F&C Dumps Tradition

The Foreign & Colonial Investment Trust (FRCL) announced today that it will be changing its name to F&C Investment Trust in 3 days time. FRCL is one of the oldest investment trusts and celebrated 150 years since foundation in this year. It was also so far as I recall the first share I ever purchased (via their savings scheme) although I have not held it for some years.

FRCL is a global investment trust. How is it doing lately? Well after a rather dull patch it seems to have picked up in the past year, although it looks to have the usual big US cap stocks in its portfolio such as Amazon, Microsoft and Alphabet which are the top 3. It’s otherwise very diversified. The share price discount has also narrowed so it’s now on a very small premium. If they decided to change the name to make the trust more marketable a few months back, they perhaps need not have bothered.

FRCL has proved to be a good example over the years of the benefit of investment trusts for those who want boring and steady long-term returns from equity shares.

The company is also changing its TIDM from FRCL to FCIT which will annoy some.

Now one can argue that it was overdue for a “rebranding” to give it a more modern image but “Foreign & Colonial” was at least very memorable. The acronym “F&C” is not a good choice in my view. F&C is registered as a trade mark but it would not be my ideal choice of one – too many similarities to others. I prefer brands, and companies, to have strong, simple, memorable names that are clearly unique.

On that subject I received confirmation of the registration of the trade mark “Roliscon” from the Intellectual Property Office this morning, which is the name of the service company I own. I should have registered that years ago so I now have two registered trade marks to my name. It’s a very simple process.

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

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Arron Banks on Leave.EU, Smithson and Patisserie

The Andrew Marr interview of Arron Banks was all good knock-about stuff but there was no knock-out blow inflicted. Andrew Marr was interviewing Arron Banks about his £8 million funding of the Leave.EU campaign. The Electoral Commission have recently asked the National Crime Agency (NCA) to investigate the matter as they apparently do not believe his story about the source of the funding. The suggestion has been made that the funding came from Russian sources or from a company registered in the Isle of Man (Rock Holdings) which would not have been permitted under electoral law.

You can watch the full interview here: https://order-order.com/2018/11/04/arron-banks-marr-interview-full/

Mr Banks made it clear that the money came from Rock Services Ltd and strenuously denied it came from other sources. Andrew Marr suggested Rock Services was a “shell” company and that neither that company nor Mr Banks had sufficient financial resources to cover the £8 million in funding.

It is of course a simple matter to look at the accounts of Rock Services Ltd at Companies House (it’s free to do so – go here: https://beta.companieshouse.gov.uk/search?q=rock+services+ltd ).

Rock Services Ltd hardly looks like a “shell” company which is normally used to describe a company with no revenue and no assets apart from possibly some cash. Rock Services had Turnover of £50 million for the year ending December 2017 but little in the way of profits or net assets. But it did have fixed assets of over £1 million. This is hardly a “shell” company in the normal usage of the word. The “Strategic Report” says the company’s “principal business activity is that of performing a recharge function for services for the Group and other related parties”. The profit of the company is generated from service charges added to costs and salary recharges.

Aaron Banks has been running motor insurance companies for many years and is involved in a group of companies which includes Rock Services, Rock Holdings and UK registered Eldon Insurance. I vaguely recall he was involved in a company called Brightside I held shares in from 2012/2014 which was publicly listed before being taken over. The accounts of Eldon Insurance can also be read at Companies House and indicate revenue of £77 million and profits of £1.8 million in 2017. Another substantial company in the Group is Southern Rock Insurance which is based in Gibraltar. You can see a complete list of group companies and their transactions through Rock Services Ltd on page 15 of their accounts.

In summary the allegation that Mr Banks or his UK companies did not have the financial resources to make the donation to Leave.EU is not reasonable, and Andrew Marr and his researchers should have looked into the background more before making the allegations he made.

As Mr Banks said in the interview, other donations were made to the remain campaign from subsidiaries of foreign companies. Why were they not being investigated? It certainly looks like a witch-hunt to me. It would seem to be more about politics than election regulation.

