Witan Investment Trust — Update 6 December 2015

Witan’s composite global benchmark (see note to Exhibit 2, below) has made strong progress since the beginning of 2013 to end November 2015 (+31%) and has outperformed the UK market (+23%) over this period. The current year has, however, seen considerable volatility reflecting renewed problems in Greece, the deflation of a bubble in the Chinese equity market, concerns over China’s growth and continued risk aversion towards emerging markets generally. The IMF and others have also trimmed economic growth forecasts suggesting a more challenging background for corporate earnings prospectively. However, with world economic growth still expected to be just over 3% for the current year and improving to 3.6% in 2016 near term, negative revisions should probably not be overemphasised.

Turning to valuations, the global forward P/E ratio is below its peak but towards the upper end of its 10-year range (see right-hand chart, Exhibit 2) and, while price-to-book and yield measures are close to average values, this suggests that market progress may become more dependent on earnings growth. With global returns on equity running below average levels, there may be scope for these to normalise over time and there is considerable differentiation between and within markets providing stock and sector opportunities for actively managed funds to identify. Taking this backdrop and a consensus view that government bond valuations may be vulnerable, an equity fund with an active global multi-manager approach could appeal to many investors.

Witan was founded in 1909 and listed on the London Stock Exchange in 1924. Previously managed exclusively by Henderson, it became self- managed in 2004, adopting its current multi-manager approach. The trust invests across global equity markets with the objective of generating long-term capital growth together with real income growth. The blended benchmark includes 40% UK exposure, with 20% each for the US, Europe and Asia Pacific. Mandates are normally allocated to between 10 and 15 managers. Witan looks for managers with a distinctive fundamental approach and a willingness to run high-conviction portfolios to ensure that the fund as a whole, while diversified, is differentiated from its benchmark. Witan may also invest up to 10% directly in collective funds that give exposure to mispriced or specialist assets and recovery situations.

At the beginning of 2015, Andrew Bell took a cautiously positive stance on the market on the view that the global economy would continue to make progress assisted by the lagged benefits of the fall in the oil price. In the event, concerns over China’s volatile equity market and slowing economic growth together with fluctuating expectations on central banks’ monetary policy have contributed to a bumpy ride in equity markets that has left Witan’s benchmark only modestly ahead.

While acknowledging risks, the managers still have broadly positive expectations for the global economic background with oil prices seen as a positive driver of consumption in many countries and central bank actions likely to be carefully calibrated. Looking ahead, the managers see the Asia Pacific region as more interesting than others, so the c 15% exposure here could creep up modestly. Similarly, emerging markets and commodities, after prolonged relative weakness, look more interesting and the managers have expressed their view here by purchasing emerging market index futures and adding to the BlackRock World Mining Trust holding.

Bell and Hart are attracted to private equity as they see the longer-term investment commitment and close manager involvement with investee companies as positives to set against the relatively high fees charged. One new top-10 holding in this area is Apax Global Alpha, where Witan sees the target 50/50 split between private equity and a range of debt and equity investment ideas derived from Apax private equity activity as an effective way to manage cash flows and commitments.

Witan has followed a multi-manager approach for over 10 years. The approach evolved following the appointment of Andrew Bell as CEO in 2010, as he reassigned a number of the mandates to ensure that each manager in the portfolio was genuinely active and conviction-led in their approach.

Witan seeks managers whose approach should allow them to harvest the longer-term growth arising from equity investment by focusing on fundamental values rather than short-term momentum. Funds are allocated to 10 to 15 managers employing a range of styles, including value and growth, but Witan is also conscious of the need to avoid over diversification. There are dedicated country/regional mandates for the UK, Europe, Asia Pacific and emerging markets but geographical allocations within the global mandates (approximately one-third of the portfolio) are determined by the external managers.

Catalysts for a change in manager are likely to be style drift or persistent underperformance that cannot be explained in terms of the manager’s approach and prevailing investment conditions, rather than short-term weakness in performance. When selecting a new manager, Witan draws on the knowledge and experience of the directors, advisers and consultants, with a shortlist of managers invited to present to the Witan board prior to a decision being made. In addition to allocating mandates, Witan’s board and management are responsible for adjusting asset allocation as opportunities arise, the appropriate use of borrowings and managing direct investments.

Up to 10% of the portfolio (at the time of investment) may be invested directly in collective funds selected by the Witan investment team. These will be in ‘special situation’ areas that appear to be undervalued, or to offer superior long-term growth. Investments have been made in areas such as private equity, and to augment geographical allocations as in the case of Japan where Witan invested in an OEIC and futures instrument to gain greater exposure to the benefits of Abenomics.

Witan has allocated 11 mandates to external managers including three UK, five global and also pan-European, Asia Pacific (including Japan) and emerging market remits. The most recent changes in managers were made in 2013 but since then there has been some shifting of allocation between managers. This year, modest changes included a reduction in the Lindsell Train weighting after a particularly strong run with funds reallocated to the team at Artemis, which had gone through a softer patch but subsequently staged a recovery. Witan also allocated more money to Matthews International (Asia Pacific) and Marathon (Europe), including funds raised through share issuance.

