The Advantages of Investment Trusts

The AIC has issued a video which spells out some of the advantages of investment trusts over open-ended funds. They spell out that with most investment products you don’t have a say, but with investment trusts you do because you can vote on important decisions about how your company is run and what it invests in. You can also attend the Annual General Meeting (AGM) to meet, and question, the board directors and the investment manager. Investment companies also have independent boards of directors.

You may think that all of this is theoretical and in practice shareholders have little influence. But that is not the case. When push comes to shove, shareholders can change the fund manager and even the board of directors. I have been involved in several campaigns where this actually happened – not just in smaller companies such as in VCTs but at Alliance Trust. The outcome is usually positive even if a revolution does not actually take place.

But attending AGMs is now only available as an on-line seminar using various technologies. I have attended several in the last few weeks of that nature, and they are less than perfect in some regards. Technology is not always reliable and follow up questions often impossible. But they do save a lot of time in attending a physical meeting and they are certainly better than nothing. I look forward to when AGM events can return in a “hybrid” form where you can attend in person or via a webinar.

The AIC video is available from here: https://www.theaic.co.uk/aic/news/videos/your-investment-company-having-your-say

Brexit

I see my local M.P. Sir Bob Neill, is one of the troublemakers over the Internal Market Bill. He gave a longish speech opposing it as it stands in the Commons. But I was not convinced by his arguments. Lord Lilley gave a good exposition of why the Bill was necessary on BBC Newsnight – albeit despite constant interruptions and opposing arguments being put by the interviewer (Emily Maitlis). A typical example of BBC bias of late. Bob Neill is sound in some ways but he has consistently opposed departure from the EU and Brexit legislation. To my mind it’s not a question of “breaking international law” as the unwise Brandon Lewis said in Parliament but ensuring the principles agreed by both sides in the Withdrawal Agreement are adhered to. Of late the EU seems to be threatening not to do so simply so they can get a trade agreement and fisheries agreement that matches their objectives.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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FCA Seminar and Property Funds Rule Change

The Financial Conduct Authority (FCA) is consulting on a rule change for open-ended property funds. The problem of such funds holding illiquid investments in direct property are well known. If investors want to sell when property goes out of favour, the funds simply cannot sell their underlying holdings fast enough. It can take months to do so when investors in the funds expect their cash immediately. Or as the FCA puts in, there is a mismatch between the liquidity offered to investors in the funds, and the liquidity of the fund’s holdings.

This problem has resulted in the funds having to be “suspended” or “gated” to stop redemptions, and many still are after the March crash this year.

The FCA’s solution is to require investors to give notice before they can get their cash – potentially up to 180 days. But this would probably mean that investors would not be able to hold such funds in ISAs, unless their rules are changed. Needless to say, investors who currently do so are not going to be best pleased as they would have to sell them.

This is a very simplistic solution to a long-standing problem, and to my mind may not solve the problem as disposing of property can take longer than 180 days if you want to obtain a fair value for it. Permitting illiquid investments of any kind to be held in open-ended funds is simply wrong.

Such funds should be wound up, or converted to investment trusts which is surely not impossible. Meanwhile I won’t personally be responding to this consultation as I am not so daft to hold such funds, only property investment trusts.

See the FCA press release here for details: https://www.fca.org.uk/news/press-releases/fca-consults-new-rules-improve-open-ended-property-fund-structures  and for how to respond to the consultation.

Yesterday the FCA presented at a seminar hosted by ShareSoc and UKSA as a webinar. Mark Seward was the speaker from the FCA but he did not cover the above issue at all (he is responsible for “Enforcement and Market Oversight”).

He did cover the outcome of the Redcentric case where grossly misleading accounts were published. He said the investors had “purchased a lemon”. They did not fine the company, but the company is compensating the shareholders affected and 3 former executives are awaiting trial. He explained the reasons for the FCA’s actions which seemed reasonable to me (I never held the shares though – those more familiar with the case might have a different view). He also mentioned the Burford case and the legal decision re disclosure of trading data and made some uncalled for derogatory remarks about the comments made on it by some ShareSoc members.

He covered the emergency measures introduced by the FCA for the Covid-19 epidemic which he said enabled the UK markets to raise 3 times more capital than any other European market in the first half of the year. But Mark Northway raised the issue of the problems of private investors participating in these fund raisings. I would also have liked to see the issue raised of companies not providing access to AGMs nor any other means for shareholders to talk to the directors while the epidemic rages.  

Another issue discussed was the outright refusal of the FCA to provide any information on the progress of an investigation. This is exceedingly frustrating for investors as it means after a complaint is made, there is no apparent action for many months if not years. When many of the facts are reasonably well known and in the public domain already (as in the Redcentric case, or in other cases such as those of Globo or Patisserie) this can appear quite unreasonable.

Mark Seward suggested that no regulatory body (for example, the Police) discloses anything about their investigations, partly because the evidence might disappear if they did. But this is simply not true. The Police often inform victims of crimes about the progress of a case, sometimes albeit on a confidential basis. Victims and the police are also entitled to follow the “Code of Practice for Victims of Crime” published by the Government which the police have to adhere to (but not the FCA who are specifically excluded for no good reason).

