Hansa Trust — Update 24 November 2015

Hansa Trust has three main underlying geographical portfolio exposures: the UK, at 36%, North America, 24% and Latin America, 18%. Most of the Latin American exposure is through Wilson Sons, which earns some of its revenues in US dollars and has Brazilian trade volumes, and to some extent oil industry activity as revenue drivers. Looking ahead, expectations for global growth have been trimmed (the IMF being a recent example) and Brazil in particular faces economic and political challenges. However, the US and UK economies appear relatively resilient and the circumspect approach to monetary normalisation adopted by the Fed and the Bank of England together with China’s efforts to stabilise its tapering growth could minimise the downside risks identified by the IMF and soften the slowdown in emerging market growth. Recent additions have increased Japanese and European holdings, providing exposure to potential economic improvements in those areas and broadening the stock universe addressed.

Looking at market performance and valuations (Exhibits 2 and 3) we can see the world market’s progress since the global crisis and how far the Brazilian, Bovespa index has fallen in sterling terms (arguably discounting many of the country’s difficulties). Valuations on a long, 20-year, view, do not appear stretched compared with prior highs or, in most cases, averages. Therefore it is not obvious that investors would wish to allocate away from equities based on valuation but, given the prevailing risks and recent volatility, the appeal of a fund with the ability to allocate across asset classes with a long-term wealth-protection approach is underlined.

Hansa Trust was launched in 1912 (then called Scottish & Mercantile) and the Salomon family have been significant shareholders since the 1950s. Salomon family trusts account for 52.3% of the 8m ordinary voting shares, there are a further 16m “A” shares. Hansa Capital Partners has managed the whole investment process since 2003. The benchmark is the three-year rolling average of a five-year UK government bond plus 2% with interest reinvested semi-annually. The use of an absolute benchmark reflects a focus on wealth protection and creation that the investment approach seeks to achieve with a long-term approach; accessing investments that are not available to retail investors, investing in UK equity special situations and through a strategic stake in Ocean Wilsons Holdings.1 The portfolio is invested roughly equally in four silos: Core Regional, Eclectic and Diversifying (includes Ocean Wilsons’ investment portfolio, OWIL), UK Special Situations and Strategic (Ocean Wilsons’ 58.25% holding in Wilson Sons, the listed Brazilian maritime services company). The ownership structure and a look through analysis of NAV, including Wilson Sons at market value are shown in Exhibits 4 and 5. The look-through NAV shown is approximately 12% above the ex-income reported NAV as at 31 October.

Alec Letchfield, CIO of Hansa Capital, sees the stock market cycle as more mature but still sees potential for equities to make further progress albeit with interruptions, as experienced recently. Corporate earnings have been strong and valuations in G20 markets have generally risen but are not threatening their historical highs. He also points out that fears over the impact of a slowdown in China may be overdone given that it is not a dominant export customer for most developed markets: US goods exports to China amounted to 0.7% of GDP in 2014 and even in Brazil exports to China account for less than 15% of all exports. The expectation that the Fed will start to raise rates is another subject whose effects Letchfield does not expect to be dramatic, at least at the outset. He foresees rates rising slowly. He also points out that US growth seems to be entrenched and that the UK’s growth appears steady too.

Hence the manager continues to favour equities, albeit, recognising that the cycle is maturing, has added some lower-correlated names:

BlackRock Global Event Partners is a special situations fund that Hansa Trust helped seed in July 2015 alongside BlackRock itself, which has made its largest ever seed investment in the fund. The manager, Mark McKenna, focuses on event-driven investments affected by a variety of catalysts; it is differentiated by the risk management strategy through which the manager seeks to hedge out any market risks.

Investments were also made in two ETFs, which complement existing holdings in Japan and Europe and can be quickly realised and reallocated.

In the core regional silo the manager has added Pershing Square Holdings, run by the investment management firm founded and led by Bill Ackman. It has an approach similar to private equity in some respects, identifying businesses whose performance could be improved with more efficient operations, finance and management and taking an active role by influencing their direction. It is long-biased and holds a concentrated portfolio of mid and large cap listed US companies. The fund actively engages with its investee companies’ management teams, boards and with other shareholders seeking to enhance returns.

Within the Special Situations portfolio, UK equity manager John Alexander highlights a number of the holdings. The largest holding, NCC Group, is described as essentially a services business with a range of activities including a global team of “ethical hackers” who test companies’ cyber defences providing an interesting play on this prominent theme. It also offers domain services aiming to provide a safe corner of the internet, as well as its core escrow division that stores software source code for critical applications as a protection for users in the event of that a software supplier fails. The company has recorded compound dividend growth of 25% since its 2004 flotation.

Galliford Try is a leading UK housebuilder and contractor where Alexander sees strong trading, and cash flow as supporting further healthy dividend growth and also providing the basis for a potential split in the business. Hansteen Holdings is a property company investing mainly in industrial properties in the UK and Europe with the potential for high yields and value improvement: management is very hands on. Finally, Hargreaves Services is a supplier of solid fuel and bulk material logistics. The company has faced a perfect storm of low coal prices and collapse in coal import volumes. The investment interest is created by the management initiatives to respond to this by simplifying the business and exploiting its skill sets and asset base.

