Volatility hinders returns at Keystone – Keystone Investment Trust (KIT) posted a NAV return of 0.0% for the year ended 30 September 2018, compared to last year’s NAV return of +7.8%. Share price total return for the year was also down compared to 2017 (share price total return for 2018 was 0.8% and 2017 was 3.2%). The All-Share Index posted a total return of 5.9% for 2018 compared to 2017’s return of 11.9%.
During the year Keystone made investments in Tesco, Royal Bank of Scotland, Amigo, Rolls-Royce, Phoenix Spree Deutschland, MJ Gleeson, Bushveld Minerals, CVS, Endeavour Mining, On the Beach, Capita, Future and Dairy Crest. Keystone sold its investments in Lloyds, Shire, BTG, SAGA, Rentokil, Hiscox, BAE Systems, Electra Private Equity and Real Estate Investors.
Total revenue return after tax for the year was 55.9p per ordinary share, which is down from last year’s total return of 61.5p per share. Despite the volatility and low NAV total returns, Keystone has decided that there will be a second interim dividend of 38p per share which is up from last year’s 37p per share. The total dividend for the year is 56p per share which is up from 55p per share in 2017. This gives a yield of 3.3% for the year and compares favourably with the UK All companies sector average of 2.0%. Keystone was able to fund the dividend by drawing on its revenue reserves. Special dividends are down for the year, with the special dividend per share being 1.75p compared to 2017’s 4.7p.
Extract from the manager’s report
According to the manager, KIT’s underperformance of its benchmark can be attributed to two main problems “The first is an increasingly difficult market backdrop for a valuation-driven approach. Recent years have seen an ever-greater premium attached to companies globally that are perceived to be capable of delivering growth and reliability of earnings such that the relative valuation of growth stocks to value stocks has widened to historically extreme levels. In a UK market context this phenomenon has been compounded by anxiety around Brexit that has resulted in the valuation of domestically
focused businesses (and especially financials), the potential losers in a bad Brexit outcome, compressing to unusually low levels for a non-recessionary environment. In the light of such relative valuations, the portfolio is overweight domestic value and underweight international growth and resources, and this has hurt performance.
The second source of underperformance is a series of sharp share price corrections following operational disappointments from a handful of companies in which the portfolio is invested.
The largest detractor over the twelve-month period, in both relative and absolute terms, was N Brown. Shares in the online outsize clothing retailer were weak throughout the period, against what has proven to be a particularly difficult environment for the retail sector. The company issued a trading update in January 2018, provoking fears that reduced margins would impact full year results and when those results were released in April they were below analyst estimates. These challenges, coupled with disappointing footfall and a steady decline in the value of the shares led to action by the new Chairman, first announcing the closure of their high street stores and then taking the decision to change the Chief Executive. This renewed focus on the company’s online operation is being supported and the stock is still held.
The share price of TP ICAP, an inter-dealer financial derivatives broker, weakened after a disappointing trading update in March 2018. The share price then fell very sharply at the beginning of July as the company cut its cost savings target for the year and parted company with its Chief Executive. Whilst the outlook has certainly deteriorated, the dramatic decline in the share price looks overstated and so the position has been maintained.
Shares in consumer goods company McBride fell sharply in January on the release of a disappointing trading update. The update cited cost challenges, including raw materials, labour market pressures and transportation costs, which had impacted the Group’s first half profit performance and saw analysts cut their forecasts for future profits. Notwithstanding the share price performance, this business has been significantly improved by the current management team and its dominant market position remains attractive. Whilst it operates in a competitive sector, many of the issues impacting recent performance are likely to prove transitory. Shares were added to the position opportunistically at lower price levels.
Barclays, the portfolio’s largest holding, also detracted from returns. The share price posted a positive return for the first half of the period but traded lower in the second quarter of 2018 as falling bond yields and fears of fallout from political turmoil in Italy weighed on sentiment towards the global banking sector and fears around Brexit weighed on the UK banks in particular. The shares fell further in the third quarter, despite the bank reporting higher-than-expected net operating income for the first half of 2018. The portfolio’s significant weighting reflects conviction that the stock market’s low valuation of Barclays implies an overly pessimistic assessment of the company’s earnings outlook and capital generation – and therefore of the potential for the company to return capital to shareholders.
The portfolio has two holdings in the oil & gas sector, namely BP and Royal Dutch Shell, and together they provided the largest absolute positive contributions to the year’s return. The oil majors’ shares rose throughout the period, helped by the higher oil price environment. Whilst the portfolio has a significant exposure to the sector, it is still underweight relative to the FTSE All-Share Index, and correspondingly failed to benefit to the same extent as the index.
Performance was also supported by a number of holdings in the financial sector, including AJ Bell and Sigma Capital. Unquoted investment platform AJ Bell provided a positive contribution and confirmed its intention to IPO by the end of 2018. Specialist fund manager Sigma Capital’s share price performed strongly throughout the period. In particular, the market responded positively to a statement released in February that PRS REIT, the residential real estate investment trust that Sigma manages, had successfully raised an additional GBP250 million via a placing. This additional capital increases the revenue that Sigma earns for developing and managing the assets. There is significant growth potential for PRS REIT, which is also held in the portfolio. With this dual
exposure the portfolio can benefit from PRS REIT’s future income generation potential together with the long-term capital growth opportunities presented by Sigma Capital as the investment manager.
The portfolio’s holdings in Bushveld Minerals and Gamma Communications also provided notable contributions to returns. Shares in Gamma, a telecommunications services provider, traded strongly throughout the period, making gains on the release of results for the first half of 2018, which showed an improved growth outlook buoyed by contract wins and an expanded pipeline.Meanwhile AIM-listed vanadium producer Bushveld Minerals was bolstered in the latter half of the period by news that the company had acquired a further 21.22% stake in Strategic Minerals Corporation (SMC). SMC is the majority owner of Vametco, Bushveld’s South African vanadium mine, of which the company now owns 76% (the residual having been transferred under South Africa’s Black empowerment rules). With vanadium showing the strongest performance of all industrial metals this year to date and the supply demand outlook still compelling, the position has been maintained.
However, the portfolio’s exposure to the mining sector was not positive overall. Whilst the sector as a whole provided a positive return to the market, this portfolio has no exposure to large-cap diversified miners, only to gold miners. Two of those names, Acacia Mining and Randgold Resources were a drag on the portfolio’s return. Shares in the Tanzania-based gold miner Acacia Mining had already fallen substantially in early 2017 following a tax dispute with the Tanzanian government that prevented the export of gold in concentrate from the country. Barrick Gold, which owns 64% of the company, is negotiating on Acacia’s behalf but the outcome remains uncertain and the shares have remained weak accordingly. Meanwhile, the share price of Randgold Resources also performed poorly throughout the period, driven by concerns around tax hikes affecting operations in the Democratic Republic of Congo. The share price of both Acacia Mining and Randgold Resources rallied into the period end on news of a proposed merger between Barrick Gold and Randgold Resources. However, gains were insufficient to offset the losses incurred earlier in the period.”
KIT-Volatility hinders returns at Keystone