The seminar was not altogether a waste of time, but could have had a much sharper agenda.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Tech Stocks Bubble Bursting? And Is Stockpicking a Waste of Time?

The bubble in technology stocks seems to be bursting. There were a couple of interesting articles published in Shares Magazine and in the Financial Times this week. The first was headlined “Tech Stock Mania”. It suggested investors had been piling into technology stocks in volumes not seen since the dotcom bubble of 1993/2000 which I well remember. That was an age when the market valuations of such companies became totally detached from reality and the fundamentals on which you value companies. The mantra was that growth was everything to capture market share in the brave new computer software and internet world. Is it different now?

Technology stocks have been attractive of late because revenue growth is still there and the avoidance of personal contact has driven the need for more digitization and for new software products. Shopping has moved decisively to the internet and video tools and social media have become more widely used. Zoom’s share price has risen by 260% since the start of 2020 and electric car maker Tesla almost as much making the company the most valuable car producer in the world, even though they produce relatively few cars. There was a general rise in all the big technology shares this year until a sell-off in mid-July. It appeared that the increase in valuations was being driven by momentum as investors bought in response to share price rises, which is a great merry-go-round if you can jump on and off at the right point. Just looking at the vertiginous charts of some of these companies can spook you. It’s not that I am a great follower of charts, but when I see a rise in the share price faster than any growth in sales or profits, then this tells me that the market is getting over-excited.

I am of course a great believer in the merit of technology companies where growth can be achieved but past technology giants did not always grow for ever – IBM, Hewlett-Packard and Oracle are good examples. Management errors in not keeping up with technology and market changes are usually the cause, i.e. they collapse like empires from their own internal weaknesses.

I have to admit to recently selling a few shares in the large investment trusts that invest in technology companies – you can guess which they are. The private investors and institutions who buy the shares in such trusts may have even less real view of what is happening in the real world and hence their share price discounts have shrunk to zero or are even negative.

The mega-cap technology stocks such as Apple, Microsoft, Amazon, Alphabet and Facebook now represent more than a fifth of the US stock market according to an article in the FT. That is surely a dangerous level of concentration. Investors seem to think that such companies are not just defensive because of their near-monopoly control of certain markets, but that they still have growth opportunities. They may be right but there is a limit to how much you should pay for any business when the valuation is founded on future growth. Sometimes the growth disappears as markets become saturated and the valuation then crashes as valuations are a discounted calculation of future earnings.

The big winners from the technology boom have been stock-pickers. But Chris Dillow wrote an article for Investors Chronicle a week ago that was headlined “The Impossibility of Long-Term Stockpicking”. It argued that because few listed stocks survive for many years on the market, you are wasting your time stock-picking. Also only 1.3% of shares accounted for all the rise in global markets between 1990 and 2018 according to academic research. The three companies that accounted for 6% of it were Apple, Microsoft and Amazon which were never sure bets if you look at their history.

Mr Dillow therefore argues that as you have no hope of picking the winners you might as well buy an index tracking fund, and you would have done better to hold cash than invest in small cap stocks on AIM.

The article is well worth reading but I am not convinced. My investment portfolio has done better than the FTSE-Allshare over the last 20 years. It might apply to unsophisticated investors that an index tracker may give a good return with minimal effort but you do have to take into account the management charges. You also need to consider what index to follow – global index tracker of large companies perhaps? If so you will have significant exposure to currency risk and the fact that large companies generally underperform. You still have to make some investment decisions and they won’t be any easier than studying individual companies.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Babcock Price Fall, Segro Placing, TR Property and EKF Diagnostics Virtual AGM

I said in a previous blog post “that I tend to avoid FTSE-100 companies as their share prices are driven by professional analysts’ comments, by geo-political concerns, by general economic trends and by commodity prices. You can buy a FTSE-100 company and soon find it’s going downhill because one influential analyst has decided its prospects are not as they previously thought”.

Indeed that is exactly what happened after I made a recent purchase of Babcock International (BAB). Soon after Shore Capital Markets published a note that said it would be skipping its final dividend. The share price promptly fell by 7% on that day even though they claimed to “retain a buy stance” on the shares.

The last announcement by the company covering the subject of dividends on the 6th April simply said “The Board will consider the final ordinary dividend for this financial year ahead of our full year results announcement [due on the 11th June] taking into account developments over the next two months”. Do Shore Capital have inside information or are they just guessing? Or did they consult the company first? If they were given any relevant steer on this matter, the company should have issued a statement on it. Regardless it’s somewhat annoying even if some moderation of the dividend might make some sense and everyone else is cutting them. I would not be too concerned about the loss of dividend because I never buy shares for dividends alone, but I don’t like to suffer capital losses.

Yesterday property company Segro (SGRO) announced a placing “to take advantage of additional investment opportunities”. There was no open offer but private shareholders could participate via Primary Bid if you were willing to accept the price agreed with institutional holders. The shares issued represented 7% of the existing capital and the placing price turned out to be 820p, a discount of 4.5% to the previous close. I declined to participate, mainly because I have enough of their shares already. One has to ask why they could not have done a proper rights issue as there seemed no great urgency in the matter.

