Trusts investing in UK equities are among some of the industry’s most popular vehicles, with the 23 portfolios in the Association of Investment Companies’ UK All Companies and UK Equity Income sectors managing £14.4bn between them.

Yet these funds offer little by means of diversification as managers jostle to invest in a small, and shrinking, equity pool, according to CT Global Managed Portfolio.

Managers Adam Norris and Paul Green are ‘consciously trying to increase the overall global parts of the portfolio’ since taking over the trust in June, which is divided into two portfolios; one targeting growth (CMPG ) and the other income (CMPI ).

When long-running manager Peter Hewitt handed over the reigns in May, UK trusts were the largest positions in both at 41% in the income fund and 33% of the global portfolio. Those weightings have since fallen to 37% and 26% respectively, with the US becoming the largest exposure in the latter, as the new managers stripped out some of the overly corelated UK trusts.

‘You get an illusion of diversification,’ Green said. ‘You might see five or six names in the portfolio, but they’re all pretty much doing the same thing. So what we’re trying to do is work out where there’s a lot of commonality between holdings and ask ourselves whether we really need three funds here, or can we just pick out the best idea and have a higher exposure?’

One of the first to go was Nick Train’s Finsbury Growth & Income (FGT ). The £1.1bn trust was a market darling in the 2010s era of low interest rates but has taken a turn for the worst in the past five years. Shares are up just 20.8% over the period, trailing four times behind the FTSE All Share’s 99.5% return as Train’s quality growth stocks went out of vogue.

However, Norris and Green are still keen on quality growing – they would just rather invest in those businesses beyond the UK alone.

‘It’s been out of favour for a good five years now, having performed well for a decade, and that has really eroded long-term returns,’ Green said. ‘We still think quality businesses will serve a purpose when markets get tougher, but we don’t need to limit that to the UK. We prefer looking for that rich opportunity set on a more global basis.’

In its place, they’ve added a position in STS Global Income & Growth (STS ). It too has ‘struggled more recently’, but Norris and Green like its defensive nature in downward markets – it just isn’t reliant on a single country like Finsbury.

‘We want to increase the amount of global exposure, and when I say global, I mean ex-UK,’ Norris added.

‘There’s definitely been a large component of UK in both portfolios in the past, and we want to represent the global nature of the trust.’

A value market for the foreseeable

Also on the chopping block were growth trusts such as Bailie Gifford UK Growth (BGUK ). Norris and Green liked the investment strategies on some of these funds, but do not think the UK will become a growth market anytime soon.

Instead, they’ve doubled down on  a smaller number of value funds in an effort to be ‘comfortable taking more concentrated, bigger positions that are additive to the trust over time’.

The duo are aiming to slim both portfolios to 25 holdings each, down from 39 in the growth fund when they took over in May and 36 in the income trust.

Several trusts moved away from their value roots when growth was outperforming five years ago, so Norris and Green were drawn to managers that stuck to their guns. One they highlighted was Temple Bar (TMPL ).

‘They held a review in the depths of Covid in 2020, and it had a value manager Alastair Mundy who had been a poor performer for some time,’ Norris said. ‘Everything value got whacked by Covid, and it would have been really easy for the board to go with one of the growth mangers that was performing really well at the time.

‘That was the psychologically easy thing to do, but they switched to value managers again – Ian Lance and Nick Purves – and they’ve been the best performing income fund over five years.

‘There’s only about two or three value managers left in that space as everyone’s moved to either core or growth, because that’s what’s worked in markets since covid essentially.’

The £1.1bn trust is up 226.3% over the past five years, far outpacing the 90.9% return from its average peer in the AIC’s UK Equity Income sector.

Another high-conviction holding they’ve added to is Fidelity Special Values (FSV ). Green has been a long-term holder in his multi-asset funds, but manager Alex Wright has put him through his paces over the years, leading to an on-off relationship.

‘I first invested in him on 2012 when he was running an open-ended UK smaller companies fund because I really loved his process, but when he got given bigger funds, I wasn’t sure whether he could replicate that up the cap scale. We did sell the fund too early as it turned out, because it’s continued to do really well,’ Green said.

‘There have been a couple of periods where he’s underperformed when value has been really out of favour, but never by a huge amount. When value has worked, he’s really been able to generate decent alpha, so we’re glad to be back invested. He’s now our biggest UK holding [in the growth portfolio].’

Norris and Green later had their doubts when Wright upped the trust’s gearing as interest rates were soaring, but the bold bet paid off, with shares up 164.4% over the past five years – more than double that of the UK All Companies sector’s 66.8% average.

‘We didn’t hold the trust at that time because he added quite a lot of gearing to the portfolio as markets were falling, which felt like the wrong thing to do at the time,’ Green said. ‘As it turns out, it was the right thing because he was able to extend exposure at a cheap point in time, and that has really benefitted into the recovery.’

Growth beyond the large caps

Norris and Green are not completely opposed to growth in the UK – they are just finding opportunities further down the market cap spectrum.

‘We’ve been selling some of our UK trusts from both portfolios, but I wouldn’t say we’re completely bearish on the UK – it has been a value market for a while and may continue to be so,’ Norris said.

‘We’re preferring trusts down the cap scale. It’s the flows picture that we’re a bit pessimistic of, so you get much more M&A activity down the cap scale.’

One such trust they’ve added in recent months is Strategic Equity Capital (SEC ). Manager Ken Wotton also runs an open-ended small-cap fund, Gresham House UK Smaller Companies , though SEC’s trust structure has lended itself to better performance.

This is a trend across the market, with trusts in the AIC’s UK Smaller Companies sector far outperforming their counterparts in the Investment Association open-ended version. They are up 63% on average over the past five years versus 25.9% thanks to less liquidity requirements.

‘You find larger cap holdings in open-ended funds because they’re at the mercy of inflows and outflows,’ Green said. ‘With trusts, managers can go down the cap scale a lot more because it’s a close capital vehicle, so you’re getting their best ideas.’