Witan Investment Trust — Turning a corner

WTAN’s investment approach primarily uses external managers. Around 75% of its assets are in its core manager line-up (five global and one UK). Global is 65% of the portfolio (±10%) and the UK is 10% (±5%). The balance of the portfolio is made up of specialist investments including dedicated emerging markets and climate change strategies. WTAN’s specialist managers tend to invest in companies (or regions) with superior long-term growth prospects, which may otherwise be underrepresented in global portfolios due to the specialist knowledge required to research and monitor these investments.

The benefits of a multi-manager strategy include access to a broad range of opportunities, many of which are only available to the professional investor; the potential to smooth volatility in returns; and WIS’s executive team can adjust manager allocations and portfolio exposure. The individual managers make their own decisions in terms of asset allocation within their portfolios, and run high-conviction funds, helping to ensure WTAN’s combined portfolio is not overdiversified. In Exhibit 1 we show the recent weighting of the various parts of the portfolio.

Longstanding investors will be accustomed to the incremental changes made within the portfolio. in the year to August 2022 there have been relatively modest changes at the geographic (Exhibit 2) and sector level (Exhibit 3).

WTAN offers investors a diversified portfolio of around 250 mainly larger companies (not including the holdings at the underlying fund level). Looking closer at changes in the top 10 portfolio positions versus a year ago (Exhibit 4), the principal difference is the increase to the broad themes of sustainability with an increase of 2.5% to the allocation in the GMO Climate Change fund and an initiation of 1.5% in the VH Global Sustainable Energy Fund. In aggregate, these two positions account for 7.7% of the portfolio. Later in the note we take a closer look at some of the modest but discernible changes in sector weightings, but it is useful perhaps to indicate the new top 10 positions (but not new to the portfolio) in energy via BP and healthcare via UnitedHealth Group. The largest three positions added to the portfolio in 2022 include Shell, Novo Nordisk and Bio-Rad. All three feed into the marginal increases to the energy and healthcare sectors at the aggregate portfolio level (Exhibit 4).

Energy is a sector where active managers tend to tread carefully with volatile spot prices often being the major driver of returns. In addition, in a world where a company’s ESG merits can have a tangible influence on the investment decision, energy (despite the arguments about the sector’s influence on the transition to low carbon) has generally been out of favour with investors. One way to consider it is as a hedge against the largely energy driven price input inflation that is surging through the global economy. WTAN’s energy weighting (Exhibit 5) remains modest overall and below that of the wider global equity market weighting. Understandably, the energy sector has performed strongly through 2022. Key names in WTAN’s portfolio are primarily accounted for via the aforementioned BP and Shell, which are trading on cheaper trailing valuations (price to earnings and price to book) compared with US peers, but there is also a tail of additional holdings within the portfolio including ExxonMobil, Total and Eni. As well as supporting energy stocks, higher energy prices also provide longer-term support for the GMO Climate Change Fund, which seeks to benefit from companies that mitigate climate change and enhance the efficiency of resource consumption. Other plays on energy efficiency and renewable infrastructure within the portfolio include BlackRock World Mining, VH Global Sustainable Energy, Vinci, and railroad operators such as Canadian Pacific Railway.

Healthcare has been an underweight position in the recent past, but additions to the sector have brought the overall weighting in line with the MSCI ACWI. It is a classically defensive sector, but with powerful secular trends such as demographics and a growing emerging markets middle class, healthcare has performed strongly through 2022. WTAN’s exposure is via the whole gamut of subsectors including pharmaceuticals, biotech, drug manufacturers, medical devices and medical instruments. There were a number of portfolio additions to the sector in 2022, which have augmented the existing funds that are also invested in the life sciences subsector, including the SPDR S&P Biotech ETF (XBI), the Biotech Growth Trust (BIOG) and Syncona.