Note that Companies House is an invaluable source of information on companies and their directors. All investors should be familiar with it. It can be useful in other ways – for example I recently obtained a bid from a company to provide web site development work. That was done from the email address of a company that was different to that from which they suggested would do the billing. When I looked the former company up at Companies House it had actually changed name a couple of years ago and under its latest name had got appallingly bad references on the internet. Needless to say I decided not to do business with them.

Smithson Investment Trust (SSON) is now trading at a remarkable premium to net asset value of 7.4% according to the AIC after its recent IPO. Bearing in the mind the state of the market and the fact that it can hardly have yet invested the money raised (one might call it a “shell” company), it would seem investors are putting a high premium on the name of Terry Smith and his involvement in this trust. There must be investors out there who are purchasing shares at that premium to maintain this “discount” but that seems very unwise to me when most investment trusts have historically traded at a discount. The reason for this is quite simple – investment trusts incur costs in management and administration which reduces the yield and returns on the underlying shares they hold. Investors can always buy the underlying shares directly to avoid those costs. In the recent bull market and recognition of late of the merits of investment trusts, some have been trading at small premiums but a premium of 7.4% when the company has no track record and will be mainly holding cash seems somewhat unreasonable.

As I said when reviewing the IPO, it may be best to wait and see what transpires for this trust.

Patisserie (CAKE) and the recent General Meeting have been covered in several previous blog posts. I have previously mentioned that I was not happy that Luke Johnson did not answer my questions – he ruled them out along with a lot of others. When can a Chairman refuse to answer questions in a General Meeting? It was always judged to be matter of common law that questions should be answered but that has now actually been put into a Regulation.

I have written to Mr Johnson and my letter includes these paragraphs:

  1. As regards the conduct of the General Meeting, I suggest you not only handled it badly as Chairman but that refusing to answer my questions was a breach of The Companies (Shareholders’ Rights) Regulations 2009. There are valid grounds on which you can refuse to answer questions at General Meetings but the reason you gave for not answering mine (refusal to answer any questions that might prejudice the investigations) was not a valid one.
  2. Holding a meeting a 9.00 am is also not good practice. This note published by ShareSoc (and partly written by me) gives guidance on how to run general meetings, and includes references to the law on the subject: https://www.sharesoc.org/How_To_Run_General_Meetings.pdf

If you study the aforementioned regulations, you will see that the directors can refuse to answer questions that would require disclosure of confidential information or “if it is undesirable in the interests of the company or the good order of the meeting that the question be answered”. That may be quite broad but it hardly covers the questions I posed and the answers to my questions would certainly not have prejudiced any investigations.

I have therefore asked him to answer the questions in my letter. He may have other things on his mind, but all company directors should be aware of the law, or take legal advice when required.

Shareholders should not allow directors to ignore their responsibility to answer reasonable questions.

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

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Standard Life UK Smaller Companies AGM, WPP and Tesla

For those folks who invest in smaller companies, it’s always educational to attend the Annual General Meeting of Standard Life UK Smaller Companies (SLS) which I did today. This investment trust has been managed by Harry Nimmo and his team for many years and he has consistently beaten the company’s benchmark (currently Numis Smaller Companies Plus AIM index).

Harry’s presentation highlighted that smaller companies were a “great place to be until the last 4 weeks”. He said that we often see sharp setbacks toward the end of the economic cycle. One tends to see bursts of selling in the high performing stocks with profits being taken (one example being Fevertree he mentioned). There are some concerns in the market about the US prospects, rising interest rates, Brexit and other worries. But he suggested investors need to have a long-term perspective and hold the shares for 6 years or more.

The investment process followed is unchanged. They use a proprietary stock selection process focused on quality, growth and momentum. See pages 12/13 of the Annual Report for details. Valuation is secondary, i.e. they don’t buy “cheap” stocks. New purchases for the portfolio were Gooch & Housego, Alpha Financial Markets, Safestore, Blue Prism and Gym Group (note: I have bought a couple of those recently also). As an aside, Blue Prism still looks relatively expensive to me although it’s down 35% from its peak share price in the recent market crash.