Last night I watched a presentation by Marcus Phayre-Mudge, fund manager for TR Property Investment Trust (TRY), on the internet. This tended to simply confirm my view that this is a well-managed fund which is withstanding the Covid-19 epidemic well. It has avoided many of the property sectors most damaged by the virus. It has a pan-European focus when internet retailing in the rest of Europe is still well behind that in the UK. He said “retailing is in an accelerating structural shift” but he does not “believe the end of the office is nigh”. A very useful and informative presentation via PI World even if he got cut off at the end due to some unknown technical issue. You can see a recording of it here: https://www.piworld.co.uk/

This morning I attended the virtual AGM of EKF Diagnostics (EKF), a medical products manufacturer mainly for diagnostic applications. There were about 12 attendees via a Zoom conference call and it worked quite well. Attendees were asked to register and submit questions in advance, although there was time to ask impromptu questions in the meeting also which were invited at the end.

Voting was done on a poll so the results of that were displayed first. The meeting was chaired by CEO Julian Baines.

I submitted a question about their investment in Renalytix AI (RENX) and its progress, which had been recently listed. I suggested progress was slow but the response was that progress had not been slow at all. However the Covid-19 situation has delayed tests in hospitals in the USA.  Progress on approvals is significant and revenues are expected shortly.

There was a question on the ramp-up of sales in McKesson and the answer was they had slowed significantly. But the company overall was only about 10% down on core products. They had seen business coming back on line in May and June.

Another question related to the Longhorn product which was claimed to be “the world’s safest sample collection product” (very relevant to virus sample collection of course). They are selling millions of these tubes in the USA. There is only one competitor who is allegedly infringing their patents – they are speaking to them “robustly” at present.

There were several other questions and answers of no great significance, but it was certainly a useful meeting and a good example of how any small/medium company could run a virtual AGM very easily. Why do they not do so?

My thanks to EKF for running such an event, which took less than 30 minutes in duration.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Scottish Mortgage Investment Policy and LSE RNS Announcements

The Scottish Mortgage Investment Trust (SMT) have issued their Annual Report and AGM Notice. Readers who hold this trust will not need reminding that it has shown a remarkable performance over the last few months. That’s when the stock market has been decimated by the Covid-19 epidemic and the share prices of many other similar trusts and of the companies they hold have fallen sharply.

Last year SMT achieved a total share price return of 12.7% to the end of March and in the current year it achieved a share price increase of 23% to the 12th May. How has it achieved this return? Primarily by holding “hot” stocks like Tesla, Amazon.com, Illumina, Tencent and Alibaba to name the top five holdings. Over a third of the current holdings are unlisted ones. They claim the flexibility to invest in such companies “has been an important driver of returns over the last decade”. I do not dispute that but they are now proposing to change the “investment policy” of the company to raise the maximum amount that can be invested in such companies from 25% to 30%, based on the proportions when invested (that is why they have managed to already exceed that figure).

Is this a good idea? Should investors support it? Bearing in mind the travails of Neil Woodford where the funds he managed had large numbers of unlisted holdings, is it wise one has to ask?

Personally, I do not think it is and will be voting against. I am not suggesting that Baillie Gifford, nor the individual fund managers they employ, will make the same mistakes as Woodford. Just that valuing unlisted companies is a different matter to that of listed companies where there is always a market price. In addition unlisted holding are very illiquid in nature. Disposing of them can be very difficult. Private equity investment trusts often trade at a considerable discount to their net asset values for those reasons, while SMT currently trades at a premium of 2%.

Retaining the existing limit would prevent more unlisted investments being made, unless some of the unlisted holdings are disposed of, but that may be no bad thing given the current market enthusiasm for them.

I also note that Prof. John Kay is retiring from the board after serving since 2008. Much as I admire the wisdom of Prof Kay, I welcome this change. I hate to see directors of trusts serving more than 9 years and ignoring the UK Corporate Governance Code, as they so often do.

LSE RNS Announcements. I use the London Stock Exchanges free service to deliver RNS announcements via email. This morning it suddenly changed to a new format without prior notice. The first such notice I received was not in the best format in several ways. Wasted space in a right-hand margin, and no way to print just the announcement text and not the excess.

The second announcement I received just led me into an incomprehensible dialogue. I have sent them a couple of complaints.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Recent Annual Reports and Trust Discounts

After the news over the weekend, it’s clearly going to be another very bad day on stock markets. One rare riser initially was Ten Entertainment Group (TEG) despite the fact that they announced this morning that all their bowling venues had been closed but they made some positive comments about their cash balances and Government support which might have helped.

As per guidance issued by the Financial Conduct Authority (FCA) it has delayed publication of its Preliminary Financial Results for two weeks as many other companies will be doing. This seems unfortunate to me as a company could just give only a limited outlook statement in there and issue separate trading statements as the crisis developments. But there is no reason to delay the historic figures for the last year.

The AIM Regulator (the LSE) has also announced that in response to the epidemic it is making the rules around suspension of listings more flexible. It is also permitting Nomads not to do site visits to new clients. See https://www.londonstockexchange.com/companies-and-advisors/aim/advisers/inside-aim-newsletter/inside-aim-coronavirus.pdf for details.