Conversely there has been a decrease in the allocation to technology and consumer cyclicals within the portfolio. The portfolio has been underweight in technology versus peers and the index (Exhibit 6). After its multiyear outperformance, the technology sector has been weak in 2022. The catalyst was the market’s perception of the effect of interest rate increases on the valuation of long duration low yield assets. Some of the underlying managers have been reducing or exiting their ultra-high growth long duration holdings such as Shopify into arguably more reliable and less highly rated growth stocks such as Mastercard, while some managers have moved away from technology to high-quality brands such as Lululemon Athletica, whose growth prospects are less highly rated. With the weaker sentiment to high growth names creating a valuation opportunity, there have been several new additions to this sector in 2022 via stocks such as Atlassian and Samsung Electronics.

WTAN’s weighting to consumer cyclicals has also declined during 2022 (Exhibit 6). The weighting is broadly in line with peers but below the MSCI ACWI. The macro headwinds that have created a cost of living crisis in many parts of the world and are stalling global economic growth have understandably reduced the perceived attractiveness of consumer cyclicals. This exceptionally broad group of companies however encompasses sub industries such as internet retail, luxury goods and restaurants. The largest stock weighting in allocation is Amazon, although prominent positions include LVMH, Tesla and eBay.

The core portfolio manager line-up remains unchanged and overall, the portfolios at the end of December 2021 and August 2022 share, as one would expect, a high level of commonality. The five largest stocks that have left the portfolio include Shopify, Universal Music Group, Vivendi, Sherwin-Williams and Nike. Despite some change at the stock level, in aggregate the portfolio has maintained its large cap balanced core/growth positioning through the period (Exhibit 7).

In our previous note Strong absolute performance in 2021 published in March 2022 we looked at three of the external managers, WCM, Jennison and GMO Climate Change Fund. In this update we focus on Veritas, Lindsell Train and Artemis, which in aggregate account for 38% of the portfolio (at August 2022). For context, we set out the weighting to the individual managers and the specialist portfolio in Exhibit 1. All three strategies have experienced managers and follow proven investment approaches. Artemis was appointed in May 2008, with Veritas first appointed in November 2011. The most recent addition of the three was Lindsell Train in December 2019, although it successfully managed a UK sleeve for WTAN from September 2010 until the mandate was broadened out globally in December 2019. One of the key considerations for WIS and the board is that the various managers add diversification to the overall portfolio with limited overlap (eg Veritas shares just a single common holding with each of Lindsell Train and Artemis).

The portfolio is managed by Andrew Headley and team with the investment process focused on creating a relatively concentrated portfolio of liquid, high quality cash-generative businesses. High quality means ongoing competitive advantages via high barriers to entry, patent protection and well-regarded management teams, resulting in long duration, reoccurring and growing cash flows. The team’s valuation discipline is key to not overpaying as is its patient approach to building up positions. The resultant portfolio trades at a premium to the market and peers in terms of price to earnings and price to book, but with better earnings and cash flow and book value growth. It is also more overweight those businesses that have a competitive advantage (wide moats) versus the index. The portfolio is currently around two thirds invested in the US, which is perhaps not a surprise (major positions include Microsoft, Cooper Industries and Thermo Fisher Scientific), but it does have an overweight UK position via BAE Holdings and Unilever etc. Across the portfolio in aggregate there is less in cyclical stocks such as basic materials and financials and more in defensives such as healthcare (CVS Health and Baxter International) and communication services including Alphabet, Charter Communications and Meta Platforms (Facebook). The focus on valuation leads to a current lowly exposure to technology and an above -benchmark allocation to industrials (Canadian Pacific Railway, Aena and Vinci). The process results in a portfolio with lower volatility than peers or the broad global index, with less deep drawdowns, more resilience and lower sensitivity to market movements (Beta).