There were a number of questions on the merger with Dunedin Smaller Companies Trust which was recently voted through. I voted against it because I could see the benefit for the Dunedin holders and for the manager but not for SLS shareholders. The benefits were argued to be “reduction in on-going charges” and “enhanced liquidity”, but when I asked what the actual reduction in charges might be, nobody seemed able to supply an answer. I also have doubts about the liquidity argument as Dunedin was substantially smaller than SLS, i.e., the extra assets acquired won’t add a great deal. The disadvantage of a larger trust, particularly in the small cap sector, is that it makes the manager less nimble, i.e. more difficult to get in and out of stocks. I remain to be convinced that this merger made sense for SLS holders but it may not be too damaging.

One somewhat irate shareholder berated the board for paying out too much in dividends (most of the “income” received) when the company is supposed to be focused on capital growth. I supported the board because in fact only a very small proportion of the overall profits are paid out in dividends. The current dividend yield according to the AIC is only 1.6% and many shareholders do like dividends. Trusts that don’t pay any or have very small dividends tend to have larger discounts to NAV.

Another interesting question was on the investment in AIM shares and the risk to AIM from changes to Inheritance Tax Relief (IHT). Harry said the AIM market had improved considerably in the last 6/7 years, from being full of rather “dodgy” companies to being a broad spectrum of growth stocks. He suggested this was important to the UK economy and it both creates wealth and jobs. The Chancellor would likely be careful on withdrawing tax benefits. Comment: I don’t judge that as a big risk and even if IHT relief was withdrawn any substantial decline in AIM share prices might simply draw in other investors to replace those only interested in IHT relief.

I asked Harry Nimmo a couple of questions after the formal meeting finished. How did he avoid investing in Patisserie shares? It seems they did not altogether and mentioned the company met their investment criteria, based on the false accounts. I also asked him about the changes to the Abcam remuneration scheme, a company they hold. It seems their corporate governance team had made representation on the subject to Abcam (see my previous blog post on that subject).

In summary, a useful AGM to attend, as many are. This is a very good trust to hold in my view if you don’t wish to speculate in individual small company shares. But smaller company shares can be more volatile in times of market panics, so SLS is down 18% since late September. That’s certainly not been helped by profit taking in such shares as Fevertree (their biggest holding at the year-end), First Derivatives, Dechra, etc, although the company had often reduced their holdings below their target maximum of 5% of their portfolio before the recent crash.

Bad news today in a trading statement from WPP the advertising agency business. This was brought to my attention by one of the attendees at the above AGM as I don’t hold it. I suggested the likely problem was the advertising world is becoming digital, bypassing the traditional agency model. In addition there were few barriers to entry in the advertising agency world. New businesses could be created by two men and a dog (or two women I should probably have said to be PC). The share price of WPP is down 14% today. This is what I later discovered the company had said: “As previously stated, our industry is facing structural change, not structural decline, but in the past we have been too slow to adapt, become too complicated and have under-invested in core parts of our business. There is much to do and we have taken a number of critical actions to address these legacy issues and improve our performance”. On a prospective p/e of 9 and yield of over 5%, I think following Harry Nimmo’s policy of not buying stocks just because they are cheap is probably good advice.

But let’s talk about good news for a change. Tesla have declared a profit in the third quarter. Cash flow also improved and is expected to be positive in the fourth quarter. So the doomsayers about this company might have to change their stance. There may still be risks associated with this business, particularly the management style of Elon Musk, but they are rapidly changing the auto industry through new technology. Traditional car makers are facing major disruption to their business, or as the FT put it in a headline to a long article yesterday: “German carmakers face their i-Phone moment”. Even Dyson is getting into the electric car business and opening a plant in Singapore to produce them. Technology is changing our world more rapidly than ever, and the pace of creative destruction in business continues to rise. Smaller companies tend to be leaders of such changes, in the advertising world, in car manufacturing (relatively) and in many other fields.

