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Investment Trust Watch: Terry Smith looking 'cheap'

17 February 2017

Star fund manager Terry Smith's emerging markets investment trust has lagged rivals, leaving the shares looking 'cheap'.

Shares in Fundsmith Emerging Equities (FEET) are looking 'cheap' as star fund manager Terry Smith continues to find emerging markets a trickier environment to navigate than the US and the UK, where he has reaped such success for his table-topping Fundsmith Equity open-ended fund.

Shares in the emerging markets trust have fallen to a rare discount, as Smith's fund trails rivals amid the rally in the sector. Trading 1.1% below net asset value, below their average 1.9% premium over the last 12 months and well down on the double-digit premium they enjoyed in the months following the trust's launch in 2014, they are on a Z-score of -2.1, placing them in the list of 'cheap' investment trusts compiled by Numis Securities.

Just to recap, a Z-score is a measure used by analysts to tell if an investment trust share is trading beyond its normal one-year range. Broadly, a Z-score of -2 or below is considered cheap, while a score of 2 or more is viewed as getting expensive.

'Cheap' trusts Share price premium (- discount) to net asset value % 12-month average premium (- discount) % Z-score
CATCo Reinsurance Opportunities C (CATC) -6.1 0.0 -2.3
Strategic Equity Capital (SEC)  -15.1 -7.3 -2.2
Drum Income Plus REIT (DRIP) 5.0 11.1 -2.1
Fundsmith Emerging Equities (FEET)  -1.1 1.9 -2.1
Qannas Investments (QIL) -4.7 0.0 -2.1
Qatar Investment Fund (QIF) -19.0 -14.3 -1.8
Terra Capital (TCA) -18.3 -14.2 -1.7
JPMorgan Emerging Markets (JMG)  -14.6 -13.0 -1.6
Perpetual Income & Growth (PLI) -9.3 -6.2 -1.6
BB Healthcare (BBH) -0.2 2.5 -1.5
Edinburgh IT (EDIN) -4.9 -2.4 -1.4
Investment Company (INV) -7.0 -2.5 -1.4
Finsbury Growth & Income (FGT) -0.2 0.4 -1.4
JPMorgan Brazil (JPG)  -15.6 -11.1 -1.4
Weiss Korea Opportunity (WKOF) -6.8 -4.7 -1.3

Source: Numis Securities 16/2/17

Perversely, the rally in emerging markets which kicked off last year and has proved resilient even with Donald Trump's election as US president, has hurt FEET's relative performance.

Over one year, the shares are up 17.5%, substantially lagging the 51.5% return of the MSCI Emerging Markets index and that of its emerging market trust peers, led by Templeton Emerging Markets (TEM), up 68% over the last 12 months.

FEET had already begun to trail the market in the first half of 2016, a fact acknowledged by Smith in the trust's half-year report.

'It is not surprising that in the early stages of renewed interest in emerging markets the large cyclical stocks and sectors which benefit most are not the ones in which we would invest,' he said.

'However, if this presages an improvement in the fundamental economic conditions in the developing world we would still expect this to lead to superior fundamental and share price performance from our portfolio companies in due course.'

Smith's investment process has a heavy focus on companies' return on capital employed, and the manager is typically drawn to 'defensive' companies which he holds for the long term.

It's an approach that has proved remarkably successful in developed markets, with his £9.3 billion Fundsmith Equity fund riding high at the top of the Global sector, up 158.3% over five years.

But his process will tend to lag markets in the midst of a full-throttle rally, as has arguably been the case in emerging markets over the last year, and can been seen in his flagship fund's dip in performance amid the rally in global markets sparked by the election of Donald Trump as US president.

That is shown by FEET's performance since launch. Investors who got in at the £10 launch price will now be sitting on a 5.9% return, well below the double-digit returns delivered by most rivals over that period, led by JPMorgan Emerging Markets (JMG), up 31.7%.

But they have also avoided the worst of the volatility that is a feature of the sector. At their lowest point, FEET shares were down 12.6% from the issue price, in January last year, at which point Templeton shares were down 32.8% over the same period, and JPMorgan Global Emerging Markets Income (JEMI) a whopping 37.1%.

Share issues

The derating of the shares is not all to do with performance. FEET has been issuing new shares in the trust since March, raising nearly £42 million in the process, and swelling the trust, which raised £193 million at launch, to £247 million.