In some ways Lindsell Train shares some similarities of approach with Veritas in that the managers are looking for high quality, cash generative and easily understood companies, although at the end of June 2022 the two portfolios shared only a single holding (Unilever). The portfolio is highly concentrated (20–25 stocks) and follows a patient investment approach with very long-term holding periods. As a result, the portfolio has typically exhibited lower levels of volatility than peers, with less downside participation in weaker markets. Quality is evident within the portfolio, which according to Morningstar has more wide moats or barriers to entry in aggregate than the index. Unlike Veritas, the managers find more opportunity in the UK and Japan where the portfolio is currently weighted at 29% and 22% respectively at the expense of the US, which is only 35%. The portfolio trades at a premium to the market and peers in terms of price to earnings and price to book. From a sector perspective the portfolio has significant exposure to consumer defensive companies such as Diageo, Heineken and Unilever, and communication services via Nintendo and Walt Disney versus peers and the index. The portfolio is very underweight technology and healthcare. The process scores very strongly on Sustainalytics with the maximum five globe rating and holds the Morningstar Low Carbon designation (June 2022).

Artemis manages the UK Special Situations Fund and it has been one of the longest held mandates in the WTAN portfolio, since 2008. The strategy has been overseen by Artemis founding partner Derek Stuart since its inception in March 2000. The portfolio is the sole single-country mandate, focusing on self-help turnarounds and out of favour valuation opportunities. The portfolio is unconstrained by sector and stock weightings and has a bias to small- and mid-caps with an average market cap of c £15bn versus the c £48bn of the broad UK equity market. From a sector perspective the portfolio is substantially overweight consumer cyclicals via holdings such as Weatherspoon and Entain, industrials via Melrose and Smiths Group and Technology via Spectris and Computacenter. As a result, the portfolio is more volatile than the index with higher Beta and corresponding historically larger upside and downside capture ratios, which given the all-cap nature of the portfolio is to be expected.

The company aims to pay a dividend that grows faster than inflation over the longer term, however if inflation remains at the current elevated levels, dividends paid by WTAN may not exceed inflation each calendar year. WTAN has paid a second interim dividend of 1.40p (H121: 1.36p) on EPS of 2.51p, which is a 39% increase from H121 earnings of 1.80p. Some of the more cyclical parts of the portfolio have seen the greatest recovery in the dividends they pay to WTAN, having been most affected by COVID, but overall, the recovery in dividends has been fairly broad-based across the portfolio, illustrating improved trading and cash flow generation at the stock level. The board is confident that it will be able to pay a fully covered dividend to investors over the coming years. As an AIC dividend hero, the company has delivered 47 years of consecutive increasing dividends, with the board guiding to a further increase for FY22, utilising revenue reserves if required, which stood at £52m (or 1.2x the FY21 full year dividend) at the start of 2022. WTAN currently yields 2.5%, which is a premium to its AIC Global peers.

The board has been actively buying back stock and in H122 it bought c 30.7m shares into treasury, which resulted in an increase to NAV of £5.7m. This action also had the unintended benefit of offsetting the fees paid to the underlying managers (£4.3m) during the period. Since the end of H122 (30 June) to 22 September, the company has bought back a further 14.6m shares.

The current discount of 11% is broadly in line with WTAN’s AIC Global peers, however, it is wider than the company’s long-term historical average of c 4.6% (Exhibit 9). In our view, this provides a decent opportunity to add to or initiate new positions, with the expectation that the board is keen to keep the level of discount closer to NAV and have shown its resolve though consistent large-scale buybacks.

In the eight months to the end of August 2022 the fund has returned -7.5% in NAV terms versus the Morningstar Global Large-cap Blend category return of -6.8% and the MSCI ACWI return of -4.3%. WTAN’s performance during 2022 has been volatile, with the fund underperforming in the first quarter as the market’s attention shifted from the positive prospects of economic reopening post COVID-19 to the war in Ukraine, rising inflation and tightening monetary policy. The market’s first leg down troughed in early March and after a brief rally fell again in mid June. Within these mini cycles the market’s concern about stalling global growth, soaring inflation and rising interest rates was especially detrimental to a portfolio that is in aggregate focused on quality growth and some cyclical businesses. The use of gearing in these circumstances was also clearly a pressure on performance, although the board also used market weakness to increase gearing during weaker periods in the market (Exhibit 10).

