British Empire’s value style continues to underperform growth

British Empire Trust (formerly British Empire Securities & General trust) has announced its interim results for the six-months ended 31 March 2016. During the period, the trust provided NAV total return of 5.6% and a share price total return of 4.6% both of which underperformed its lead benchmark index, the MSCI All Country World ex-US Index, which returned 8.6% during the same (all in sterling terms). The discount widened a little from 11.6% as at 30 September to 12.7% at 30 March 2016. The trust’s interim dividend has been maintained at 2.0p. The board say that the underperformance reflects the fact that the trust’ value investment style continued to underperform growth during the period.

Joe Bauernfreund (pictured) became the lead portfolio manager on 1 October 2015 and, in his first six months as lead portfolio manager, the board say that he has adjusted the investment portfolio, in particular by reducing the number of holdings, to focus on those stocks in which he and his colleagues have the highest conviction. On 5 November 2015, the Company’s name was simplified to British Empire Trust plc as the trust had previously indicated in its 2015 annual report.

In terms of financing, the Board announced on 18 December 2015 that it had agreed to issue 20-year unsecured private placement notes to obtain fixed-rate, long-dated Sterling and Euro denominated financing at a price that the Board and AVI consider attractive. The Notes were issued on 15 January 2016 in two tranches. The first tranche was £30 million, denominated in Pounds Sterling. The second tranche was €30 million (equivalent to approximately £22.6 million at the exchange rate on 15 January). The company says that the blended annualised cost of this new debt is 3.79%. The Notes are due to be repaid on 15 January 2036 (interest payment dates will be 15 January and 15 July of each year). Total fixed-rate borrowing, including the Notes, increased from £15m to £66.8m following completion of this transaction. The manager says that the bulk of the proceeds of the issue were invested in early 2016 following sizeable falls in markets and widening discounts and that, with markets having risen by 5.6% since the end of January, the timing of these purchases proved fortuitous for the trust.

In terms of performance attribution, the manager says that the underperformance, relative to the formal benchmark, can be explained by a limited number of factors: 1) The accounting effect of marking to market the debt reduced NAV by 1%, 2) the trust entered into a Japanese Yen hedge during 2015, which was closed in January 2016, crystallising a notional loss equivalent to 0.5% of NAV. However, the manager says that, since then, the Yen has appreciated further against Sterling by 5% and this has been a benefit to the trust given the c.11% exposure to Japanese listed companies and 3) Two investments detracted a total of 1.2% from the trust’s NAV. These were Dolphin Capital Investors and Dundee Corporation (there were no other substantial detractors from performance during the period).

The manager says that his value investment style has been out of favour for eight years and, in addition to this, the outperformance of the US, where the trust has little direct exposure, and the strength of Sterling have been additional headwinds to performance. The manager says that, of these headwinds, it is the reversal of the trend of Sterling strength that has been the most pronounced in this period. On a trade weighted basis, the Pound has fallen by 6.6% since 30 September 2015 and, with 91% of the trust’s portfolio in companies listed in and conducting business in currencies other than Sterling, the manager says that this has provided a welcome boost to returns over the period. In regards to the other headwinds, the manager says that, whilst the US has continued to be a robust performer, there are tentative signs of “value” starting to recover some lost ground. He also says that growth stocks, which have been the star performers in recent years in his view, have undergone a reversal of fortunes thus far in 2016, with the tech-heavy NASDAQ Index underperforming the S&P 500 Index by a wide margin.

Looking forward, the manager sees cause for optimism. Commenting that, as markets fell by 20% from their highs in April 2015 to their recent low point in mid-February 2016, the weighted average discount on the trust’s portfolio widened from 24% to 33%. The manager says that this widening has been a substantial obstacle to generating good relative performance. However, the level is now close to that reached at the depths of the market sell offs in 2009 and 2011, where it reflected an inflection point in valuations and, in this respect, he is now looking forward to the positive effects of discount contraction from these levels. Furthermore, the manager says that he is seeing the potential for corporate events within the portfolio, which he believes will lead to a substantial narrowing of discounts in some key holdings. Reflecting this, he says that adjustments have been made to the portfolio, which has been accompanied by the decision to increase the level of structural gearing.

