Bankers Investment Trust (The) — Navigating through choppy waters ahead

Crooke has been in the ‘higher for longer’ camp when it comes to inflation and still believes that, while inflation is currently reaching levels not seen in many years, it will likely moderate over the medium to longer term then settle in a 2–4% range. In the meantime, with inflation surging, interest rates rising, recession looking imminent and the continued conflict in Ukraine, there is more uncertainty and potential variances of outcome than investors have been accustomed over recent years. Markets have sold off through 2022, with global indices witnessing their sharpest corrections since Q120. For UK investors in some cases the losses have not been too material but emerging and European markets are still deeply in negative territory this year. The broad UK market has not seen much correction (although UK small and mid-sized companies have been weak), thanks in part to its valuation support versus other markets, however it remains unloved as evidenced via investor fund flows. The US indices have seen somewhat of a recovery from their nadir in June, while China, which had been sold off aggressively in Q122, has made something of a recovery, although markets remain volatile.

Forward valuations on a price to earnings basis look more reasonable in some cases (Exhibit 1, right-hand side), but the US arguably still looks more expensive relative to its history. Currently many of the companies that BNKR’s sleeve managers invest in are not seeing a significant decline in end user demand, but there are clearly some concerns that should the current economic slowdown morph into a full-blown recession, corporate earnings, profits and cash flows may come under significant pressure, which in turn makes the case for a more widespread correction in equities more likely. With this in mind, the focus of the regional sleeve portfolio managers is on ensuring that the companies that they invest into are, wherever possible, low-cost price makers and operating in non-discretionary goods and services. On a relative basis, these types of companies should be better insulated from falling demand and rising input costs. In a world where economic growth is stalling, Crooke is looking to tilt the portfolio into areas where economic growth and monetary policy are likely to be more supportive over the next two years and where valuations may be offering better relative value. Thus, it is likely that the portfolio’s already material weighting (Exhibit 2) to Greater Asia (which includes China) may well tick up given the supportive fundamentals and valuations across the region.

The Chinese zero-COVID-19 policy has been a source of concern for global economists as it has contributed to a slump in consumption and exacerbated supply chain problems (such as delays in shipping), while increasing costs and fuelling inflation. Mike Kerley, who is deputy fund manager on the trust and has managed the Asia ex Japan sleeve since 2006, notes that while officially the policy has not changed, lockdowns are becoming more targeted in conjunction with mass testing on a localised basis rather than being applied wholesale. This development could help to mitigate the effects of lockdowns on both the Chinese and global economies.

Against this backdrop, President Xi Jinping has reiterated the official 5.5% target for economic growth in 2022. While there may be some scepticism about the likelihood of meeting this target, there is a realisation from the Chinese authorities that the whole economy needs to contribute if it is to meet its growth targets. Consequently, the reopening process must become more effective and the rhetoric around some of the damaging policies previously directed at parts of the economy, such as the internet and education sectors, have been dialled back. The government is currently utilising measures such as increased infrastructure and real estate investment, but could pull yet more levers such as tax cuts and payment vouchers to support growth. In addition, after the market weakness from early 2021 and into 2022, Chinese equities in aggregate trade on lower valuations relative to historical levels

The emphasis within the portfolio (as ever) is to identify supportive regional growth and to allocate capital to the best quality companies in these regions at the right price. The resultant changes in the portfolio over the past 12 months have seen an increase to more defensive, less richly valued holdings. The fund’s beta (or sensitivity) to market movements is currently around 0.86%, which is towards the lower end historically for the portfolio. New material positions within the portfolio such as Oracle, which was added in March 2022, have lower betas than stocks that they have replaced in many cases such as Meta (Facebook), which was sold in October 2021.

From a sector perspective, increasingly the focus has been on battening down the hatches, selling where valuations have run ahead and where business models are not as resilient as may be expected. From a high level, the consumer discretionary weighting has decreased, and consumer staples increased, so as to reduce the effects of potentially declining demand in discretionary goods and services. Technology has seen a reduction, after good long-term performance but more recent weakness for longer-duration growth assets in a rising interest rate environment. The defensive healthcare sector has been increased and energy has seen a slight increase in allocation versus a year ago.

In our December 2021 update note on BNKR (Steady as she goes), we took a closer look at the European, Japanese and Asian regional sleeves. In this update we focus on the UK and US sleeves, which together account for 57% of BNKR’s assets.

