Nick Greenwood: the three things to buy now

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Merryn Somerset Webb talks to Nick Greenwood, of the Miton Global Opportunities Investment Trust, about the pros and cons of investment trusts in general, explains why you should buy them over open-ended funds, and his three favourite areas to invest in now.

Merryn: Hi, I'm Merryn Somerset Webb, editor-in-chief of MoneyWeek magazine. Welcome to another one of our interviews. Today, we're very lucky. We have with us Nick Greenwood, who's the manager of two funds. One is the Miton Global Opportunities Investment Trust. As you know, MoneyWeek is very keen on investment trusts, and this is a fund of investment trusts. So lots of interesting stuff coming out from that. He also runs a similar fund, which is open-ended, called the Miton Worldwide Opportunities Fund. So I think we'll put that one to the side for one minute. We will talk mainly about investment trusts. So let's talk about why you run a fund of investment trusts.

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Nick: Exactly. The day job is working out what the true value of the portfolio is. The closed-ended world is moving more towards being a natural home for alternatives, where the calculations are more subjective. German properties probably are the most extreme situation, where the methodology values a couple of investment trust portfolios as though they were rental properties, which is exactly what they are. But in Germany, most people rent. Therefore, most voters are tenants. You have a lot of landlord-unfriendly rules and regulations. If you were able to take that rental flat and convert it into the private market, sell it on as what we know as leasehold, there's an enormous difference in the price. So, typically, in Berlin, the rental average is something like €880 a square metre. You can sell those flats as private for over €4,000. The net asset value takes the rental figure but, of course, our view is these flats will be sold over the next few years into the private market at a big premium.

Nick: Yes, it's moving away from the regulation, which gives you an extreme value. The investment trust world is used to treating stated net asset values as verbatim because historically they were mainly equity funds and you'd just run your Bloomberg and you know what the NAV is at the end of the day, taking the closing prices of all the equity holdings. Using that Berlin property as an example, the valuation process is subjective. Sometimes, you get a big difference between the stated NAV and what these assets would be worth in the real world. But the market still tends to follow the stated NAV, creating an enormous inefficiency. That's how I fill my days, looking for these sorts of things.

Merryn: OK. Now, we weren't going to talk about the trust first. We were going to talk about "why investment trusts" as opposed to specifics. So let's go back a little bit to why investment trust. The first reason there is you're saying this is where the value is. They're trading on big discounts because there are now people who invest in funds in general who are too big to look at the smaller trusts, which leaves inefficiencies in the market for people like you with much smaller amounts of money to pick up.

Nick: Yes. The important difference between an investment trust and an open-ended fund is the fund manager is protected from inflows and outflows, which means if a sector falls out of favour, he's not forced to go into the market and take very poor prices. We've had quite a high profile example recently with property open-ended funds, which is a prime example of what happens if you own liquid assets in an open-ended fund where investors can walk at 24 hours' notice, but the poor fund manager can't do the same in the underlying portfolio. You get this fatal mismatch.

Merryn: So they're superior investment vehicles for us, for the retail investor because it's much longer term capital. We know that the fund manager has the ability to invest properly for the long term. And he can also, to a degree, ignore how much everyone gets at it if he underperforms for a couple of years because the capital just stays there. So as long as his directors are nice to him, he's good.

Merryn: I always think one of the great advantages of investment trusts is that they do have the directors there, whose job is to protect the shareholders. And an awful lot of funds in particular, open-ended funds are not really run for the people who hold the units. They're run for the people who hold the units, they're run for the company that manages the fund and that's where the money goes. But with an investment trust, you can look at the directors and say, "Hang on, guys. It's your job to protect the shareholders, not to protect the fund manager". It seems to me to be one of the great things about an investment trust.

Nick: But the downside was that superior investment vehicles are not particularly user-friendly. And this is what's causing all the disruption in the pricing at the moment because, historically, the old private clients' stockbrokers used to be the buyers of investment trusts and the IFA world used to buy the open-ended funds. What's happened is that maybe 100 companies that were the member firms of the London Stock Exchange, the old Shepherds and Chases and the Greens and Grants of this world, have all been merged into these vast chains and they're looking to increasingly standardise portfolios.