Clearly all companies affected by the closure of all public entertainment venues such as pubs, bowling alleys and cinemas are going to suffer greatly. Although they might get some financial relief from the Government, a close examination of their balance sheets and debt will be essential. Some might request suspension of their shares until their financial position becomes clearer. Property companies seem to have been badly hit simply because independent valuers are having difficulty valuing commercial properties as the market is frozen. Retailers with physical stores are also closing them, apart from supermarkets who are doing well due to panic buying and the shift from eating out to eating in as restaurants close. But they seem to be having difficulties adapting their supply chains and coping with the new demands for on-line ordering.

With preliminary announcements being delayed, the AGM season might be delayed also. Companies might have difficulty holding physical meetings and venues might become unavailable, particularly in London. We might see companies holding small meetings in their own offices instead as they won’t expect many people to turn up – I certainly won’t be attending as I am one of those people being told to stay at home for 12 weeks. Some larger companies may try and provide a live on-line stream of the meeting such as Alliance Trust (ATST) who just issued their Annual Report which I would certainly encourage them to do, preferably with some way to submit questions.

It is interesting to look at the discounts to NAV of the share price of that trust and other similar large trusts. According to the AIC, their discount was 17.5% at the weekend, and others were Brunner on 17.5%, F&C on 19.3%, Monks on 12.6% and Witan on 15.6%. These are much higher discounts than such trusts have traded on of late. When private investors have lost faith in the stock market, the discounts tend to rise, although some of the discount can be accounted for by the delay in reporting.  There may be some bargains in investment trusts in due course as private investor sentiment tends to lag financial news.

One company that just distributed their Annual Report and which I hold is property company Segro (SGRO). They had a good year last year although the share price is down 28% from its peak in February due to the general malaise in the property sector as open-end funds close to redemptions and run out of cash. I won’t  be attending their AGM but I will certainly be submitting a proxy vote which all shareholders should do anyway. I will be voting against their remuneration report simply because the total pay of executive directors is too high. The remuneration report consists of 27 pages of justification and explanation, which is way too long and is a good example of how both pay and pay reporting has got out of hand of late.

With bonuses, LTIPs and pension benefits, the total pay of the 4 executive directors (“single figure” report) was £20.4 million. They also wish to change the Articles of the company to raise the limit on the total pay of non-executive directors to £1 million so I will be voting against that also. I would encourage shareholders to do the same.

Lastly for a bit of light relief as it looks like we might have a major recession this year, I mentioned the book “Caught Short!” by comedian Eddie Cantor on the 1929 Wall Street crash in a previous blog post. Now Private Eye have repeated one of his comments in October 1929 after John D. Rockefeller (probably the richest person in the world at the time) said “during the past week, my son and I have for some days been purchasing sound common stocks”. This was seen as an attempt to calm the market in a world where a few very wealthy investors could influence financial markets. Eddie Cantor’s response was “Sure, who else has any money left”. I hope readers do not feel the same.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Edinburgh IT Fires Manager and Grant Thornton Fined

The Edinburgh Investment Trust (EDIN) has fired fund manager Invesco. This company is an equity income trust focused primarily on the UK, although it also has an objective to increase the Net Asset Value per share in excess of the growth in the FTSE All-Share Index. But in the last few years it has signally failed to achieve that objective. According to the AIC it has fallen behind the sector average in growth in net asset value per share in all of the last year, the last 3 years and the last five years. In the last year alone the total return was 7.0% versus 15.6% for the sector. In other words, it’s a pretty abysmal record.

The company is appointing Majedie Asset Management as the new manager. This is what the company had to say about the reason for the change: “As detailed in the Interim Results announcement also published today, the Company has experienced another period of weak investment performance. This extends the period of underperformance relative to the Company’s benchmark to over three years and is a major disappointment for the Board as well as our shareholders. The Board understands that all good conviction fund managers experience periods of underperformance and a focus on long-term results requires shareholders sometimes to bear bouts of relative weakness especially during times when the fund manager’s style is out of favour. However, your portfolio has suffered from a number of stock specific issues: that is to say large falls in prices of stocks held in the portfolio, the cause of which is specific to each stock rather than resulting from broad market movements. Collectively these stocks have been a significant contributor to the weak performance of the Company and increasingly has led the Board to question the effectiveness of the investment process”.

These are the top ten holdings in the trust: BP, British American Tobacco, Legal & General, Next, Shell, Tesco, BAE Systems, Roche, British Land and Derwent London.

Comment: Firing an investment manager does not happen very often, but certainly the board of the company seems to have given the manager quite long enough to show that improvement was taking place. Shareholders will question whether they allowed the underperformance to go on way too long.

Grant Thornton has been fined £650,000 by the Financial Reporting Council (FRC) after identifying various failures in an audit on an unnamed company in 2016. They refuse to disclose which company was involved.

Grant Thornton has been involved in a number of poor or defective audits, such as at Patisserie Holdings, Vimto, Globo and Salford University. The FRC claims that “We promote transparency and integrity in business” on its web site so why should we not be told the company concerned? It is surely not in the public interest to conceal the name of the company. They clearly still have a “cultural” problem about how they handle investigations.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Technology and Media Leads the Way, and the Renew Party

The Association of Investment Companies (AIC) have just issued an interesting press release. It gives the top performing investment companies and sectors for the year to date under the headline “Technology and Media Leads the Way”.