Hansa Capital Partners’ updated investment process (since April 2014) has put in place a framework that shifts dynamically from higher-risk asset classes to more defensive ones as valuations rise and business cycles mature. The underlying principles remain unchanged though: all asset classes are considered, although the long-term outlook naturally leans towards equities; top-down asset allocation identifies regions and asset classes; fundamental analysis and long professional experience are used to select securities or third-party funds, with the latter often not being available to private investors; assets with uncorrelated investment returns are sought and they do not allocate by reference to a benchmark; directors and investment managers are aligned with shareholders by being invested themselves.

UK equity selection is typically of small and mid-cap special situations stocks. The core regional and diversifying & eclectic silos are populated by third-party funds which are selected on a variety of criteria: the managers’ track records and investment processes are rigorously examined; the strategy needs to be one that either complements existing holdings or is uncorrelated and is generally unavailable to private investors; the team is cost conscious; key-man risk and liquidity are also taken into account.

The underlying sector and geographical exposures of the portfolio are shown in the first two columns of Exhibit 6. From a sector perspective the overweight (versus the MSCI World index) to industrials reflects the Wilson Sons holding while there are noticeable underweights to energy, consumer staples and healthcare. Geographically the UK is still the largest, albeit reduced exposure with North America the next largest (and also the largest underweight versus the index).

The final two columns show the portfolio by silo at end September this year and last. The reallocation from UK equities to Core Regional Funds and Eclectic and Diversifying Funds is clear.

In the eighteen months to the end of October 2015, the period in which the portfolio was repositioned, the performance in the expanded silos was good (up by more than 10%), with particularly strong performance from the core regional silo (Exhibit 7). All the active funds made a positive contribution and only an ETF, a tracker and a fixed income fund made a negative one. The main negative contribution came from the strategic investment in Wilson Sons and the rest of the portfolio making gains of over 8%.

Performance to end September is illustrated in Exhibits 8 and 9. Recent weakness was partly driven by the soft Brazilian market and currency impacting the sterling value of Wilson Sons (hence also Hansa’s strength versus the Bovespa index). Despite this near-term weakness Hansa’s NAV total return has outperformed the FTSE All-Share and its own absolute benchmark over 10 years.

The board sees its main priority in relation to the discount as being to ensure that the investment policy followed by the manager is likely to provide above average returns over the long term. While the board may buy back shares if this is seen as advantageous to all shareholders it would not do so simply to reduce the discount. Reduced size and liquidity, a requirement to have a more liquid portfolio and the potential for the percentage exposure to Ocean Wilsons to rise are cited as disadvantages of adopting a buyback policy to defend a discount level. As noted earlier the discount is at the wider end of its recent range (see Exhibit 10) and on a look-through basis is even wider at 38%. A turn in sentiment towards emerging markets and evidence of the new strategy’s success could see a significant narrowing; even without this the existing discount appears to provide a substantial cushion for investors.

Hansa Trust has 8m ordinary shares and 16m ‘A’ non-voting shares and is authorised to repurchase up to 14.99% of the latter. The trust may employ gearing and has a borrowing facility of £30m, which has not been drawn on significantly in recent periods. The trust has an unlimited life.

Hansa Capital Partners charge a management fee of 1% of net assets after borrowings and after deducting the value of Ocean Wilsons Holdings. Hanseatic Asset Management, which is connected to Hansa Capital Partners, charges a management fee to the investment subsidiary of Ocean Wilsons Holdings. The ongoing charge for the last financial year was 1.1%. Hansa Capital Partners also acts as company secretary and charges £100,000 per annum.

The board’s dividend policy is to pay two similar interim dividends per annum, which will be declared at the start of the year to provide visibility to shareholders. The first is paid in November and the second in May after the end of the financial year in March. The company expects dividends to grow over time and will pay an extra final dividend if circumstances warrant it. Shareholders have given the board permission to pay some of the dividend from capital reserves where appropriate.

Hansa Trust has several unusual characteristics that make it hard to compare directly with other trusts in the AIC’s Global category: its stake in Wilson Sons, the absolute mandate and the breadth of its asset allocation. With that in mind we have used a selection of trusts from Morningstar’s Global sector that have a combination of capital preservation and growth approaches.

Partly reflecting recent weakness, Hansa has lagged averages for both the whole global sector and the selected companies in the peer group, however cumulative three, five and (not shown) 10-year absolute returns are positive. As noted earlier the discount is above its historical average and, as shown here is wide in the context of its peers.

Of the five directors William Salomon is the second-longest serving, having been appointed in 1999. He is a significant shareholder directly and through family interests. He is also the senior partner of Hansa Capital Partners and deputy chairman of Ocean Wilsons Holdings and Wilson Sons. All the directors are non-executive and all but Mr Salomon are independent. The others are: Alex Hammond-Chambers (chairman, appointed 2002), Jonathan Davie (2013), Lord Oxford (2013) and Geoffrey Wood (1997).

Apart from Mr Salomon’s responsibility as a director of Ocean Wilsons and Wilson Sons, the board (and the portfolio manager) visit Brazil regularly to ensure oversight of its most significant investment. The board believes that the investment is both diversified away from Brazil (through Ocean Wilsons Investments) and stands to gain market share for the operating business during a difficult period for the Brazilian economy. The board has determined that the company’s future holds promise and that the risk involved in the investment is worthwhile.