Nick: Exactly. There's a regulatory push and a commercial push to standardise portfolios. But that makes life difficult for the investment trust movement because these companies now individually might have been running a billion and they're now part of a vast empire running 25 billion. And if you're trying to standardise across a whole range of portfolios, you need to buy a lot of stock in the market at any one time.

Nick: Probably several times over. The industry has said it's a quarter of a million but if you think of the size of these vehicles, even a quarter of a million pound investment trust will be difficult to buy and allocate. So the bar steadily rises. 400 million is the figure I look at. And if you say there are around 450 investment trusts, 360-370 are below that bar. The problem is these are listed vehicles. The natural buyers are moving on and therefore they have to find new buyers. And that may well happen in time. But if you're listed and you have no natural buyers and a few sellers, your share price will keep falling. And liquidity is worse than it used to be. The market makers are not putting up as much capital behind markets. And this is how you end up with being able to buy stocks at 71p in the pound when the vehicles are actually doing nothing wrong; it's just that their client base has moved on.

Nick: Normally, sadly, the most common exit from my fund is the end of the underlying fund. If you're buying something that's already trading on a 30% discount, they are in the last chance saloon. We've had examples this week. If something else goes wrong or just exhaustion then the trust will very often go into an orderly windup. Probably half of my exits come that way. If you can actually find something that finds a new client base or a new manager or a new reason to exist in the audience, you can get a powerful combination of a rising on NAV and a narrowing discount. If you do the sums of buying something at a 30% discount and it moves to a 10% and you get a 10% move in the NAV, you can get a spectacular move.

Nick: Yes. That's one of our core holdings. That one actually trades at a premium but we're just purely backing the managers. The situation there: they've got a good long-term record but most of their funds are in obscure offshore locations and they really wanted a vehicle that their fan club that could only buy UK vanilla vehicles could access. So the trust is very small and that allows them to grow the trust. Therefore, there's more demand than there is supply because the trust is very small in the first place. Hence, we're trading at a premium. The other important point is that they run very concentrated portfolios the ability to be closed-ended. Again, going back to the inflows and outflows, if you're going to have a ten-stock portfolio, you really don't want to be hit by redemptions and having to go across and sell a very short range of underlying stocks.

Merryn: Now we're on Aurora, let's move on to the subject of fees. Aurora has a performance-only structure. In the past, everyone was bandying around numbers showing how investment trusts have generally outperformed open-ended funds over time. And people have argued about why that is: is it because managers are so good at dealing with their leverage or is it actually just because in the end the fees would be lower, the overall cost is being lowered because they haven't gone through the IFA system, the commission system etc? But now that that's all changed, post-RDR, which takes a while to flow through, we are beginning to see a situation where the investment trusts don't look so cheap, compared to the unit trusts. We worry or I worry, anyway that over time, if that outperformance won't continue if it's entirely based on the fees. So where are fee structures going in the investment trust world? And to what extent does it matter?

Nick: I think historically there was a fact that investment trusts were cheap. I don't think that's been particularly true in recent years. Some of the older generational trusts were cheap. What's tended to happen is that fees were under more pressure and therefore the rest of the world has come down to that level. But a lot of the newer alternative funds have quite generous fees and actually are quite expensive. But I don't think it's possible to make sweeping generalisations.

Nick: I quite like it but they haven't proved to be popular. The trust I ran used to have a performance fee. We dropped it and raised the general fee from 50 basis points to 65 basis points because that's what the market liked. I have no problem, as long as I understand the performance fees. Going back to Berlin property, Taliesin, which is our second largest holding, has an enormous performance fee. I think the fund manager took €11 million home last year.

Nick: Yes. That's high. But if they have a difficult time, it will become a low cost fund. And that's possibly why people don't like it. And I think also the problem is a lot of end users obsess about the level of fees and they have to declare the level of fees. If you've got a Taliesin and an Aurora who've had very good years that have generated great returns for their shareholders, it's going to make the advisors look expensive on the data that they have to produce. So that's also a reason why.

