10:34 Wed 23 Dec 2009
Investment Line: Time to buy Perpetual Income & Growth trust
The investment trust sector teaches us that there are some lessons investors never learn.
One of those lessons is that no matter how consistently a fund manager proves his mettle his funds are still sold after bouts of short-term underperformance, when his holdings are at their cheapest. The shrewd investors know that provided you know enough about the man driving the car that could be just the opportunity to buy.
This is in my view the case for Mark Barnett (pictured), manager of the Perpetual Income & Growth Trust.
This £412 million investment trust is run by Barnett, a senior member of Neil Woodford's leading UK equities team at Invesco Perpetual in Henley-on-Thames.
It has an extremely strong long-term track record. Barnett has run the fund for a full 13 years. It aims to deliver a strong income stream alongside capital growth. It currently offers a yield of 4.3%.
Over his tenure on this trust Barnett's record is exceptional. Since the day he took on the trust its share price has grown 217%, compared to a rise of 115% from the FTSE All-Share index.
Over the past year however the trust has disappointed. delivering a return on its portfolio of 17.42% compared to the FTSE All-Share's return of 27.73%. True to form, investors have reacted to this by selling the trust's shares which means that over the past year the trust's shares have risen by just 5.93%. As a result of this the shares are trading at a discount of 8.6% to the net asset value of the trust.
Why has this underperformance occurred? For a very simple and exceptionally well articulated reason. Barnett, like his colleague Woodford, believes that the economic recovery is likely to falter and that the rally in cyclical stocks which has driven the market recovery is not reflected by economic fundamentals. As a result he has refused to buy into soaring mining or banking stocks which he believes are still fundamentally unsound. Woodford sets out the view to Citywire here.
Whether you believe as the Invesco Perpetual team do that the recovery will falter their strategy has meant that they have bought the most unloved sectors of the market over the past year and as a result they now own some of the cheapest shares.
Barnett's top ten holdings include both of the biggest pharmaceutical stocks AstraZeneca and GlaxoSmithKline as well as British American Tobacco and Reynolds American. Over the past year all of these stocks are in the bottom quartile of the FTSE 100 in terms of their relative performance.
Barnett's long-held view that these companies are due a renaissance is rapidly becoming the consensus among shrewd managers. Jupiter Investment Management's John Chatfeild-Roberts last week told Citywire that he is currently buying a stake in Barnett's colleague Woodford's funds for just that reason. Likewise Cazenove's private client investment managers have made the decision that now is the time to hold or buy these funds even if in the short-term it leads to underperformance.
So in this context is it appropriate that Perpetual Income & Growth is trading on a discount of close to 10%? It seems likely that this will close. Stockmarkets could of course falter in the New Year. They could be knocked sideways by risks associated with the election, the rising dollar, the end of government stimulus or the bursting of bubbles in China.
So a key question is perhaps whether Perpetual Income & Growth could still rebound in a falling market, or at least if it could outperform on a relative basis. There is some evidence that in times of market turmoil investors do buy this trust. In the final quarter of 2008 for example when the market was experiencing its most profound sell off shares in their trust rose to a premium of around 5%. They had been trading at a discount through the momentum markets of 2007. In other words people flee to Barnett when his warnings about the nature of the recovery are proved right. When those fears appear more distant they dump his fund. Perhaps the shrewd thing to do is to buy now at a discount before his fears come to pass.
Simon Elliott from Winterflood Securities explains: 'The fund's discount has mirrored its relative performance, albeit with a lag. The discount steadily narrowed from 20% in mid-2000 to trade at a premium towards the end of 2002 and the beginning of 2003. The discount then slowly widened over five years to 11% in July 2008 before rapidly narrowing towards the end of 2008 to trade at a premium. Following the sharp reduction in interest rates, investors searching for sources of regular income provided a high level of demand for shares in funds that could provide it.
'Perpetual Income & Growth was one such fund and its premium spiked as investors took note of the fund's reserves which would allow it to continue paying dividends even if income decreased. The fund also saw few dividend cuts from its underlying holdings. As risk appetite returned in 2009, the discount widened again and is currently approximately 9%, which is well below the one-year average. Significantly, more than 30% of the share capital is held by the company's PEP/ISA and dividend reinvestment provides steady marginal demand.'
But before we all jump in perhaps it is wise to pause to do some fundamental analysis of the trust. The sort of thing Barnett would do when analysing his portfolio.
Firstly, this trust has the highest level of dividend cover in the AIC Income Growth sector, with 1.4 years waiting to be paid. The other issue underneath the service which should be examined is the fact that there are some subscription shares operating as warrants still to be subscribed. There are 17.7 million in issue that could result in a potential growth in the assets of £38.7 million, this could have a marginally dilative effect.
The one final question investors invariably have about this trust is this: Why would I buy Mark Barnett's trust when I could buy Neil Woodford's trust, Edinburgh Investment Trust? After all isn't Neil Woodford the real genius?
It is true that Woodford and Barnett to a certain extent move in tandem. There is, according to Winterflood, about a 70% commonality of holdings between Edinburgh and Perpetual Income & Growth. However, this year Barnett's trust has outperformed by around 4%. This is largely driven by the fact that while both men are cautious Woodford is more cautious. He has for example dumped all his big oil shares over fears about their dividends, while Barnett has retained some.
This could mean of course that if Woodford's worst fears come to pass investors would be best served being in his fund rather than Barnett's. However, a bet on Barnett could mean that if they prove broadly right but not completely so he outperforms by holding some more cyclical stocks. In other words, for those who find Woodford's view now a little extreme Barnett represents a more moderated version of it.
Ultimately though both look well placed. The key deciding factor may well be that Edinburgh Investment Trust is saddled with expensive long-term debt and Perpetual Income & Growth is not.
Elliott said: 'Edinburgh has been positioned more defensively than Perpetual Income & Growth, which has led to the difference in recent performance. Barnett's fund also has the advantage that, unlike Edinburgh, it is not saddled with expensive long-term debt, which we believe makes it a more attractive vehicle.'
In investment trusts it is not just the man but also the machine that needs to perform and Perpetual Income & Growth has both.
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