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

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Fishing Republic, Pattiserie and Smithson Trust

Fishing Republic (FISH) shares have been suspended and it looks like it’s run out of money with folks unwilling to finance it further. A new CEO was about to join but now is not. I have never held shares in this company so I just had a quick look at the history of its listing on the AIM market.

It listed in 2015 with an initial market cap of £2.7 million – yes it always was a small business. The share price rose as high as 46p as it went for growth, but was 5.22p when suspended. The last interim results looked terrible – loss of £2.5 million on revenue of £3.4 million. The company suggested its problems were down to competitive pressures and tough market conditions, but it looks to me more a simple case of mismanagement. Was there really a big market for fishing tackle where fishing enthusiasts would pay good money for such kit in any case?

This is probably going to be just the latest poor-quality business, or ones with unrealistic ambitions, to disappear from the AIM market which has been shrinking. It’s now down to 937 companies when it was nearly 1,700 in 2007. That near halving in the number of companies has probably improved the overall quality of the market with an emphasis on larger companies now. That’s probably good for investors.

Hindsight always makes the problems look obvious of course. In the case of Patisserie Holdings (CAKE) I have seen it said that the cakes were boring, the shops often empty and it seemed odd that they could make good profits in such a competitive sector. The first two I discounted because that was not my experience of visiting their cafes (I always try to sample the wares of companies I invest in). As regards the latter issue, we await more information, but Whitbread have just flogged off their Costa coffee chain for an enterprise value of £3.9 billion, representing a multiple of 16.4 times FY18 EBITDA. That’s a rich price for a similar business in a competitive sector with no obvious barriers to entry is it not?

Shareholders in Patisserie Holdings can attend the General Meeting at 9.0 am on the 1st November to approve the second share placing, and ask some questions. That’s a very inconvenient time for many shareholders and is certainly not “best practice”.

The UK stock market seems to have stabilised somewhat after recovery in the US. It’s always worth having a quick look at the S&P 500 to see how it is trending if you wish to know where the UK market is going to go. This should bode well for the launch of the Smithson Investment Trust which raised its fund-raising limit and will be the biggest ever UK investment trust launch at £822 million. Dealings will commence on the 19th October, but best to wait and see how it performs longer-term in my view. There’s obviously some short-term enthusiasm for another fund from the Terry Smith stable regardless of having no track record.

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

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Should I Buy Smithson Investment Trust?

I am a great fan of Terry Smith and his investment approach. As an investor in his Fundsmith Equity Fund, I have seen annual returns of 21.7% according to ShareScope since I first purchased it in 2014. That fund is a global large cap fund. Terry has now launched a small and mid-cap investment trust based on similar investment principles which is called the Smithson Investment Trust. Subscriptions are being invited here: https://www.smithson.co.uk/

The Fundsmith Equity Fund is an open-ended fund whereas Smithson is a closed-end investment trust so may trade at a premium or a discount to net asset value (NAV). Fundsmith already have another investment trust in their stable – the Fundsmith Emerging Equities Trust (FEET) which was launched in 2014 and had a disappointing initial performance, but it has done better of late. It has consistently traded at a premium to NAV and is now at 1.5%. That is not common for investment trusts and rather shows the confidence investors have in Terry Smith and his team.

Smithson will be following the same investment philosophy as the main Fundsmith fund – namely “Buy good companies, “Don’t overpay” and “Do nothing”, i.e. they will not be active traders and will have a low stock turnover.

The “Owner’s Manual” for Smithson is worth reading. The focus will be on companies with an average market cap of £7 billion, so these are not going to be really small companies. The document argues that small and medium size companies have outperformed larger companies which is probably true in recent times. Hence the investment saying “elephants don’t gallop” originally attributed to Jim Slater.