Nick: It's eight. Post-Brexit, the NAV went up very nicely because the Indian market held up quite well and the pound sunk against the rupee. We reached the point where the warrants or the subscription shares came to the end. The undiluted NAV was £1. We had the right to buy more shares at 61p, as everyone else did. But that created 37 million new shares in a small and liquid trust. Therefore, with all of that supply, we've a lot of shareholders owning more than they would like in the short to medium term. The share price has not kept remotely up with the value of the underlying assets. People describe Modi as India's Thatcher. My view is he's more a supreme administrator. He's trying to make the existing systems work better. India is going from an economy that's been incredibly badly run to what we call "less worse".

Nick: For example, moving a lot of the planning processes onto the internet to avoid all the bribery, corruption and bureaucracy. So the system will work better. You've got a stock market that looks vaguely similar to the UK market. They've inherited the system. So you can generally stock pick. The top 20 companies in India tend to be owned by the big multinationals and tend to be on very high ratings and often rather unexciting businesses. But you've got several thousands of companies in India and therefore, you can generally stock pick. The new managers at India Capital Growth, I think, are quite good.

Nick: The trust is India Capital Growth. Historically, the trust has been a bit of a disaster. Very often, the discount reflects the track record of the vehicle, not the team that are running it at the moment. India Capital Growth is a prime example of that. Launched about ten years ago, the first team lost half the money. They left. Another team was hired. They repeated the exercise, lost half the money again. Third team came in three or four years ago and found a portfolio full of microcaps run by mates of the second team, which took them a long time to sell. That whole process took the stock eventually from £1 at launch to 29p. At that point, the market has a very poor perception of this trust and views it as a bit of a disaster. But the guys probably took a year to clean up the portfolio. Over the last two or three years, it performed very well. It focuses on midcaps and therefore, they're genuine stock pickers and performed a lot better than the very big general funds.

Nick: We did buy some stock at 29. But the big purchase recently was at 61. It was the exercise of warrants. But it's an arbitrage between perception and reality. And we like the macro as well. It's an economy where the central bankers still have tools to use, unlike in the West, where we used all the ammo. The economy is growing. You're paying 17-18 times for the portfolio but typically, earnings are actually growing but 15-20%. So it's just a good old-fashioned profits are going up, stock-picking type situation that's very poorly perceived and trades way below its intrinsic value.

Nick: The proposal put into place to liquidate the portfolio and sell the portfolio to someone else. It's one of the classic situations at the end of the trust, is very often the windup, which gave us a nice uplift, obviously, because the thing was trading at a reasonable discount up until Monday morning. That was another area. The biggest theme is private equity. If you include underlying gearing, that's probably 20% of the portfolio.

Nick: Yes. One of the tools in the box it doesn't work all the time but you can help things along is to explain to people what the value is. Obviously, you're going out, talking to your shareholders and you're talking to brokers. The shares of my trust are trading on the market so I have to go out and explain to investors what's in the portfolio. Sometimes I go out and buy one or two of the ideas directly.

But private equity is a sector where discounts are still very wide. They've been narrowing in recent days. Part of that is because of history. They all blew up in 2008 and a lot of people haven't got the confidence or the nerve to get back involved. Part of it is just coincidence. A lot of these funds have market values of 200, 300, 400 million, which is the dangerous area. It's the area where they're just coming off the buy lists of the big chains and they're just going into this period of actually having the discounts wide. I think with private equity, it's just a coincidence that the number of the funds are of that sort of size.

If you look at the UK investment trusts, with a very mature portfolio if we look at Pantheon, its average age of its underlying investments are seven years this stuff is ready to sell into a market that's desperate. You've got the mother of all seller's markets. Again, it's a situation where the stated NAVs are fairly historic and those stated NAVs will have to rise 10-15% over the next 18 months as those assets are sold. Yet many of these things are trading on enormous discounts. There's a number of factors there.

