Witan Investment Trust — Increasing exposure to continental Europe

As illustrated in Exhibit 2 (right-hand side), since early-2016, there has been a positive rerating of global equities. Investors have been encouraged by a broad-based improvement in corporate earnings, which has outweighed macro concerns such as higher interest rates, political uncertainties in Europe and heightened tensions in the Korean Peninsula. On a forward P/E valuation basis, global equities, as measured by the Datastream World index, are trading on a multiple of 16.0x, which is a c 20% premium to the 13.1x 10-year average. Digging deeper into the analysis shows that emerging markets look relatively attractive. They are trading on a forward P/E multiple of 12.6x, which is a 13% premium to the 10-year average versus 16.7x and a 23% premium for developed market equities. In an environment where equities in aggregate are looking more fully valued, investors may be rewarded by considering a fund that offers broad exposure to focused strategies seeking both growth and value from global equities.

WTAN was established in 1909 to manage the estate of Alexander Henderson, the first Lord Faringdon. The trust was listed on the London Stock Exchange in 1924 and has net assets of c £2.0bn. There was a change in strategy in 2004 when WTAN became self-managed, appointed its first CEO and adopted a multi-manager strategy, aiming to reduce performance volatility that can occur with a single manager. The trust seeks long-term capital growth and real (above-inflation) dividend growth. WTAN typically has eight to 13 external managers, investing in both developed and emerging market equities, with both growth and value investment approaches. They are selected for their high-conviction active management styles. Up to 10% of the portfolio can be invested directly by Witan’s executive team in specialist funds, which includes private equity and lesser-known or newly established managers. Gearing of up to 20% of net assets is permitted, typically in a range of 5-15% and a small net cash position may be held when considered appropriate. At end-October 2017, gearing was 11%. Derivatives may be used to implement investment policy, for example exchange-traded futures have been employed to quickly gain exposure to a particular market without having to interfere with the external managers’ strategies.

WTAN’s benchmark has evolved over time to reflect where its internal managers believe the opportunities lie for a global investor. The relatively high UK weighting reflects the global nature of many UK index constituents that derive a large percentage of their earnings overseas. The benchmark comprises FTSE indices: from 1 September 2004 to 30 September 2007, 50% All-Share and 50% World (ex-UK); from 1 October 2007 to 31 December 2016, 40% All-Share, 20% All-World North America, 20% All-World Asia Pacific and 20% All-World Europe (ex-UK); and since 1 January 2017, 30% All-Share, 25% All-World North America, 20% All-World Asia Pacific, 20% All-World Europe (ex-UK) and 5% Emerging Markets.

Investment director James Hart believes that following a broad-based revaluation of global equities, share prices can continue to move higher, but there is an increased need for corporate earnings to underpin valuations. He says that 2017 is panning out as hoped for; following the global financial crisis, the US dragged the global economy out of recession and then in late-2016 and early 2017 there was confirmation of broader-based economic growth such as in Europe and Japan, where growth is being sustained but at a low level. Hart points to a couple of clouds on the horizon: Brexit and the uncertain outlook for sterling; and increased tensions in the Korean Peninsula. However, he states that over the long term, corporate earnings drive stock prices and there is evidence of an improving global economy, which is supportive for earnings growth.

Regarding the withdrawal of monetary stimulus, Hart believes that central banks will be incredibly conservative, requiring clear signs of economic growth and inflation before they raise interest rates. It has been a long time since developed economies were in an inflationary period, and consumers have become accustomed to declining interest rates. There is a significant amount of debt outstanding, so consumers will be squeezed by a marginal increase in interest rates. Hence, central banks are keen not to increase borrowing costs ahead of consumers’ ability to service them.

Since adopting its multi-manager investment approach in 2004, the majority of WTAN’s funds are allocated typically between eight and 13 external managers. These asset managers are selected for their active, high-conviction approaches across both growth and value strategies. There are currently 10 external managers with the following mandates: three UK, three global, two European, one Asia Pacific (including Japan) and one emerging markets. Up to 10% of the portfolio is managed by Witan’s executive team, who invest in specialist funds, including private equity and small asset managers. External managers are monitored regularly and reviewed at least once every year by the board, which also seeks alternative external managers to replace or supplement the existing line-up. The external asset managers are more likely to be replaced if they deviate from their investment style or for persistent rather than short-term underperformance. WTAN’s board and executive team are also responsible for asset allocation and the use of gearing.

Exhibit 3 shows WTAN’s current multi-manager line-up. There have been recent changes to the European exposure to take advantage of the improved political and economic backdrop in the region. The pan-European portfolio managed by Marathon has been liquidated, with the assets reinvested in two portfolios of continental European equities managed by CRUX Asset Management and S.W. Mitchell Capital. Each manager was allocated c 5% (c £100m) of the portfolio, comprising the assets formerly managed by Marathon plus an additional £24m from WTAN’s cash resources. The new managers will be benchmarked against the FTSE Europe ex-UK index. Their actively managed, concentrated portfolios will result in higher active share (a measure of how far a portfolio deviates from a benchmark, with 0% representing full replication and 100% representing no commonality). WTAN’s European active share will increase from c 70% to 86%, while the trust’s overall active share will rise to over 76% (from c 74% in June 2017). Both new managers are considerably smaller than Marathon; WTAN likes managers with a unique mind-set, where there are principals involved who often have a significant stake in the business.