Since WTAN’s half year end at 30 June 2022 to the end of August 2022, the fund has staged something of a recovery returning 8.0% versus the Morningstar Global Large-cap blend category return of 6.5% and the MSCI ACWI return on 7.5%.

Performance is broadly a function of the stocks (or manager selection), investment style and geographic asset allocation. WIS and the board have done a decent job at manager selection and the track record of the individual managers, when measured against their respective benchmarks over the long term, is generally good. The exceptions are the relatively recent additions of Lindsell Train’s global portfolio, WCM and Jennison, which in aggregate accounted for 33% of the portfolio at end June 2022. While it is too soon to judge the performance of these managers within the context of WTAN’s portfolio, there have been clear stylistic headwinds facing these strategies as the returns from ‘quality growth’ stocks have stalled after many years of outperformance.

From a geographic allocation perspective, WTAN’s underweight position to US equities and overweight positions in UK and European equities versus global indices and peers has been a long-term headwind for performance against these comparators. For example, the S&P500 has outperformed UK and European markets by an annualised 4.2% and 3.6% respectively over the past 20 years (to the end of August 2022. All returns in GBP). At the start of 2020 the board decided to change WTAN’s benchmark to better represent the available opportunity set. The US benchmark weighting was increased from 25% to 51% and the UK and Europe were reduced from 50% to c 30%. Given the performance and valuation differential between these markets there were not wholesale changes made to the geographic asset allocation, however the US weighting was incrementally increased from 22% at the end of 2019 to 40% at August 2022. WCM and Jennison were appointed in August 2020 as growth stocks made up the majority of the increased US weighting. Retrospectively the timing was unfortunate as growth investing as a style fell out of favour shorty after.

For the half year to 30 June 2022, five of the six core managers underperformed their respective benchmarks, with all ending in negative territory over the period. The growth investment styles of Jennison and WCM were the weakest performers as growth stocks de-rated substantially over the period as global growth slowed and interest rates were raised to counter rising inflation. The stylistically more balanced strategies, such as Lansdowne and Lindsell Train, performed better than the growth strategies but still underperformed. Veritas, which has more of an absolute return approach performed broadly in line with global indices, while Artemis with its small-cap bias was weaker than its mainstream UK index, where major oil companies performed particularly well. Overall, the specialist element of the portfolio, which accounts for around a quarter of the overall portfolio, performed better relatively versus comparators. The unquoted growth portfolio, which consists of two funds (Lindenwood and Lansdowne Opportunities) outperformed the WTAN benchmark, while the direct holdings sleeve was the weakest performing. Longer term, of the 10 constituent core managers or elements of the specialist portfolio, only three are behind their benchmarks since appointment, with the recently initiated positions of Unquoted Growth, WCM and Jennison lagging.

The directly invested portfolio underperformed in the first half of the financial year, as the private equity investment trust holdings such as Apax Global Alpha and Princess Private Equity saw their discounts to NAV move substantially wider as investor sentiment weakened with the equity market volatility seen from Q122, which was despite robust NAV performance. WTAN estimates that the effect of this wider discount contributed to a c 100bp detraction at the overall NAV level. If investor sentiment improves, it is likely that this derating will reverse and instead contribute positively to WTAN’s NAV performance. The holdings in BlackRock World Mining and Schroder Real Estate were reduced into strength in the first half of 2022. While biotech has attractive long-term investment characteristics, the sector has been weak over recent years. This prompted the managers to initiate a new holding in an exchange traded fund that tracks the S&P Biotechnology Index. This vehicle is equally weighted, meaning that it has a higher weighting to the smaller, more innovative companies in the index rather than being more concentrated in the four largest index constituents of Gilead, Amgen, Vertex and Regeneron, which in aggregate account for around 30% of the index. This holding adds to the existing healthcare positions of the Biotech Growth Trust (BIOG) and Syncona.