Looking at the trust’s European Holding Companies portfolio, the manager says that Investor AB was the largest positive contributor to performance over the period, as its discount narrowed slightly along with a strong currency improvement. Aker also contributed positively with a discount narrowing of 3.5 percentage points despite a fall in the oil price over the period, to which around half of its companies are exposed. The largest detractor over the period was Spanish holding company Sacyr, whose large exposure to Repsol weighed down its NAV.

Looking at the trust’s Asian Holding Companies portfolio, the manager says that the largest positive contributor over the period was Jardine Matheson, whose share price rose by 21% in local currency (27% in Sterling). Whilst the NAV increased by 9%, the share price return was greater than this as the discount narrowed from 22% to 13% over the period. The manager says that this left the discount well below historical average levels and also substantially narrower than “sister” company Jardine Strategic, whose discount remained above 30% over the period. Much of the discount narrowing was driven by the inclusion of Jardine Matheson in the MSCI indices which encouraged position building by the passive index trackers. The manager say that this gave him an opportunity to exploit a pricing anomaly and he sold the position in Jardine Matheson, on a discount of 11.5%, locking in an IRR of +20% over the trust’s ten year holding period. He says that the proceeds have been reinvested into Jardine Strategic on a wider than average discount of 34% and so the portfolio retains its exposure to broadly the same high-quality underlying assets, but on a more favourable valuation.

The manager says that First Pacific was the second largest contributor, which benefited from discount narrowing and that negative contributors were negligible (Hitachi posted the largest loss). The manager says that Japan appears relatively attractively valued but concerns over the weak economic environment and a strengthening Yen have fuelled an exodus of foreign investors and this has weighed on the market.

The manager says that he initiated a new position in Swire Pacific during the period after the sharp sell-off in Asian markets during August 2015. He says that the majority of its assets are invested in Swire Properties, a listed Hong Kong developer that controls a portfolio of high-quality Hong Kong commercial assets. Swire Pacific also owns a stake in Cathay Pacific and a beverages business. The manager says that, like many Asian companies, its share price had performed poorly and it currently trades at a 50% discount to its NAV. The B shares in which the trust is invested currently yield 5.2%.

Looking at the trust’s Closed-end Funds portfolio, the manager says that this was the top performing category over the period. He comments that Symphony International, the Asian-consumer focused fund, was the largest contributor to performance (recording a 27% gain in Sterling – 21% in its traded currency of USD), which was boosted by a distribution in March. The manager says that this is the third year in a row that Symphony has paid a substantial distribution, and should help counter the perception that management are oblivious to the very wide discount to NAV at which the company’s shares trade (39% at period-end). The manager increased the trust’s shareholding in Symphony over the period by almost a third to reflect his high level of conviction in what he saw as a compelling level of valuation. The manager reports progress in their activist campaign with DWS Vietnam with an announcement in January that two of their nominated candidates would be joining the board. Open-ending proposals are to be put forward to shareholders before the end of the year. At the end of the period, the shares traded on a 21% discount to NAV and the manager says that the prospective narrowing of this represents significant upside potential. Furthermore, the manager says that he remains excited by the number of near-term catalysts for discount reduction/elimination amongst the trust’s Closed-end Fund holdings, and he has raised weightings accordingly.

In terms of the property portfolio, the manager says that the trust’s directly-held listed real estate companies added substantially to returns during the period. He says that NAVs increased as valuers caught up with transactions, but share prices failed to keep pace as discounts across the real estate exposure widened over the six-month period.

British Empire’s value style continues to underperform growth : BTEM

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