Talking to people, it's a more difficult concept to get over to investors and you've got to drill down a little bit. But I think what we've seen recently is there's so much value there that we're starting to get hostile takeover bids. Obviously, you've seen Electra but SVG was attacked earlier this week. I think what that is is people are actually looking harder and delving and thinking, "Well, there must be value here. All these are trading at discounts." I think people are looking over the sector. We've seen some quite strong runs in some of our stock over the last two or three days.

Nick: Obviously, we'll put a curse on the future. I would say Geiger Counter, which is a very small trust that focuses on effectively owning uranium and uranium miners. The discount varies but it's a penny stock. It trades at about 17 pence a share, the NAV is about 22-23p and those figures move around. Typically, it's a 20-odd percent discount, like other things. Uranium is quite odd because it went into its decline two or three years before the mining sector did because of the accident in Fukushima. And sentiment is absolutely dire. Price is quite low. But nobody is looking for new uranium mines. But the uranium is being used up quite fast.

Nick: No political risk. For example, there are 100 nuclear reactors in the United States. We have had some upheaval in the Stans with the recent departure or death of one of the leaders. That isn't in the price. I'm not necessarily expecting that to change. But you would lose half of your global supply. At the moment, probably there's 20% less uranium being mined than needed by the nuclear industry.

Nick: We're going from about say 450 nuclear reactors in the world when the ones under current construction are finished, that will be 600 and it may go to 1,000 if things like Hinkley Point, which is looking more likely this morning, go ahead. It would be on that list between 600 and 1,000, the ones that might make it but most won't. Let's say we end up in five years' time with 650-700 nuclear reactors, we're not even mining enough for 450 and the mining supply will keep dropping every year as things get exhausted. Nobody is going to actually look for a new uranium mine until it's $70 or $80 so we're going to get this massive spike up in the price at some point. I'm just surprised it hasn't happened already.

Nick: I have a fondness for it because we sold half the holding. I think the tidal wave was heading towards a nuclear power station the moment we sold it. We sold half a holding at £1.35. And I used to joke that now it was the same but just take the 1 off the front. But it's done that and halved again. I think it's just a case of I can't see where the supply is going to come from. We mentioned earlier the Kazakhstan situation. Half of this supply comes from Kazakhstan. If there is political change, there is upheaval nobody's going to say that there should be that would have an absolutely dramatic effect because we're already in shortage. There's ever more demand and there's ever less supply. And it's hated, and that's why it trades on a discount and it's why all the underlying stocks trade on a discount.

Nick: It's worked very nicely as a result of Brexit and the pound heading lower, in the short term. So it's still cheap. I think demand will keep going because in Germany,people who are 40 and underare globaland are buying property. The 50-somethings, the 60-somethingscarry on rentingbecause that's the culture. There isa generational change,which is more extreme in Berlinbecause it is a sort of happeningplace. That's come froma very low level. But there are other things.

But the other thingthat is not talked about muchis that,like in private clientstockbroking,the pots of moneywill have managed to become big,it's the same in the property world. There's beenconsolidation. Property managers and investors needvery big ticketsand thereforethe valuefor a portfoliois vastly morethan the valuefor an individual building. The NAVsare calculatedby what those buildings would fetchindividually,not as part of the portfolio. Sothere is another discount there.

Nick: There is one ProspectJapan would give you some access. That's a very specialist fund and at the moment their big bet is trying to get control of the two big banks in Fukushima. I don't know the size of it but Fukushima is probably on a par with Devon and Cornwall, it's had $100 billion pumped into it after the accident. So the economy there is ticking over fine. So the banks are in a better state. But the manager there has managed to buy in at 30% of book and I suspect his plan is that if the authorities don't particularly want a Western investor in the sensitive bank, they might buy him out. But the rest of the portfolio is pretty well focused at businesses a bit like we did in the '80s. Spinning mills and things like that that own vast tracts of Tokyo for a business that was industrial and not really being used. He's got a lot of companies, cheap property, overlooked property. And that's the only way.