23rd June 2016
Today’s EU referendum has been hailed as a ‘once in a generation event’, although as anyone living in Scotland can testify, such claims have a chimerical quality. What both sides of the bitterly contested campaign can agree on is the importance of the outcome, which will potentially have far reaching consequences for not just the UK but the world beyond these shores. Winterflood thought it would be helpful to highlight those investment trusts in our model portfolio that, in our opinion, might benefit or at least provide a safe harbour in the case of each result.
In the event that the UK votes to remain in the EU, we would expect a relief rally, which arguably has already started, in predominantly UK focused businesses. As such, we would not be surprised to see a strong short term fillip to mid and small cap companies. We believe that investment trusts are a good way of playing any such rally due to the impact of gearing and, more importantly, the possibility that discounts might narrow as a result of renewed buying interest.
Our favoured names in this space remain The Mercantile Investment Trust* and Henderson Smaller Companies. Both offer some value on discounts of 13% and 14% respectively to their NAV. Mercantile has the advantage of greater liquidity with a market cap of £1.6bn, although Henderson Smaller Companies also offers good liquidity in the secondary market and has a market cap of £452m. We do not believe that a bounce would be confined purely to UK Mid and Small caps and our favoured more mainstream UK names include Temple Bar (7% discount), managed by Alastair Mundy of Investec AM, and Fidelity Special Values (3% discount), which is managed by Alex Wright.
The patterns of the last week suggest that it is not just the UK market that would receive a ‘shot in the arm’ in the event of a ‘remain’ result. We suspect that it would be perceived to be a good result for Europe in general and would expect funds such as Jupiter European Opportunities (3% discount) to benefit. Another Pan-European fund that should, in our opinion, be assisted by a ‘remain’ outcome would be TR Property (7% discount), which is managed by Marcus Phayre-Mudge of BMO Global AM.
If the UK votes to leave the EU today we would expect a negative reaction from equity markets and a sell-off in Sterling. A sizeable stock market crash cannot be discounted but even in the event of a more moderate sell-off, it seems reasonable to assume that discounts will widen across the investment trust sector. In the event of a ‘leave’ result there are certain funds amongst our long-term recommendations that we would expect to outperform, certainly on a relative basis.
This includes Personal Assets, managed by Sebastian Lyon of Troy Asset Management. This fund has the objective to “protect and increase (in that order) the value of shareholders’ funds” and invests in a wide range of asset classes including equities, index-linked bonds and gold. Furthermore the fund, which has a market cap of £648m, has a well-established zero-discount policy and so the risk of discount volatility is essentially eliminated. One of the ramifications of a ‘leave’ outcome could be further central bank intervention, possibly including the bond market. We believe that this would indirectly benefit City Merchants High Yield* (3% premium), which invests in high yield credit and is predominantly exposed to European issuers.
There is likely to be substantial movements in currency markets as a result of a successful leave vote and we suspect a number of our recommendations may be advantaged by this. While private equity funds invariably struggle in a ‘risk-off’ environment, we believe that Pantheon International looks an interesting ‘post-Brexit’ play as a result of its exposure to US dollar denominated assets and its already wide discount, which is currently 27%. Another beneficiary of currency moves could be Baillie Gifford Japan (2% discount). The Japanese Yen is seen as a safe currency in times of market stress and has already appreciated by 13% against Sterling so far this year. This may have further to go. Murray International (6% premium) could also benefit from Sterling weakness, both in capital value terms but also in terms of its revenues. With a dividend yield of 4.8%, its dividend cover could be boosted.
Another fund that could benefit from volatility in the currency markets is BH Macro (10% discount). It focuses on interest rates and FX strategies and historically volatility in these areas has provided greater opportunities for the fund. In addition, it has tended to have a relatively low correlation with equity markets and the preservation of capital remains a key objective for the manager.
This note is also available in full on the Winterflood web-site: www.winterfloodresearch.com