The Technology and Media Sector was up 34%, compared with an overall average of 14% for all investment companies (excluding VCTs) in share price total return. The top performing company was Blackrock Throgmorton Trust (THRG) which is a UK smaller and mid-cap companies focused trust. It is up 49%. A quick review of how they achieved their stellar performance indicates derivatives although several other smaller company trusts were listed in the top ten.  The Blackrock web site says this: “Derivatives may be used substantially for complex investment strategies. These include the creation of short positions where the Investment Manager artificially sells an investment it does not physically own. Derivatives can also be used to generate exposure to investments greater than the net asset value of the fund / investment trust. Investment Managers refer to this practice as obtaining market leverage or gearing”.

Dan Whitestone, Manager of BlackRock Throgmorton Trust, is quoted in the AIC press release as saying: “As we have long argued, stock and industry specific outcomes can triumph over the volatility created by macro, political and economic events. This certainly held true in 2019, which has been a strong year for the trust in absolute and relative terms, aided by positive contributions from both long and short positions. The management teams of the companies the trust invests in have played a key part in helping deliver value and wealth creation for shareholders, not just this year but over the course of many years.

The premium for genuine secular growth is high, as we remain within an era of low inflation, low interest rates and weaker growth. However, we see many companies with solid business models, that have enormous growth potential, are all too often dismissed by the market as expensive. Conversely, many so-called value shares are under significant pressure from the structural changes wrought by technological disruption, resulting in fundamental changes in distribution, manufacturing and customer behaviour.

Throgmorton aims to identify and own, for the long term, the exciting, fast-growing companies that we believe are truly differentiated and disruptive and taking full advantage of the structural changes reshaping industries. Our belief is that the stock market persistently undervalues these companies, which have strong balance sheets, and have been able to heavily invest ahead of their peers. Combined with solid management teams, dominant market positions, and a compelling product offering, investing in these companies can lead to years of dramatic compound growth, regardless of the wider political or economic environment.”

I can probably agree with most of what he says, but am not sure about the use of derivatives. I’m happier with the three other UK smaller companies trusts in the top ten list who all achieved more than 40% share price total return, one of which I hold. Does the cleverness of Throgmorton result in better long-term performance? It might do so if you look at the 10-year performance figures in the UK smaller companies AIC sector where it is beaten by only one other company – the Rights & Issues Investment Trust (RIII), although they seem to have a more variable performance. I may have a closer look at Throgmorton. This is definitely one where a read of their Annual Report will be essential (all 114 pages of it).

You can read the full AIC press release here: https://www.theaic.co.uk/aic/news/press-releases/top-performing-investment-company-sectors-over-2019

Investing in UK smaller companies rather than the rest of the world probably requires you to have confidence in the UK economy after Brexit. Which brings me onto the subject of politics.

The Renew Party

I was interested to receive a flyer through my door just now for the Renew Party. Bromley & Chislehurst is one of only four constituencies where they are putting up candidates. The Renew Party have an interesting manifesto including political reform.

This is what it says on their web site:  “Our system of politics rewards adversaries, not collaboration. These systems need radical reform to get the best, in candidates and in MPs. Whilst vigorous debate is critical to the evolution of our society, it does not need to become personal, crude and nasty…….. We support electoral reform to make representation in parliament proportional to the number of votes cast for each party. This means the abolition of the first-past-the-post voting system”.

That’s something I would vote for, but unfortunately their General Election platform also supports staying in the EU, which may be arguable, and delivering a “People’s Vote”, i.e. another referendum which is a profoundly daft idea. So they are not going to gain my vote this time.

Neither are the Labour Party who delivered a leaflet that referred to “Tory cuts” to the NHS. It’s simply not true – the real expenditure on the NHS has gone up. Indeed the service from the NHS has improved enormously over the 25 years I have been an active user of it. See https://fullfact.org/health/spending-english-nhs/ for the facts. I sent their candidate a complaint about her grossly misleading leaflet but she did not respond. Regrettably there seems no way to easily get such gross distortions by politicians stopped.

Other candidates are from the Christian People’s Alliance, the Green Party, the Liberal Democrats and the Conservative Party (no Brexit Party runner). It may not be a difficult choice.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Mindless Investment Wins Out?

Last week on-line investment news site Citywire published a report headlined “Tracker fund sales smash records as UK investors pile into passives”. I was the first to add a comment which was “Mindless investment wins out. But at least folks are wising up to open-ended property funds and highly dubious ‘absolute return’ funds”. That generated a number of other comments, mainly from people defending tracker funds.

For example, a couple were: 1) Retail investors, with enough sense to be aware of their limited knowledge of macro-economics & its uncertain effect upon investments, stick to more understandable passives; and 2) Sensible folk realise that indexes will always outperform stockpicker funds in the medium to long-term, give thanks for Samuelson and Jack Bogle and ignore sneers from knowalls.

Let’s take some of those claims. It is certainly true that as the market comprises the whole universe of investors, a general stock market index must reflect the gains and losses of all investors. In other words, if all investors were “active” investors then there would be as many winners as losers. So you cannot achieve outperformance just by deciding to be an active rather than passive investor.

The other problem with active investment is that fund management charges are typically higher than for an index tracking fund. Charges are a major influence over long term returns so an active fund manager has to outperform the index substantially just to offset the higher charges. The flip-side of this is that as index tracking funds do have some charges, plus you may be paying a “platform” charge to hold or invest in them, your investment is bound to underperform the index.