The directly held investments (8.0% of the total portfolio at the half-year end) included three private equity trusts – Apax Global Alpha, SVG and Princess Private Equity (3.7% in total end-October) and a holding in the BlackRock World Mining investment trust (1.2%). The holding is a response to Witan’s view that the fall in commodities has been overdone and there now exist some mispricing opportunities. The trust exited its holding in the Polar Capital Japan Growth OEIC and its positions in Nikkei futures in the first quarter, as Witan believed that the benefits of Abenomics had been more fully factored into market valuations. Also a number of the underlying managers, notably Matthews, had started to increase their holdings in Japan. There are also holdings in the Edinburgh Dragon convertible loan stock and a Neuberger Berman distressed debt fund.

As Exhibit 4 shows, the UK forms the largest portion of the portfolio at 43% with only modest changes over a year including a reduction in Japanese exposure and increase in Europe. In sector terms, shown in Exhibit 1, financials has the largest weighting at 25.4%; the main change over a year was a reduction in open-ended funds reflecting the sale of the Japan OEIC.

Both Witan’s share price and NAV total returns have outperformed the composite benchmark over all periods shown in Exhibit 5, with share price strength additionally reflecting the narrowing of the discount. Looking at alternative measures, the NAV return lagged the MSCI World return modestly over periods up to five years, but was significantly ahead of the FTSE All-Share. The UK market has lagged the global index so the trust’s relatively high weighting in the UK has acted as a drag. Nine of the 11 external managers have exceeded their benchmarks since appointment or over the half year to end June (see Exhibit 3 for half-year performance). Witan’s direct holdings also outperformed.

The discount has contracted substantially over the last three years probably in reflection of the trust’s performance and the appeal of its global multi-manager proposition. After some volatility at the beginning of 2015 the shares have generally traded close to NAV. Witan has the authority to buy back up to 14.99% of the issued share capital with the objective of achieving a sustainable discount of 10% or less, but this has not been necessary this year. Instead, the trust has provided liquidity by issuing approaching 10m shares to end of November at a premium to NAV, raising nearly £79m (compared with £112m devoted to share buybacks between 2009 and 2014).

Witan has 199.4m ordinary shares and a total of 2.6m preference shares in issue. In April this year the company took the opportunity to put in place an additional £75m of long-dated debt through a private placement (£21m at 3.29% for 20 years, £54m at 3.47% for 30 years). This took total fixed-rate borrowings to £185m but this figure is set to reduce to £140m when a £44.6m 8.5% debenture is repaid in October 2016. The weighted cost of structural debt will then fall to 4.6% from 7.0% prior to the new debt issuance. The size of Witan’s short-term multi-currency debt facility has reduced from £70m to £25m and none was drawn at the June half-year end.

Board policy is to use gearing to manage risk actively and take advantage of investment opportunities. The external managers are not allowed to employ gearing but may hold cash. The board’s policy is not to allow gearing to rise above 20% and it cannot be more than 15% when first committed; in the last five years it has generally been between 5% and 15% and where appropriate Witan may hold a small net cash position. Net gearing remains stable at around 11%.

The trust is self-managed in terms of allocating assets to external managers and the ongoing charge for 2014 of 0.96% with performance fees and 0.74% without, captures Witan’s costs and the underlying charges associated with the manager mandates.

While Witan is managed to deliver total returns, where possible its policy is to provide real dividend growth, measured against the UK consumer price index. The board does not set external managers yield targets as it considers this may constrain investment choices. The range of managers and diversity of underlying holdings should reduce the chances of large fluctuations in investment income. Witan has increased its dividend every year since 1974 and over the 10 years to end 2014 the trust delivered 6.0% compound annual growth in dividends, comfortably ahead of 2.6% consumer price inflation.

The trust pays quarterly dividends with the first three payments expected to be made at the rate of one quarter of the full-year dividend for the previous year (for 2015: 3.85p). The final payment is then set to give the full-year dividend. At the half-year end Witan had a revenue reserve equivalent to c 30p per share in issue, nearly twice the level of the 2014 dividend (15.4p) providing a cushion if there is a near-term revenue shortfall.

Witan is one of the 37 investment companies in the AIC Global sector, and in Exhibit 8 we include the 11 with market caps above £600m. These peers have a diversity of approaches and exposures, but most invest directly in equities: Witan is unique in having a full multi-manager approach. Witan’s 43% UK allocation is above the 33% sector average and compares with the 8-49% range for the companies shown. Witan’s NAV total return is above the weighted averages for the sector and the selected peers over three and five years. It is a little behind over one year, as might be expected given its higher UK weighting. Looking at risk-adjusted returns as measured by the Sharpe ratio, Witan is in line with peer and sector averages over one and three years. Witan’s ongoing charge and dividend yield are also in line with peer group averages.

The board is unchanged from the last review. There are eight board members of whom seven are independent and non-executive. The directors, with year of appointment as director in brackets, are as follows: Harry Henderson (appointed 1988 and chairman from March 2003), Andrew Bell (CEO from February 2010), Robert Boyle (2007), James Bevan (2007), Catherine Claydon (2009), Suzy Neubert (2012), Richard Oldfield (2011) and Tony Watson (2006, senior independent director from February 2008)