The UK sleeve was previously managed by Alex Crooke until 2017 when David Smith took on the day-to-day management of this pool of assets. Smith and Crooke have worked closely together since 2010, with Smith being appointed alongside Crooke on the Henderson High Income (HHI) investment trust in January 2014 before assuming sole responsibility in June 2015. It can be assumed that the two share a similar investment philosophy from their many years of working together. The wider experience within the global equity income franchise at Janus Henderson Investors (JHI) is substantial, with the likes of James Henderson, Job Curtis and Ben Lofthouse. Since June 2021, Smith has also been co manager with Job Curtis on the flagship City of London Investment Trust (CTY), which has some £1.9bn of total assets investing in predominantly large UK equities for secure and growing income. Smith’s investment approach is based upon identifying quality companies providing secure and growing dividends at the right price. Specifically, this sleeve is tasked with providing a market level of yield but one that grows its dividends at a faster rate. At 19.8% (July 2022) the weighting to UK equities is substantially above the MSCI ACWI level of 3.8% (July 2022). This overweight position must be put within the context that it provided 32% of portfolio income in FY21. Because this is just one part of an overall portfolio, the UK sleeve’s characteristics are more nuanced than can be seen in Smith’s other UK portfolios. Specifically, because Crooke can also draw upon other forms of income within the portfolio, such as reserves, gearing and revenues from other geographic areas, the UK sleeve is marginally less value biased and has a combination of more blended styles. This is a characteristic that is evident in some other areas of the portfolio (ie Crooke sometimes looks to smooth out material stylistic biases at the regional sleeve level).

The UK sleeve has a bias to mid and small caps when compared with the index, but not hugely out of line with UK equity income peers or Smith’s other mandates. Historically the sleeve has been at a slight premium to the index in terms of aggregate valuations such as price to book or earnings, but with better quality metrics such as return on equity or cash flow growth. From a sector perspective, when compared with the index the portfolio has a larger allocation to cyclical sectors, such as basic materials, consumer cyclicals and financial services, and less in economically sensitive sectors such as energy and industrials. Key cyclical holdings include Anglo American, Compass Group and Lloyds Banking Group. The sleeve incorporates 29 holdings (April 2022), which is more concentrated than it has previously been (FY20: 44 holdings) and it has been a priority for Crooke to concentrate this sleeve down into Smith’s best ideas, which compares to the c60 equity positions in HHI and 45–55 range in his other institutional funds.

Performance of the UK sleeve has been a little challenged historically, with underperformance in FY16 and FY21 and modest underperformance in FY18. There were some errors around stock selection in 2018 with holdings in some arguably value traps such as Ted Baker, while the bias to mid-caps also weighed on relative performance. The failure to keep up with a strongly rising market in FY21 was a result of the focus on quality within the process. Holdings such as Reckitt Benckiser, Hilton Food Group, Sage and Cranswick performed well, but failed to match higher returns from lower-quality companies within the index. Pleasingly the honing of the investment process seems to be coming through in improved investor returns and in CY22 the UK sleeve is 1.2% ahead of the broader UK equity market (to the end of July 2022), with performance driven by defensive holdings such as AstraZeneca and Reckitt Benckiser. Additionally, stocks in the industrial sector, such as RELX and Bunzl, performed well for the sleeve, as did the financial services companies such as the London Stock Exchange.

The US sleeve represents 37.1% (July 2022) of the portfolio and is the largest single country allocation, however this is still substantially less than the MSCI ACWI weighting of 61.9% (July 2022). While it is the single largest geographic region, it only provides 13% of portfolio income. Gordon Mackay has managed the US sleeve since July 2018 and is part of the global equity team. He does not manage a US fund, rather this is a carve out of the various global portfolios managed by him.

There are a number of themes played within the portfolio that tap into some longer-term secular tailwinds, such as the digitalisation of the economy via holdings such as Alphabet. Then there are cashless payments, which is via American Express and Visa. Another theme is monetisation of data, which is via exchanges such as CME Group and Intercontinental Exchange.

The investment process has a focus on identifying long-term quality growth that is sustainable via barriers to entry and moats such as dominant brands or technology. These criteria mean that certain sectors, such as banks, energy and commodities, are likely to form a small or negligible part of the opportunity set. While the investment process tilts towards growth, there is a valuation discipline, which lends this strategy a necessary pragmatism that avoids the risks arising via valuation bubbles that can form in growth investing. For example, in October 2021 Mackay sold Meta (Facebook) and reinvested into a new position in Oracle to take advantage of the divergent valuation and outlook for growth; likewise, he sold Netflix and used the proceeds to initiate a new position in Coca-Cola. Mackay and team work closely with the JHI technology team in Edinburgh and through them are able to leverage off the extensive global JHI analyst and portfolio management team in the United States, which gives them notable insight in this area.

The US sleeve does have a stylistically growth bias (albeit not high growth) versus the S&P 500 and the Morningstar US large-cap blend category. In terms of average market cap, the portfolio is similar in market value to the S&P 500 but stands at a substantial price premium to historical earnings and book value. Growth and quality measures such as earnings growth, return on equity and net margins are higher. From a sector perspective the portfolio has a significant overweight to cyclicals such as industrials and financial services companies via larger positions such as Roper and American Express and corresponding underweights in aggregate to defensives and economically sensitive sectors such as utilities and energy. The sleeve is relatively concentrated with 24 holdings (April 2022). Mackay has managed the Janus Henderson Global Equity Unit Trust since September 2019, which shares some 41% commonality with the BNKR portfolio (at June 2022). At the end of June, the unit trust had 59.1% invested in US equities, so he is well versed with the opportunity set in the region.

