of concerns over global growth, unstable geopolitics and volatility of returns. However, he says he reserves the right to re-introduce an allocation to emerging markets once he has got to know the new team.

At 31 October 2019 there were 179 stocks in BNKR’s portfolio, down from 188 a year previously. The top 10 holdings made up 18.0% of the total, a slight increase in concentration from 17.0% at 31 October 2018. As part of a move to reduce gearing (from 3% net geared to 2% net cash over the 12 months) against a backdrop of heightened geopolitical risk and high valuations, Crooke says it was prudent to lock in some profits, and he has been asking the underlying portfolio managers to sell or trim holdings where they see risks and talk to him before reinvesting. ‘I don’t want to add new holdings unless they are really great companies,’ he explains.

In geographical terms (Exhibit 3), the balance of the portfolio is little changed over the past 12 months, with the largest changes being a 1.3pp increase in North America (as a result of strong performance from the US portfolio) and a 1.3pp decrease in non-Asian emerging markets, as the portfolio is being liquidated following the departure of the team that managed it. Relative to the FTSE World Index, BNKR remains very underweight North America and very overweight the UK, with smaller overweights in Asia and Japan, and a broadly neutral weighting in continental Europe. While non-Asian emerging markets is now an underweight versus the index, BNKR’s incoming Chairman Sue Inglis noted in the H119 interim report that the trust still has significant exposure at the underlying company earnings level to the African and Latin American regions, through companies listed in Europe and New York.

Sector weightings (Exhibit 4) are also broadly unchanged over the year, with the largest moves being reductions in oil & gas (-2.2pp and now a 2.2pp underweight versus the index), and industrials (1.7pp, now a broadly neutral position). In oil & gas, Crooke says the demand backdrop is tough as the pendulum swings further away from fossil fuels. He currently prefers mining (basic materials) to either oil or utility companies, as he sees the likes of Anglo American and BHP as good dividend payers with strong balance sheets. The manager says that their income is more secure than that of the oil companies, while they offer a better total return profile than utilities. The largest increases were in financials (+1.5pp, increasing the overweight position), and healthcare (+1.1pp, but still underweight versus the index). Crooke explains that the portfolio managers in aggregate have been net buyers of financials, which selectively look good value on a two-year view given the relatively low likelihood of a global recession. However, they remain underweight real estate and insurance, and overweight ‘other financials’ such as stock exchange operators London Stock Exchange and Deutsche Boerse, and credit card companies American Express, Mastercard and Visa. The increase in healthcare is largely a product of good performance from stocks such as Daiichi Sankyo, although Smith has added to the holding in UK pharmaceutical giant GlaxoSmithKline. Relative to the FTSE World Index, the largest active sector positions are a 9.4pp overweight in consumer goods (including Estée Lauder, which is currently the second largest position), and a 5.5pp underweight in technology.

BNKR has a strong long-term performance record, with NAV total returns of c 12–14% pa over one, three, five and 10 years (Exhibit 6, RHS), beating the blended benchmark over all these periods. Recent months have been more challenging, with returns somewhat lagging the benchmark over one, three and six months to 30 November 2019. Over longer periods it is worth noting that historical blended benchmark returns are based on the FTSE All-Share Index prior to 31 October 2017. Versus the current benchmark, the FTSE World Index, BNKR’s NAV total return has mildly underperformed over five and 10 years, and is marginally ahead of the index over one and three years (Exhibit 7).

In sector terms, BNKR’s strongest performance relative to the FTSE World index over 12 months to 30 September 2019 came from financials (an overweight), healthcare and oil & gas (both underweight), while underweight positions in consumer services, technology and utilities detracted from returns. Geographically, the strongest performance relative to local indices came from China, Europe ex-UK and Pacific ex-Japan, with only the UK (a marginal laggard at -0.3pp versus the FTSE All-Share) and the non-Asian emerging markets allocation (which has since largely been liquidated) underperforming. The North American outperformance (+0.6pp) came partly from avoiding dull sectors such as retail, oil & gas and some areas of financials, while overweight positions in technology and credit card providers were beneficial. Stock selection has contributed positively overall, with the top five contributors (Estée Lauder, American Tower, Anta Sports, Sany Heavy Industry and Comcast) adding 2.0pp of relative performance, while the five biggest detractors (FedEx, Activision Blizzard, Procter & Gamble, Sinopec and Galliford Try) cost 1.4pp.

Recent sterling strength, as the market began to price in a Conservative victory in December’s general election and thus a potential end to Brexit uncertainty, detracted from absolute performance over periods to 30 November, as a weaker pound boosts returns from non-sterling investments.

Following a widening in the discount to double-digit levels in the wake of the UK’s June 2016 referendum on EU membership, BNKR’s shares have rerated to levels more in line with longer-term average discounts, which stand at 1.8%, 2.6%, 3.1% and 5.5%, respectively, over one, three, five and 10 years. For the past two years the rating has remained in a narrow range of a c 2% premium to a c 4% discount, and as a result, no shares have been bought back or issued since FY16. At 13 December 2019, the shares stood at a 0.9% premium to cum-income NAV, at the narrower end of the 12month range of a 1.1% premium to a 4.1% discount.