At the end of June 2022 WTAN had £158m of fixed rate borrowings (including £2.6m of preference shares), which have tiered redemption dates from 2035 to 2054 with a 3% average interest rate fixed for an average of 25 years. In addition, there is a multi-currency flexible facility of £150m, of which £78m was drawn down at the end of June 2022. With the 30-year UK Gilt Index yielding 3.9% at the time of writing the managers are very happy to have locked in long-term debt at substantially better terms than the UK government is able to borrow at. Gearing has been a long term and fairly consistent tailwind for WTAN’s performance and WIS and the board feel that overall it is better to be geared than not. They also point to the low hurdle that the portfolio has to overcome in terms of returns to justify the long-term use of such cheap funding. As we have illustrated in Exhibit 10, the board takes an active tactical approach to utilising this facility. WTAN’s current gearing is 11%.

WTAN’s performance relative to its AIC Global peers has been competitive verses the average constituent over one and three years (Exhibit 13), but is lagging over five and 10 years. The most powerful longer-term driver of returns for global equity indices has been the US equity market and technology sectors, which have been a significant underweight within the WTAN portfolio relative to global equity indices and some peers. WTAN’s historical standard deviation has been lower than peers as befits a core one-stop equity fund and from a portfolio metrics perspective, according to work done by Morningstar, WTAN is cheaper than its AIC Global peers and broad global equity indices on a prospective price to earnings and price to book basis, which illustrates the valuation discipline implemented across the portfolio.

The managers believe that investing in well-managed companies with sustainable long-term cash flows is the foundation for achieving good returns for investors; put simply, without due care and attention to ESG factors, sustainable long-term cash flows are at risk. Failure to take ESG considerations seriously is a substantial and existential risk to the businesses and as such an assessment of a company’s ESG credentials is an increasingly important part of the investment process.

ESG is increasingly important in the investment industry and will become ever more central to investment culture and process. WTAN is not a ‘green’ fund, nor does it currently exclude any industries except controversial weapons. However, it does insist that its managers engage where relevant, as this is arguably the most effective way to influence positive change in investee companies and, in turn, to have a more meaningful and positive impact. WTAN became a signatory to the Net Zero Asset Managers initiative (NZAMI) in early 2022 and in addition half of WTAN’s managers have also signed up to NZAMI. This is a commitment by 236 asset managers with $57tn of assets under management to work with all parties within the investment supply chain to reduce greenhouse gas emissions to net zero by 2050, which is in line with global efforts to limit global warming to 1.5˚C by 2050 or sooner. WTAN will be setting out further detail on these commitments throughout 2022 and beyond.

It is pleasing that WTAN has been awarded a low carbon designation by Sustainalytics, as have the strategies managed by Jennison, Lindsell Train, Veritas, WCM and Artemis.

In addition, WTAN will also create and execute a strategy whereby the entire portfolio will be only invested in sustainable businesses by 2030. WTAN defines a sustainable company as:

WTAN is also ensuring its own operations are consistent with a sustainable business via strong corporate governance, a minimalised carbon footprint and an inclusive and diverse corporate culture. It has put initiatives in place such as only using recycled paper, removing plastic from client presentations, installing energy efficient lighting and phasing out single-use materials.

WTAN and all of its managers have ESG policies and are signed up to the United Nations-Principles for Responsible Investment, which were launched in 2006 and are seen as a code of best practice on ESG issues. They aim to spot opportunities and minimise exposure to companies that are at risk of disruption, litigation, regulation or loss of business due to poor ESG practices. Where negative issues arise, the managers are expected to engage with the company concerned, encourage positive change and vote their shares accordingly. WIS monitors WTAN’s portfolio to identify any ESG risks that may arise and scrutinises the policies of its external managers. It focuses on understanding how ESG is integrated into their investment processes and ensures that its managers adhere to what they say they do via regular ESG meetings; this process is a high priority for WTAN’s board.