Performance of the sleeve has historically been strong, as shown in Exhibit 7. However, as described above, the strategy is more than just a play on high beta growth names. In the calendar year to the end of July 2022, the performance of the US sleeve was 2.5% behind the regional broad-based US equities index, which returned -4.5% (in sterling terms), while purer growth strategies have returned broadly -14.5% over this period. Holdings that performed well within the sleeve included Mastercard, Automatic Data Processing and Visa, while Sherwin Williams, Intuit and the Home Depot were weaker. It is interesting to note that the sleeve is also contributing to the portfolio income, with the US offering investors faster-growing rather than high headline levels of dividend income.

Over the year to the end of June 2022, BNKR returned -5.0% (NAV with debt at fair value), which compared to the FTSE World return of -2.8% and the Morningstar global large-cap blend category average of -6.6%. The 2.2% of relative underperformance versus the benchmark was broadly a result of one-third sector asset allocation and two-thirds stock selection.

From a sector perspective, the underweight allocation to technology was beneficial as the sector began derating as the global economy started its recovery out of the COVID-19 pandemic and investor attention switched to more cyclical areas of the stock market. The biggest relative detractor from a sector perspective was the underweight energy position, which held back performance as the oil price rose steadily through the year as global economic activity increased and then soared on the outbreak of the war in Ukraine. Stock selection was strongest through this period in the broad industrials sector, while it was weakest in consumer staples. At the stock level, the underweight holdings relative to the benchmark in Meta (Facebook) and Amazon and the overweight position (and largest single absolute holding at July 2022) in Automated Data Processing (HR software and services) were the most accretive to returns, contributing 1.2% of relative outperformance. The overweight holding in Faurecia (French auto parts supplier) and off benchmark position in Chinasoft International (IT software and services) detracted, as did the underweight position in Apple, which in aggregate cost 0.9% of relative underperformance.

In the longer term (over three, five and 10 years), the portfolio performance is comfortably ahead of the Morningstar global large-cap blend category average and AIC global peers, but has lagged its broad global equity index. Historically the fund’s volatility sits mid-way between that of the index and peers, with risk-adjusted returns that exceed peers. The focus on long-term, relatively consistent returns with an eye to preserving capital where able has provided some downside protection to the portfolio in line with the index, but appreciably better than peers.

The AIC global category is home to some of the oldest and best-known investment companies, of which BNKR is most definitely one. This large cohort has a variety of investment approaches, styles and biases. We would categorise BNKR as a core offering, that is to say it is well represented across the various investment regions, has a bias to larger companies and is relatively style neutral at the aggregate portfolio level (although there are material stylistic tilts at the various regional sleeves; the US sleeve has historical growth characteristics, while the Asia sleeve is more biased to value opportunities). Further core credentials are illustrated by the portfolio’s low volatility of returns versus its AIC peers, less participation in downside market movements and good risk-adjusted returns. The long-term investment process followed here has resulted in a solid track record of income (55 years of consecutive dividend income), which puts it equal second on the AIC dividend heroes list. Furthermore, while BNKR is arguably a core offering, it does not mean that it is quasi passive. This is a strategy that blends active asset allocation with stock selection resulting in an active share versus the benchmark of 84% (active share calculates the similarity between two portfolios, with 0 meaning that the two are completely identical and 100% indicating no overlap at all). Lastly the management fees that investors pay for holding the trust are low, which is one of the single most important determinants of future returns.

All the quantitative measures point to a successful core investment approach, however equally as important are the qualitative merits on show here. In Alex Crooke, BNKR has one of the longest serving fund managers in the sector, with his tenure on the fund dating back to July 2003. Where BNKR has an advantage over other funds that blend asset allocation with stock selection in a similar way, is that by dint of his role of as co-head of equities (EMEA) at JHI, not only is Crooke closely monitoring macro and regional economic developments, but he is very familiar with the regional portfolio managers (many of whom report directly to him). This allows him very detailed real time insight on the performance drivers for these strategies. Thus, when it comes to allocating funds to regional managers, he is able to select with confidence those that best fit into the portfolio. He is also able to direct and tilt these regional portfolios to ensure optimal positioning for the BNKR portfolio. This is a tremendous advantage over fund-of-fund or manager-of-manager investors. Lastly this approach probably would not be as effective in some other investment firms, but here Crooke has a plethora of diverse and good performing strategies from which to select, with the sole use of in-house specialists helping to keep costs low.