Structured as a conventional investment trust, BNKR has one class of share, with 122.6m ordinary shares in issue. The shares are listed in both London and New Zealand. Although the board has the authority to buy back or allot shares in order to manage a discount or a premium, the number of shares outstanding has remained unchanged since FY16, when the trust was one of the two rollover vehicles for Henderson Global Trust (HGL).

BNKR has structural gearing (£50m of 20-year loan notes and a £15m debenture maturing in 2023), with a blended interest rate of c 4.7%. It also has a £20m short-term bank borrowing facility. Together these equate to available gearing of c 7.1% of net assets. However, the bank facility was undrawn at end-H119 (30 April), and Crooke had offset the long-term debt with cash, leaving BNKR’s net gearing at 0.0%. At 31 October 2019, BNKR had a 2.0% net cash position, reflecting a degree of caution as well as the proceeds of liquidating the majority of the non-Asian emerging markets portfolio.

JHI receives an annual management fee on a sliding scale, with 0.45% paid on the first £750m of net assets and 0.40% thereafter, charged 30% to revenue and 70% to capital. There is no performance fee, and ongoing charges (based on FY18) are 0.50%.

BNKR has the joint-longest record of annual dividend increases for an investment trust, having grown its dividend for 52 consecutive years. It is on track for a 53rd straight increase, with the board having reiterated at the half-year stage that it anticipates a c 6% increase in the total dividend for FY19 (ended 31 October). The trust reports a 50-year compound annual dividend growth rate of 10%; over the last 20 years (see front page chart) the CAGR is 8%. By way of comparison, UK CPI inflation is currently 1.5% and has averaged 2.2% pa over the last 10 years.

The trust pays dividends quarterly, in May, August, November and February. For FY18, the total dividend was 19.72p. So far in FY19, three dividends have been paid, totalling 15.55p, an increase of 5.6% on 9M18 (14.72p). Based on the forecast increase of c 6% for FY19, it would be reasonable to assume a total payout for the year of at least 20.9p. This would imply a final dividend of at least 5.35p, the same as the third interim payment. BNKR has a very healthy revenue reserve of more than 1x the latest annual payout, and currently yields 2.1%, based on the last four dividends.

The AIC Global sector, of which BNKR is a member, has 16 constituents following a broad range of investment approaches. BNKR is the sixth-largest fund in the group by market cap. One of the biggest disparities between the funds is their exposure to UK and US equities, which respectively make up 5.4% and 58.7% of the FTSE World Index. UK exposures range from -3.8% (a net short position) at Manchester & London and 2.0% at Scottish Mortgage, to 80.4% at Lindsell Train Investment Trust (52.2pp of which is accounted for by the holding in the unlisted UK-based investment manager Lindsell Train) and 77.6% at Majedie Investments. BNKR is close to the median with c 22%. US exposures range from 0.9% at Majedie to 90.7% at Manchester & London; BNKR is again mid-table with c 31% exposure, a little over half the benchmark weighting. (All figures are to 30 November.) The level of US equity exposure has been a major factor in global funds’ relative performance in recent years, as the world’s largest stock market has enjoyed a decade-long bull market resulting in multiple all-time highs.

In NAV total return terms, BNKR has outperformed the sector average over one year and lags the average over three, five and 10 years, ranking sixth, eighth, seventh and sixth, respectively. If the somewhat anomalous Lindsell Train (where performance has been driven largely by upward revaluations of the fund management firm) is excluded, BNKR’s NAV total returns are above average over all periods shown. Ongoing charges at 0.5% are the joint third-lowest in a sector where the average charge is a very competitive 0.7%, and there is no performance fee. At 13 December 2019, BNKR’s was one of five funds trading at a premium to NAV, it is currently ungeared (in line with five of the peers), and its 2.1% dividend yield is eighth in the group, a little ahead of the 2.0% average.

BNKR currently has four independent, non-executive directors, with the appointment of a fifth expected to be announced before the end of the year. The chairman, Sue Inglis, assumed her current role in January 2019 following the retirement of Richard Killingbeck. She has been a director of BNKR since 2012 and had served as senior independent director since 2015. Julian Chillingworth, who joined the board in 2015, is now senior independent director. Isobel Sharp (appointed 2017) chairs the audit committee, while Richard Huntingford is the newest director, having joined the board in September 2018. The board members’ professional backgrounds span corporate finance, fund management, accountancy and media/marketing.

BNKR retains its long-standing secondary listing in New Zealand, which makes up c 10% of the overall shareholder register. In Exhibits 10 and 11 we present BNKR’s performance and that of its benchmark in NZ dollar (NZ$) terms. Although a strengthening in sterling in September and October limited gains at the underlying portfolio level (see Exhibit 6), it boosted returns for NZ$ investors over three and six months, while sterling-based investors saw higher returns in the month of November. NAV total returns have also been higher for NZ$ investors over one and three years (while sterling has been weak in a global context since the UK’s EU referendum in 2016, the NZ dollar has been weaker), but are broadly similar over five and 10 years to end-November.