But there are some active investors who do appear to consistently outperform their indices. For example Warren Buffett has done so. The latest example I was reminded of in an email that I received yesterday was the CFP SDL UK Buffettology Fund run by Keith Ashworth-Lord. Below is a chart from their Factsheet dated December 2019 showing the performance of the fund since April 2011 versus a UK All Companies Index and the cumulative performance figures. There appears to be clear outperformance shown.

Buffetology Fund 2019-12-01

Keith has been a promoter of “Business Perspective Investing” for a number of years. I recall reading the Analyst magazine with which he was involved and which alas ceased publication many years ago. That publication influenced my own investment approach. Since 2011 he has run the Buffettology Fund which aims to replicate the principles or Warren Buftett and Charlie Munger. In essence he looks at the business first before attempting to value it and is looking for quality businesses with high barriers to entry. Such companies frequently have superior operating margins, superior returns on capital and superior cash generation.

Now readers will not be surprised to hear that I have been following the same principles also and have recently published a book called “Business Perspective Investing” (see https://www.roliscon.com/business-perspective-investing.html ). I thought it would be interesting to see how the performance of my portfolio since 2011 compared to the Buffettology Fund. The chart below gives you the comparison against the All-Share Index:

Lawson Portfolio 2019-12-01

It looks very similar does it not! Both are nearing a 300% return over the period. The only possible difference is that the chart of my portfolio does not include dividends (i.e. it’s capital only, not total return). Both are focused on UK public company shares but I probably have more smaller companies in the portfolio – and I also have more holdings (85 versus 35 in the Buffettology Fund). But that includes some Venture Capital Trusts (VCTs) that provide minimal capital gains but a lot of tax-free dividends which are not included in the data.

Perhaps you think that otherwise I have the same holdings as Ashworth-Lord in my portfolio? That’s only true to a very limited extent. I only hold 3 of his top ten holdings. So the similarity of performance may relate to holding similar types of companies but not to holding the same companies.

The key point is that both I and Keith Ashworth-Lord have done a lot better than we would have done by simply investing in a FTSE index – about 300% gain instead of 30% in capital terms since 2011.

Have we just been lucky, i.e. is the outperformance likely to continue? It’s very difficult to be certain. John Bogle, whose books are well worth reading, claims there is little evidence of persistent out-performance by fund managers. Managers tend to revert to the mean. This may be because successful managers tend to grow their portfolios as new investors pile in, and the bigger the fund the worse it performs. There are only so many good ideas to pursue.

The other reason why performance tends not to persist is that successful investment strategies can be copied by other investors, thus eroding returns. For example, recently technology-based growth stocks have been seen as the way to make money. Will business perspective investing be replicated by others in future and become too crowded a field? Perhaps but it is not a simple strategy to follow and requires both knowledge and experience.

There have been a number of fund managers with a good track record who have not managed to sustain it. The most recent example is probably Neil Woodford but that is an example of a manager changing his investment strategy. Moving from undervalued medium/large businesses to a ragbag of special situations and early stage companies, some of which were not even listed.

Outperformance does require considerable effort though in analysing companies in depth rather than doing a trivial review of their financial numbers. Understanding the strengths and weaknesses of a business is essential, and keeping a close eye on it after investing is essential.

For a private investor if you don’t wish to do the work of researching individual companies the answer is to invest in a fund or investment trust where the manager follows similar principles and has a long-term track record. Avoid “closet” index trackers, i.e. active funds or trusts whose composition is very similar to their benchmark however much they try to convince you they are pure stock-pickers. You also need to avoid funds/trusts with high management and other overhead charges. You then have a chance of outperforming the relevant index.

If you consider that too risky, and active funds can underperform their index over short periods of time, then a tracker fund or ETF may be the answer for you. You will also avoid the real dogs such as the Woodford Equity Income Fund and some “absolute return” funds. But you certainly need to be aware that investors are currently piling into tracker funds at a record-breaking pace and they accounted for two thirds of fund sales in October. To my mind this is potentially dangerous as people are buying units in these funds without any analysis of the holdings therein, i.e. they are just thoughtlessly buying the index. My original comment on the Citywire article (“Mindless Investment Wins Out”) only refers to the success of fund managers in selling the different types of fund, not to their fund performance!

What has been happening in the last few years is that long-term investment has moved to short-term speculation. When John Bogle started promoting index-tracking and founded the very successful Vanguard business, and for many years after, index tracking was a minority interest among investors. Index tracking funds would have little influence on the index. But is that still the case? There is little evidence to suggest this is so but the return on many large cap shares, which dominate the indices, does seem to be falling. You have to bear in mind that index-tracking funds rarely hold all the shares that make up the index. They can replicate the index by just holding a few of the largest components. So there is a strong herd instinct to invest in the large cap stocks, or disinvest in them.

But large cap stocks, for example those in the FTSE-100, are typically very mature business with low growth prospects and often declining returns on capital.

The length of time that investors hold mutual funds and ETFs has now shortened so the average holding period of a stock ETF is now less than 150 days. They have become tools for short-term traders rather than long-term investors. This has magnified the swings in the market to the benefit of the fund managers and other intermediaries who gain from the higher volumes.