The Owner’s Manual makes some interesting comments about their preference for companies with intangible assets as opposed to physical ones. To quote: “Intangible assets, on the other hand, are much more difficult to replicate. They are typically not ‘bankable’ in the sense of being able to borrow debt against them and so require more equity and long- term illiquid investment to build them, for which rational investors will demand a high return, all of which is good if this is being attempted by your competitors. And the best thing about investing in listed companies with strong intangible assets is that from time to time the stock market values them as if their high returns will decline in the future, just as other companies’ returns are prone to do.”

They are going to be looking for growth companies, but not extremely fast-growing ones which are often over-priced. They will avoid highly leveraged companies but will look for companies that invest in R&D.

Management charges on Smithson will be 0.9% of the value of the funds managed per annum and there will be no performance fees. This is good news. But it’s somewhat unusual in that it will be based on the market cap of the company, not the normal net asset value. The investment trust form was chosen because it enables the manager to invest in smaller companies without being concerned about liquidity – they won’t need to bail out if investors wish to sell their holding in the trust unlike in open-ended funds which require constant buying and selling.

The portfolio managers will be Simon Barnard and Will Morgan under the supervision of Terry Smith as CIO.

As regards dividends, this is what the prospectus says about dividend policy: “The company’s intention is to look for overall return rather than seeking any particular level of dividend. The Company will comply with the investment trust rules regarding distributable income but does not expect significant income from the shares in which it invests. Any dividends and distributions will be at the discretion of the Board”. So clearly the focus is on capital growth rather than dividends which might be quite small.

One of the key questions is will the shares trade at a discount or not? Small cap investment trusts often do and as the prospectus warns: “A liquid market for the Ordinary Shares may fail to develop”. There is no specific discount control mechanism although the company can buy back shares in the market and there is a provision for a continuation vote if there is a persistently wide discount after 4 years. Smaller company investment trusts often trade at significant discounts but this is more a medium-cap than small-cap trust and Terry Smith’s reputation may result in a premium as with FEET.

If you apply for shares in the IPO you can receive either a paper share certificate, have the shares deposited in a nominee account with Link Market Services Trustees or, if you are already a personal crest member have the shares deposited in your account.

Clearly though there is uncertainty about the future likely performance of the company. I said in a recent blog post that you should never buy in an IPO. To repeat what I said in that “there can be some initial enthusiasm for companies after an IPO that can drive the price higher but the hoopla soon fades”. So personally I think I may wait and see. But I suspect there may be some enthusiasm among retail investors for this offer. Terry Smith now has a lot of fans.

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

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AIC Calls for KIDs to be Suspended

The Association of Investment Companies (AIC) have called for KIDs to be suspended. KIDs are those documents devised by the EU that were aimed at giving basic information on investment funds – and that includes investment trusts which the AIC represents.

It was a typical piece of badly implemented EU regulation even if the motive was worthy. But KIDs give a very misleading view of likely returns from investment funds. Whoever designed the performance rating system clearly had little experience of financial markets, and neither did they try it out to see what the results would be in practice. Similarly, if they had bothered to consult the AIC or other bodies representing collective funds, or experienced investors as represented by ShareSoc, they would have realised how misleading the results might be.

It also imposes costs on investment managers and on brokers who have to ensure their clients have read the KID before investing – even if they are already holding the fund/shares or have invested in it previously. This means for on-line brokers we now get a tick box that we have to click on which is simply tedious. I just click on them automatically because if I intend to buy an investment trust there is a great deal of information available elsewhere in the UK and the KID does not add anything of use in my opinion.

I think KIDs should be scrapped rather than just suspended. They serve little useful purpose and just add a costly bureaucratic overhead. This is the kind of nonsense that Brexit supporters are keen to get rid off when we do finally get out of the EU monster. But will we if Mrs May gets her way?

The AIC press release is here if you want more information: https://www.theaic.co.uk/aic/news/press-releases/aic-calls-for-kids-to-be-suspended

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

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Productivity, Sage, Sophos and Investment Trust Discounts

There was an interesting article last week in Investors Chronicle where Bearbull attempted to analyse the variations between company productivity. Productivity, or the lack of it in the UK, is one of the big issues weighing on the minds of politicians of late. Is the productivity of UK companies getting better or worse was one of the questions he attempted to answer.

