QD view – four idiosyncratic investment options that provide a differentiated and diversifying addition to a portfolio

Part of the joy of investment trusts is that they allow fund managers more room to explore. It doesn’t matter too much if a strategy is highly cyclical, goes through periods of unpopularity, or is illiquid, because managers have captive assets and can swerve the problem of managing inflows and outflows.

We’ve highlighted a number of trusts that have used this flexibility to good effect and, like a good beer, can reach the parts other trusts can’t. The result tends to be an idiosyncratic investment option that provides a differentiated and diversifying addition to a portfolio. It also means that managers build up a strong specialism in a specific area. Some of these trusts will offer access to unique assets, while for others, it is the strategy that sets them apart.

Polar Capital Global Financials

Polar Capital Global Financials trust started life as a low-risk way to play the recovery in financials in the wake of the global financial crisis, but has grown and diversified to become a ‘full service’ financials trust, incorporating banks, insurers, plus diverse financials such as stock exchanges, payment companies and rating agencies such as S&P or Moody’s.

Financials – the second largest global sector (after technology)[1] – have struggled in a climate of lower interest rates, but this may now be a selling point. Nick Brind, manager of the trust, says: “Classic value sectors, of which financials are a significant component, have been weak, plus low interest rates have been a big negative for banks.”

This has substantially reversed over the last two years and even if rates are now coming back down, he believes they are unlikely to go back to 1% in the near-term – and while interest rates remain relatively high, financials can make higher profits.

There are other factors in their favour. Brind says: “The sector is likely to be the biggest beneficiary of AI – there are multiple processes that can be simplified. For insurance companies, the rise in the risk-free rate is beneficial.” Financials give investors a degree of diversification from the high growth sectors that have come to form an increasingly large weighting in global and US portfolios.

The trust is global, so can tap into varying interest rate cycles in different countries. The trust has done well out of the Japanese banking sector more recently. It is up 35.7% over the past year, but remains on a discount of 5.3%.

Herald

Herald has a unique proposition. It is not quite a smaller companies trust and not quite a technology trust, but a powerful blend of both. It is neither solely UK, nor fully global, but brings together a portfolio of idiosyncratic technology companies at the forefront of innovation in their respective fields.

This includes British success stories such as Trustpilot, which it invested in at an early stage, but also US server company Super Micro Computer and Dutch multinational BE Semiconductor Industries. The trust has around 40% in the UK, but Potts is alive to opportunities across the globe, particularly in the US, where it has a 31% weighting.

Manager Katie Potts believes the trust’s most important feature is that it invests in primary capital. This provides new capital to growth businesses and keeps the wheels of capitalism turning. “Without it, stock markets will disappear. It’s not just a UK problem, but is happening in stock markets around the world. There is no shortage of companies, but there is a shortage of capital at the smaller end.”  Potts points out that the trust has raised £95m in outside capital (through its IPO and subsequent share issues), but has invested £675m in primary capital. This is an astonishing multiplier effect.

The trust has careful risk parameters. It doesn’t invest in private companies, has no more than 5% in loss-making businesses and looks carefully at pricing. It didn’t invest in Trustpilot at IPO, for example, but only when the price came down to a level Potts considered reasonable.

It’s been a tough time for the smaller companies sector. As Potts points out, “smaller company investors have made their returns by takeovers – usually by US corporates and private equity.” The sector desperately needs outflows to reverse. This looked like it might be happening over the past couple of months, but the sector is still subject to concerns around any potential capital gains tax changes in the Autumn’s finance bill. Nevertheless, the trust is up 26.2% over the past year, yet remains on a 12% discount.

Ecofin Global Utilities and Infrastructure

The Ecofin trust was founded more than 30 years ago, as investors were still weighing up whether it was possible to be ethical and to generate high returns. The trust’s investment universe has evolved over time, and it now specialises in infrastructure and the energy transition. It invests in asset-backed companies, rather than capital goods or equipment manufacturers.

The trust targets a total annual return of 6-12%, aiming for approximately 4% from dividends and the remainder from capital growth. Portfolio manager Jean-Hughes de Lamaze says the team is looking for structural rather than cyclical growth, particularly growth related to the energy transition.

He says there are two drivers for the fund as it stands. The first is falling interest rates: “Here, the perception (of rising rates) was worse than the reality. The big sharp moves in interest rates tended to lead to big sharp moves in the infrastructure sector because it tends to be seen as a bond proxy. Companies may also carry high debt. Also, when long-term interest rates go up, it is usually a sign of a growing economy and these assets tend to be more defensive.” However, he says, the earnings of the companies in which they invest have not been particularly affected by the shift in borrowing costs and now, falling interest rates may improve sentiment.

De Lamaze also sees new drivers coming into the market. Particularly notable is the growth in data centres. Two of the group’s holdings – Vistra and Constellation Energy – have seen a significant re-rating in their share prices over the past year as a result. The trust is up 11.6% over the past year, and is trading on a discount of 11.8%.

Impax Environmental Markets

Impax Environmental Markets can also claim to have spotted the opportunity in sustainable investment before many of its peers. The trust launched in 2002, and is managed by Jon Forster, Fotis Chatzimichalakis, and Bruce Jenkyn-Jones.

The trust focuses on ‘pure-play’ environmental companies, meaning at least 50% of a company’s revenues needs to be tagged to one of its key environmental sectors – energy, water, clean and efficient transportation, sustainable food and agriculture, ‘smart environment’, which includes digital infrastructure and AI, plus the ‘circular economy’, which incorporates recycling and waste management. This gives it a universe of 1500 companies, from which they pick around 50.

The sector has had a rough period, as environmental companies have fallen out of favour. This has been a combination of rising costs, some share price exuberance during the pandemic, and difficulties in key sectors such as onshore wind.

However, Foster says many supportive factors are still in place. Environmental policies are getting tighter over time and standards are raised. He sees this as a significant driver of growth. Valuations are also more appealing. “Valuations are at a long-term average multiple despite a stronger investment case. It’s stronger than when we went into COVID, even with a few delays. We feel good about the absolute valuation. We’ve also got a 10% discount and sectors that have had some headwinds, but with the prospect of getting better”.  The trust has notched up gearing to take maximum advantage. There are signs of a tentative improvement, with the trust up 2.9% over one year.

Each of these Heineken trusts bring a different flavour to a portfolio and has reasons why the future may look brighter than its more recent past. They may be worth another look.

[1] https://www.msci.com/documents/10199/178e6643-6ae6-47b9-82be-e1fc565ededb