WTAN is not looking to increase its UK exposure, which over time has reduced from 60-70% to less than 35% (versus 30% in the benchmark), as the managers believe that there is a broader opportunity set available overseas. Emerging markets now have better legal frameworks and improved corporate governance standards, and while the UK was historically a big dividend provider, there are now better dividend growth opportunities available overseas, such as in Asia. Following the switch from a pan-European mandate to two continental European portfolios highlighted above, WTAN’s UK exposure was further reduced.

Within the directly held investments, WTAN has re-initiated a position in Electra Private Equity, which, following a series of structural changes, is now much smaller, and Hart sees it as a value opportunity. This trust has a small number of primarily UK private equity assets, which include American-style restaurant chain TGI Fridays, personalised product company Photobox Group and shoe designer, manufacturer and retailer Hotter Shoes.

As shown in Exhibit 3, during H117, the majority of WTAN’s multi-managers outperformed their respective indices, led by global manager Veritas (+9.1pp) and UK manager Lindsell Train (+5.3pp). WTAN’s direct investments also outperformed the composite benchmark by 6.3pp. The underperforming funds were UK manager Artemis (-2.8pp) and global manager Pzena (-0.7pp).

Looking at absolute returns over one year (Exhibit 5, RHS), WTAN’s NAV and share price returns of 18.1% and 25.9%, respectively, are meaningfully ahead of the composite benchmark’s 15.3% total return. On a relative basis, WTAN has outperformed its composite benchmark over one, three, five and 10 years. Of interest to UK shareholders, WTAN has significantly outperformed the FTSE All-Share index over these periods in both NAV and share price terms.

WTAN’s share price discount to cum-income NAV has been in a narrowing trend since July 2016. The current 2.8% discount is towards the low end of the 0.2% to 8.0% range of the past 12 months. It compares to the averages of the last one, three, five and 10 years of 3.5%, 2.7%, 4.4% and 7.8% respectively. WTAN actively manages the discount; the board has authority, renewed annually, to repurchase (14.99%) and allot (10%) ordinary shares. In FY16, 18.9m shares (9.4% of the share count at end FY15) were repurchased at a cost of £142.1m. As shown in Exhibit 1, share repurchases are continuing in FY17; year-to-date a further 1.5% of the share base has been bought back at a cost of £26.3m.

WTAN currently has 178.5m ordinary shares in issue. On 15 August 2017, it announced an agreement to issue a £30m fixed rate, 37-year secured private placement note at 2.74%, effective 1 November 2017. This is a record low interest rate for this term of debt, and WTAN believes that it represents a great opportunity to lock in long-term funding. Total structural borrowings will increase from £142m to £172m, with the proceeds being used mainly to repay short-term borrowings. At the November 2017 funding date, the weighted average interest payable on WTAN's structural borrowings will decrease from 4.6% to 4.3%. Gearing is managed by WTAN; external managers may hold cash, but are not allowed to employ gearing. At end-October gearing was 11%, which is towards the high end of the 5-15% range of the last five years.

There is no ad valorem fee levied by Witan Investment Services as Alternative Investment Fund Manager (AIFM), and so the only management fees incurred are those due to WTAN’s external managers; a small minority of which are also entitled to a performance fee, but their base fees are lower than for managers without performance-related fees. In FY16, WTAN’s ongoing charges were 0.75%, which is broadly in line with 0.76% in FY15. When performance fees due to external managers are included, ongoing charges in FY16 were 0.65% versus 1.04% in FY15. For FY16, the fees are lower including performance fees because performance fee accruals at end-FY15 were reduced due to the underperformance of some of the external managers during FY16.

WTAN aims to provide real dividend growth as well as long-term capital growth. Dividends are paid quarterly in March, June, September and December. Barring unforeseen circumstances, the dividend policy is that each of the first three interim dividends is equal to a quarter of the prior years’ annual dividend, with a balancing, historically higher, fourth interim payment. The trust has a distinguished dividend history; annual dividends have risen for the last 42 consecutive years.

In FY16, the 19.0p dividend was 11.8% higher than the 17.0p FY15 dividend, and the 9.6% compound annual growth rate in dividends over the last five years is meaningfully ahead of the rate of UK inflation over the period. WTAN has significant revenue reserves; at end-FY16 they were equivalent to c 1.5x the annual dividend payment, which will provide a buffer in the event of a period of lower revenue growth.

WTAN is a member of the AIC Global sector, which comprises 24 trusts. In Exhibit 9, we highlight the 11 largest, each of which has a market cap in excess of £600m. WTAN’s NAV total return is above average over five and 10 years, ranking fourth and third, respectively, while broadly in line over one and three years. Its ongoing charge is higher than average and it is the only trust in the selected peer group to charge a performance fee. WTAN has the highest level of gearing in the selected group and a dividend yield that is 0.3pp above average.

WTAN has a relatively large board of nine directors, eight of whom are non-executive and independent of the manager. Chairman Harry Henderson was appointed in 1988 and assumed his current role in 2003. The other independent directors and year of appointment are as follows: Tony Watson (2006), Robert Boyle (2007), Catherine Claydon (2009), Richard Oldfield (2011), Suzy Neubert (2012), Ben Rogoff (2016) and Jack Perry (2017). Andrew Bell is considered non-independent as he CEO of WTAN; he was appointed in 2010.