For investors, productivity is surely one thing we should look at when deciding in which companies to invest. Those businesses that get the most out of the capital they employ (measured by Return on Capital, or ROCE), and also get the most out of their employees, are surely the ones most likely to be successful and generate the profits and dividends we like as investors.

But one needs to combine the two because obviously employees can be traded off against capital. By investing in more automation, employees can be reduced. But there is also the problem that businesses vary in nature. So natural resource companies such as oil producers can have large revenues and profits generated by relatively few staff, while retailers generate equivalent profits from much larger staff numbers.

Bearbull had a stab at producing a combined productivity index for a range of large cap companies, but as the results were still very wide ranging ended up focusing on whether their productivity was increasing or decreasing. Results were still varied.

There is a way to make use of such figures and that is to compare companies in the same business sector. For example software companies employ a lot of staff, but generally little capital apart from their past investment in developed software or in acquisitions. One way I used to look at companies in the software industry when I worked in it was to look at the revenue and profits per employee and I still find those useful measures. They can tell you a lot about the nature of the business.

It’s informative for example to compare two of the larger UK software businesses – Sage (SGE) and Sophos (SOPH). Sage has recently been the subject of a downgrade by analysts at Deutsche Bank and the shares have been heading south for some time as competition from new entrants into the accounting software space seems to be increasing. But at least they are making profits. Sophos is in the hot IT security sector but is still reporting operating losses.

But it’s interesting to look at their sales per employee – that was £124,320 in the case of Sage (13,795 employees) and £116,975 in the case of Sophos (3,187 employees) from the latest Annual Reports that are available. In other words, very similar. Operating profits per employee were £25,154 at Sage while Sophos reported a loss of £8,000 per employee.

The big difference was in average employee costs which were £57,194 at Sage and £95,387 at Sophos. The latter is a very high figure which helps to explain why they are losing money.

Sophos looks to be an example of where the directors and employees are taking most of the profits leaving very little for shareholders – indeed a negative return to them.

Investment Trust Discounts

I mentioned in a previous article the high share price discount to Net Asset

Value at RIT Capital Partners which encouraged me to sell the shares. The discount was actually a premium of 6.8% which I reported although I am advised it had actually been even higher in the recent past.

It is common knowledge with anyone who invests in investment trusts that discounts have narrowed in the last year with popular trusts now often on premiums. The dangers of buying trusts that trade at a high premium was recently evidenced by the fall in the share price of the Independent Investment Trust (IIT). As reported by Citywire recently, the share price unwound by 10.9% in one week after the premium shrank from a peak of 20% in June. It’s now only 6.2% but that’s still too high in my view.

The company performed exceptionally well in 2017 (NAV up 53%) but even so this is surely a case of investors expecting “past performance to be indicative of future performance” when every health warning on stock market investments tells you the contrary. The long-term performance record is good but there is a limit to the price one should pay for anything.

You can track the company’s performance, and the discount it trades at on the Association of Investment Companies (AICs) web site. There are many other relatively high performing investment trusts that still trade at a discount.

Why should investment trusts trade at a discount? Because just looking at the income they produce, if the management and administration charges reduce their income by 1%, when their yield was otherwise 5%, then the share price should be at a discount of 20% because otherwise people can buy the individual holdings of the company directly and increase their income in that proportion. That ignores the relative proportion of dividends paid out of income versus capital growth. Of late we have had lots of capital growth but that is not always the case. If the market starts to go down then share price premiums on investment trusts could well collapse.

A particular problem with investment trusts, and the reason why discounts, or premiums, can sometimes become extreme, is the relatively low volume of share trading even in large trusts, i.e. there is low liquidity. Buyers are often long-term holders with few active traders speculating in the shares. This problem tends to worsen in the summer months when many investors are on holiday so one needs to be wary of trading such shares in that period.

I hold none of the companies mentioned above, for the avoidance of doubt.

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

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