I have been writing the column for quite a few years now but there are still a few trusts that I have not covered in detail. One of these is Merchants (MRCH ), a well-known UK equity income trust with an £818m market capitalisation. 

One reason I have not given Merchants much attention is that for many years it has tended to trade at a premium. Wobbles in the rating in March 2024 and February this year did not amount to much, but now the share price discount to net asset value (NAV) has been on a widening trend since April and currently stands at nearly 8%. That feels on the wide side for a trust that is 95% large and mid-cap stocks. I think that the last time the discount was this wide was back in October 2016.

Over five years, NAV total returns generated by the underlying portfolio still rank third in the sector – behind Temple Bar (TMPL ) and Law Debenture (LWDB ) – but more recently it has been slipping down the peer group table; over one year Merchants ranks 11th of 18 trusts. Merchants’ latest factsheet, as at end June 2025, has its three-year NAV returns lagging its All-Share benchmark by 8.6 percentage points.

On the income front, the trust’s 5.3% dividend yield is at the higher end of those available in the sector. Dividends have grown every year for 43 consecutive years and that seems unlikely to change. While, like many other trusts, it dipped into revenue reserves to maintain that track record through the Covid years, more recently it has been rebuilding those reserves (now enough to cover about eight months of the dividend).

However, over the past few years dividends have only edged up, by a cumulative 7.4% over the five years ending 31 January 2025. By contrast, UK inflation as measured by CPI is up 24.8% over that period; the real value of investors’ income has been eroding.

Merchants versus Temple Bar 

MRCH describes itself as a value investor and for a couple of years now fund manager Simon Gergel has suggested that this has contributed to it underperforming its benchmark. The problem I have with this is that TMPL – the standard bearer for value investing in UK equities – has outperformed MRCH by around 40 percentage points over the past three years in NAV terms. It feels to me as though the problem might be more one of stock selection.

In his AGM statement, Gergel said that part of the problem has been the portfolio’s relative bias towards small- and medium-sized stocks. This positioning reflects where he has been finding value and attractive dividend yields, but it has also increased the portfolio’s bias towards the domestic economy and more economically sensitive stocks. With recent GDP figures showing a slowdown in growth, this bias has worked against the trust. The manager also feels that the last budget was unhelpful in that it raised companies’ costs, which puts upward pressure on inflation, which in turn reduces the ability to lower interest rates.

The effects of this can be guessed at by looking at the returns on the various FTSE indices. From the start of this year to close of play on 13 August, the return on the FTSE 100 was 14.8%, the 250 index return was 8.3%, and the return on small cap excluding investment companies was just 5.6%. That just extends a long period of underperformance by small and mid-caps, but it also explains why MRCH is finding plenty of value in this area.

MRCH was also exposed to some of the banks that were caught up in the motor finance issues that hit Close Brothers (CBG), in particular. This took 0.7% off the NAV over the year to end January 2024 and the same amount again in the following year.

A look at the top 10 from MRCH’s June factsheet shows a familiar line up of large-cap stocks, led by Lloyds Bank (LLOY), GSK (GSK), and British American Tobacco (BATS). However, a comparison with TMPL’s top 10, which is also dominated by large caps, shows some marked differences, with just two holdings – Shell (SHEL) and BP (BP) – in common. It says a lot about the state of the UK market that two value-driven managers can find so many different value opportunities.

TMPL is also making the most of its flexibility to invest part of its portfolio overseas, with 28% of its portfolio outside the UK, compared with just 3.5% for MRCH. Although, MRCH makes much of its ability to back global businesses while enjoying the benefit of higher standards of corporate governance that come with a UK listing. Given the row about the way minority shareholders in Third Point Investors (TPOU ) have been treated after changes to related party transaction rules, that point might be debatable.

Another big difference is in the yields that the two trusts are targeting. TMPL decided to rebase its dividend when the Redwheel team took over the trust in November 2020, in the midst of companies slashing dividends during Covid. That enables its managers to look slightly further down the yield spectrum in search of income, which gives it a broader spread of stocks to choose from.

However, in recognition of the increasing importance of share buybacks to companies’ returns (as the companies also agree that their stock is too cheap), TMPL is now topping its dividend up with a small payment from capital, while MRCH is still trying to deliver its above-average yield from revenue.

MRCH could do relatively well if interest in small,and mid-caps picks up, but in the meantime, it seems about time it started to address the discount. As yet, the trust has not been buying back stock, which feels wrong given it was not shy to issue shares when it was trading at a premium.

James Carthew is head of investment company research at QuotedData.

Any opinions expressed by Citywire, its staff or columnists do not constitute a personal recommendation to you to buy, sell, underwrite or subscribe for any particular investment and should not be relied upon when making (or refraining from making) any investment decisions. In particular, the information and opinions provided by Citywire do not take into account people’s personal circumstances.