The board gained authority to issue over 4.8 million of new shares at the trust's annual general meeting in May last year, and has so far issued around 2.9 million under those plans.

Last month the board listed around 2.3 million shares, but should it want to issue all of those before the next AGM, it will need to seek shareholder approval, as that would breach the 4.8 million limit.

However, share issues have only been made at a premium to NAV, and the board may also be wary of the difficulties encountered by another star manager who has tried to raise more money for an investment trust that launched amid investor excitement.

Like FEET, Neil Woodford's Woodford Patient Capital (WPCT) shot to a premium at launch only to see the shares derate, hit by the same combination of lagging performance and share issuance.

After raising a record-breaking £800 million at launch, the board of Patient Capital began issuing new shares in the trust just a few months later. But when the board gauged opinion on a more substantial fund raise last year, shareholders rejected the plans.

Emerging markets keep rallying

FEET is not the only emerging markets investment trust looking 'cheap' this week. JPMorgan Emerging Markets and JPMorgan Brazil (JPB) also make it onto the list, on discounts of 14.6% and 15.6% that give them respective Z-scores of -1.6 and -1.4.

Perhaps they have succumbed to profit-taking. That would be understandable with the emerging markets trust up 48.4% over the last year and the Brazil trust having surged an astonishing 90.2%.

President Trump's arrival in the White House has also stoked fears over prospects for emerging markets. His protectionist tendencies and the inflationary pressures his policies could unleash are seen as bad for developing economies. With the US Federal Reserve tipped to move faster in raising rates given Trump's pro-growth policies, some investors have feared a stronger dollar that could hurt emerging markets who hold a lot of borrowing in the currency.

But things haven't turned out like that so far this year, with emerging markets outperforming as the dollar has weakened, driven lower by fears the currency had become overvalued and the US administration's seeming efforts to talk the currency down. Shares in emerging markets investment trusts have struggled to keep pace with this rally.

'Expensive' trusts Share price premium (- discount) to net asset value % 12-month average premium (- discount) % Z-score
CVC Credit Partners Euro Opps - Euro (CCPE) 1.7 -2.4 3.2
Better Capital 2012 (BC12) -44.1 -64.6 3.0
Eurocastle Investment (ECT) 8.8 -12.9 3.0
Prospect Japan (PJF) -8.3 -25.9 2.8
UK Mortgages (UKML) 9.6 3.8 2.6
NB Private Equity (NBPE) -16.1 -24.1 2.6
Henderson Smaller Companies (HSL)  -11.2 -15.4 2.5
Honeycomb IT (HONY) 6.0 1.9 2.5
Raven Russia (RUS) -2.1 -26.0 2.5
JPMorgan US Smaller Cos (JUSC) 1.8 -9.7 2.4
Apax Global Alpha (APAX) -6.1 -16.0 2.4
HBM Healthcare Investments (HBMN) -21.9 -28.6 2.3
CVC Credit Partners Euro Opps - £ (CCPG) 0.4 -3.2 2.3
Tiso BlackStar Group (TBGR) -21.1 -44.0 2.3
Princess Private Equity (PEY) -8.7 -19.3 2.2

 Source: Numis Securities 16/2/17

Turning to 'expensive' trusts, Henderson Smaller Companies (HSL) has seen its discount narrow substantially to 11.2% after a 6% rally in the shares in the five days to yesterday, giving it a one-year Z-score of 2.5.

Like other small company trusts, HSL saw its discount balloon following the Brexit vote, and despite the rally in smaller companies since, its rating had recovered only in fits and starts.

But the sustained and remarkably smooth rally in smaller companies since the beginning of December has emboldened investors, not just in HSL but other smaller company trusts, most of which are now trading on discounts much lower than their 13-week averages.

That's reflected in an impressive rally in their shares over the past month: Montanaro UK Smaller Companies (MTU) is up 10.1% and Dunedin Smaller Companies (DNDL) 9.9%.

But none can match the explosive rally of shares in River and Mercantile UK Micro Cap (RMMC), up 13.2% over the last month and 30.2% over the last three. Having seen its discount reach as high as 11.3% over the last 12 months, the shares are now trading on a 1.3% premium.

But there's one exception to this bullishness on smaller company trusts. Strategic Equity Capital (SEC) is still languishing on a 15.1% discount, well below the average 7.3% over the last 12 months, still hurt by the departure of manager Stuart Widdowson.

Investment company news brought to you by Citywire Financial Publishers Limited.

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