Playing in the large fish pools can therefore be tricky while at the other extreme investing in small or micro-cap stocks can be a triumph of hope over experience. For those reasons, business perspective investing probably works best in mid-cap companies that might be less driven by market trends and share price momentum driven by index trackers.

In conclusion, beware of mindless investment strategies and those who promote them. There are no free lunches in the investment world.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Mello Event, ProVen and ShareSoc Seminars and Lots More News

It’s been a busy last two days for me with several events attended. The first was on Tuesday when I attended the Mello London event in Chiswick. It was clearly a popular event with attendance up on the previous year. I spoke on Business Perspective Investing and my talk was well attended with an interesting discussion on Burford Capital which I used as an example of a company that fails a lot of my check list rules and hence I have never invested in it. But clearly there are still some fans and defenders of its accounting treatment. It’s always good to get some debate at such presentations.

On Wednesday morning I attended a ProVen VCT shareholder event which turned out to be more interesting than I expected. ProVen manages two VCTs (PVN and PGOO), both of which I hold. It was reported that a lot of investment is going into Adtech, Edtech, Fintech, Cybersecurity and Sustainability driven by large private equity funding. Public markets are declining in terms of the number of listed companies. The ProVen VCTs have achieved returns over 5 years similar to other generalist VCTs but returns have been falling of late. This was attributed to the high investment costs (i.e. deal valuations have been rising for early stage companies) in comparison with a few years back. Basically it was suggested that there is too much VC funding available. Some companies seem to be raising funds just to get them to the next funding round rather than to reach profitability. ProVen prefers to invest in companies focused on the latter. Even from my limited experience in looking at some business angel investment propositions recently, the valuations being suggested for very early stage businesses seem way too high.

This does not bode well for future returns in VCTs of course. In addition the problem is compounded by the new VCT rules which are much tougher such as the fact that they need to be 80% invested and only companies that are less than 7 years old qualify – although there are some exceptions for follow-on investment. Asset backed investments and MBOs are no longer permitted. The changes will mean that VCTs are investing in more risky, small and early stage businesses – often technology focused ones. I suspect this will lean to larger portfolios of many smaller holdings, with more follow-on funding of the successful ones. I am getting wary of putting more money into VCTs until we see how all this works out despite the generous tax reliefs but ProVen might be more experienced than others in the new scenario.

There were very interesting presentations from three of their investee companies – Fnatic (esports business), Picasso Labs (video/image campaign analysis) and Festicket (festival ticketing and business support). All very interesting businesses with CEOs who presented well, but as usual rather short of financial information.

There was also a session on the VCT tax rules for investors which are always worth getting a refresher on as they are so complex. One point that was mentioned which may catch some unawares is that normally when you die all capital gains or losses on VCTs are ignored as they are capital gains tax exempt, and any past income tax reliefs are retained (i.e. the five-year rule for retention does not apply). If you pass the VCT holdings onto your spouse they can continue to receive the dividends tax free but only up to £200,000 worth of VCT holdings transferred as they are considered to be new investments in the tax year of receipt. I hope that I have explained that correctly, but VCTs are certainly an area where expert tax advice is quite essential if you have substantial holdings in them.

One of the speakers at this event criticised Woodford for the naming of the Woodford Equity Income Fund in the same way I have done. It was a very unusual profile of holdings for an equity income fund. Stockopedia have recently published a good analysis of the past holdings in the fund. The latest news from the fund liquidator is that investors in the fund are likely to lose 32% of the remaining value, and it could be as high as 42% in the worst scenario. Investors should call for an inquiry into how this debacle was allowed to happen with recommendations to ensure it does not happen again to unsuspecting and unsophisticated investors.

Later on Wednesday I attended a ShareSoc company presentation seminar with four companies presenting which I will cover very briefly:

Caledonia Mining (CMCL) – profitable gold mining operations in Zimbabwe with expansion plans. Gold mining is always a risky business in my experience and political risks particularly re foreign exchange controls in Zimbabwe make an investment only for the brave in my view. Incidentally big mining company BHP (BHP) announced on Tuesday the appointment of a new CEO, Mike Henry. His pay package is disclosed in detail – it’s a base salary of US$1.7 million, a cash and deferred share bonus (CDP) of up to 120% of base and an LTIP of up to 200% of base, i.e. an overall maximum which I calculate to be over $7 million plus pension. It’s this kind of package that horrifies the low paid and causes many to vote for socialist political parties. I find it quite unjustifiable also, but as I now hold shares in BHP I will be able to give the company my views directly on such over-generous bonus schemes.

Ilika (IKA) – a company now focused on developing solid state batteries. Such batteries have better characteristics than the commonly used Lithium-Ion batteries in many products. Ilika are now developing larger capacity batteries but it may be 2025 before they are price competitive. I have seen this company present before. Interesting technology but whether and when they can get to volumes sufficient to generate profits is anybody’s guess.

Fusion Antibodies (FAB) – a developer of antibodies for large pharma companies and diagnostic applications. This is a rapidly growing sector of the biotechnology industry and for medical applications supplying many new diagnostic and treatment options. I already hold Abcam (ABC) and Bioventix (BVXP) and even got treated recently with a monoclonal antibody (Prolia from Amgen) for osteopenia. One injection that lasts for six months which apparently adjusts a critical protein – or in longer terms “an antibody directed against the receptor activator of the nuclear factor–kappa B ligand (RANKL), which is a key mediator of the resorptive phase of bone remodeling. It decreases bone resorption by inhibiting osteoclast activity”. I am sure readers will understand that! Yes a lot of the science in this area does go over my head.

As regards Fusion Antibodies I did not like their historic focus on project related income and I am not clear what their “USP” is.

As I said in my talk on Tuesday, Abcam has been one of my more successful investments returning a compound total return per annum of 31% Per Annum since 2006. It’s those high consistent returns over many years that generates the high total returns and makes them the ten-baggers, and more. But you did not need to understand the science of antibodies to see why it would be a good investment. But I would need a lot longer than the 30 minutes allowed for my presentation on Tuesday to explain the reasons for my original investment in Abcam and other successful companies. I think I could talk for a whole day on Business Perspective Investing.

Abcam actually held their AGM yesterday so I missed it. But an RNS announcement suggests that although all resolutions were passed, there were significant votes against the re-election of Chairman Peter Allen. Exactly how many I have been unable to find out as their investor relations phone number is not being answered so I have sent them an email. The company suggests the vote was because of concerns about Allen’s other board time commitments but they don’t plan to do anything about it. I also voted against him though for not knowing his responsibility to answer questions from shareholders (see previous blog reports).

The last company presenting at the ShareSoc event was Supermarket Income REIT (SUPR). This is a property investment trust that invests in long leases (average 18 years) and generates a dividend yield of 5% with some capital growth. Typically the leases have RPI linked rent reviews which is fine so long as the Government does not redefine what RPI means. They convinced me that the supermarket sector is not quite such bad news as most retail property businesses as there is still some growth in the sector. Although internet ordering and home delivery is becoming more popular, they are mainly being serviced from existing local sites and nobody is making money from such deliveries (£15 cost). The Ocado business model of using a few large automated sites was suggested to be not viable except in big cities. SUPR may merit a bit more research (I don’t currently hold it).

Other news in the last couple of days of interest was:

It was announced that a Chinese firm was buying British Steel which the Government has been propping up since it went into administration. There is a good editorial in the Financial Times today headlined under “the UK needs to decide if British Steel is strategic”. This news may enable the Government to save the embarrassment of killing off the business with the loss of 4,000 direct jobs and many others indirectly. But we have yet to see what “sweeteners” have been offered to the buyer and there may be “state-aid” issues to be faced. This business has been consistently unprofitable and this comment from the BBC was amusing: “Some industry watchers are suggesting that Scunthorpe, and British Steel’s plant in Hayange in France would allow Jingye to import raw steel from China, finish it into higher value products and stick a “Made in UK” or “Made in France” badge on it”. Is this business really strategic? It is suggested that the ability to make railway track for Network Rail is important but is that not a low-tech rather than high-tech product? I am never happy to see strategically challenged business bailed out when other countries are both better placed to provide the products cheaper and are willing to subsidise the companies doing so.

Another example of the too prevalent problem of defective accounts was reported in the FT today – this time in Halfords (HFD) which I will add to an ever longer list of accounts one cannot trust. The FT reported that the company “has adjusted its accounts to remove £11.7 million of inventory costs from its balance sheet” after a review of its half-year figures by new auditor BDO. KPMG were the previous auditor and it is suggested there has been a “misapplication” of accounting rules where operational costs such as warehousing were treated as inventory. In essence another quite basic mistake not picked up by auditors!

That pro-Brexit supporter Tim Martin, CEO of JD Wetherspoon (JDW) has been pontificating on the iniquities of the UK Corporate Governance Code (or “guaranteed eventual destruction” as he renames it) in the company’s latest Trading Statement as the AGM is coming up soon. For example he says “There can be little doubt that the current system has directly led to the failure or chronic underperformance of many businesses, including banks, supermarkets, and pubs” and “It has also led to the creation of long and almost unreadable annual reports, full of jargon, clichés and platitudes – which confuse more than they enlighten”. I agree with him on the latter point but not about the limit on the length of service of non-executive directors which he opposes. I have seen too many non-execs who have “gone native”, fail to challenge the executives and should have been pensioned off earlier (not that non-execs get paid pensions normally of course. But Tim’s diatribe is well worth reading as he does make some good points – see here: https://tinyurl.com/yz3mso9d .

He has also come under attack for allowing pro-Brexit material to be printed on beer mats in his pubs when the shareholders have not authorised political donations. But that seems to me a very minor issue when so many FTSE CEOs were publicly criticising Brexit, i.e. interfering in politics and using groundless scare stories such as supermarkets running out of fresh produce. I do not hold JDW but it should make for an interesting AGM. A report from anyone who attends it would be welcomed.

Another company I mentioned in my talk on Tuesday was Accesso (ACSO). The business was put up for sale, but offers seemed to be insufficient to get board and shareholder support. The latest news issued by the company says there are “refreshed indications of interest” so discussions are continuing. I still hold a few shares but I think I’ll just wait and see what the outcome is. Trading on news is a good idea in general but trading on the vagaries of guesses, rumours or speculative share price movements, and as to what might happen, is not wise in my view.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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