Nine investment trusts the professionals are backing

Capital Gearing Trust (CGT) is both poacher and gamekeeper: it is an investment trust that invests in other investment trusts. Wheels within wheels? Possibly, but with good reason: investment trusts have proved to be a fertile hunting ground, allowing access to a huge range of asset classes and talented fund managers. CGT has delivered roughly 15% compound annual returns since 1982, a track record that pays testament to the opportunities available in this much-overlooked corner of the investment universe.

When considering which trust to invest in we like to see a long-standing manager (ideally with a significant personal investment), a distinctive investment strategy and a competitive fee structure. Investment trusts have a number of downsides: they are relatively expensive to run and they are costly to trade. However, they provide a relatively stable pool of capital to the manager, and thus are suitable for holding illiquid underlying assets. CGT's top three equity holdings help to illustrate this.

North Atlantic Smaller Companies (LSE: NAS) is a specialist fund investing in small-capitalisation listed and unlisted companies in the UK and the US. It has been managed by Christopher Mills since 1994 and he is the largest shareholder in the trust. He employs a very hands-on investment style, often helping to deliver significant operational change in the companies he invests in, frequently taking a board seat to exercise influence. North Atlantic has delivered exceptional returns over decades, outperforming the vast majority of private-equity funds, while charging considerably lower fees.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

Rights and Issues (LSE: RIII) is another specialist fund of small and micro-capitalisation stocks. It has been managed by Simon Knott for 27 years and the Knott family collectively are significant investors in the trust. Notwithstanding its very low profile, Rights and Issues is among the best performing small-cap funds over the last decade, and over the entire 27 years that Simon Knott has managed it.

Civitas Social Housing (LSE: CSH) is a new addition to our portfolio, having only been listed for two months. It is a portfolio of social housing properties that housing associations have sold and leased back on long-term, inflation-adjusted leases. It demonstrates the flexibility of the investment trust structure to hold illiquid underlying assets with a range of risk and return profiles.

These types of opportunities expose investors to many risks, not least very high trading costs in times of market stress. These risks should be high up in the mind of any investor, given the exceptionally high equity valuations that prevail today. However, within the hands of a patient investor, as part of a diversified portfolio, selectively chosen investment trusts offer returns that more than justify the risks.

Market sentiment is currently in reflationary mode and there is a widespread belief that a global economic recovery is now under way. We believe stocks should provide some hedge against rising inflation expectations, since a company's revenues and profits tend to grow at the same rate as inflation. This also leads us to believe that US small caps will continue to outperform their large-cap peers. And, while Europe remains vulnerable to political risks, the recovery in Europe's banking sector should offer investors some near-term gains.

JP Morgan Elect Managed Growth aims for long-term capital growth from a portfolio invested in funds run by JP Morgan and other managers. The three investment trusts highlighted below illustrate our preference for weighting our portfolio towards high-quality markets.

The global growth outlook is looking uncertain, but the JP Morgan US Smaller Companies Investment Trust (LSE: JUSC) is focused on US domestic growth and earnings, which, by and large, are in reasonably good shape. US small-cap stocks have rallied since the US election, because this part of the market is seemingly well positioned to benefit from the president's pro-growth, pro-business policies, although the long-term effects on the economy and markets will very much depend on the precise policies enacted. This trust's tilt towards high-quality names has been an advantage in coping with volatility. The portfolio is built with a bottom-up approach, has a long-term focus and is made up of undervalued firms with growth potential.

The managers of the JP Morgan Claverhouse Investment Trust (LSE: JCH) are seeking to identify the winners and losers from Brexit. With the UK's economic environment likely to become tougher, companies with sound business models, robust finances and strong management should prosper the most. The managers favour quality, blue-chip stocks with overseas earnings. During the past six months the investment team has reduced its exposure to domestically orientated, mid-cap stocks that will be at a disadvantage from a combination of increased import costs and a slowing economy. Despite the global political uncertainty that lies ahead and consequences such as higher inflation, the environment should remain friendly for equity investors.

Real growth, inflation, unemployment, and corporate revenues and profits are all showing tentative signs of improvement in Europe. The story of 2017 is therefore likely to be one of better fundamentals rather than political noise, with several elections (and the looming threat of populism) on the horizon. The team behind the JP Morgan European Investment Trust (LSE: JETI) see that support for populism is waning in Greece and Spain and believe that the electoral barriers are too high in both France and Germany for populists to be able to scale them. The portfolio is tilted towards firms that will benefit from accelerating growth and is underweight in the areas most vulnerable to higher interest rates. With growth recovering not only in Europe but around the world as well, European stockmarkets, with their broad international exposure, should be well placed to benefit.

Peter Hewitt, F&C Managed Portfolio Trust

Investors have never been more uncertain, yet stockmarkets are at, or close to, all-time peaks. In times like these, rather than trying to second-guess macro or political developments, it is best to focus on funds that have good long-term records and managers with a clear strategy. The following three trusts possess these characteristics.

Temple Bar Investment Trust (LSE: TMPL) is classified under the Investment Association's (IA) UK equity income sector. It has a good long-term performance record, although it can have periods when it's out of favour. Manager Alastair Mundy's contrarian approach is part of the attraction. He employs a value-based investment style and looks for stocks, mainly in the FTSE 350, which have fallen at least 50% from their peaks, but whose balance sheets are in reasonable shape. As the turnaround can take time, he often holds stocks for at least five years. Currently he is overweight banks, food retail and certain building-materials firms, while being underweight in consumer-goods stocks and basic materials.

The trust's largest holding is Royal Dutch Shell. Recent performance has been strong and looks set to continue as stocks in these sectors remain cheap. Temple Bar trades on a 6% discount to net asset value and has a yield of 3.4%.

Monks Investment Trust (LSE: MNKS) is in the IA's global sector, and has a market capitalisation of £1.2bn. It has been run since March 2015 by the Global Alpha team at Baillie Gifford. The managers employ a broad-based, growth-focused strategy aimed at identifying firms that can deliver above-average earnings growth. An underlying theme is to invest in firms that benefit from technological innovation in areas such as robotics and gene sequencing. Since the new team took over, performance has improved and is reflected in the discount tightening from 12% to around 6% currently. The trust has just over 100 holdings and is Baillie Gifford's global "best ideas" fund.

HgCapital Trust (LSE: HGT) is in the IA's private-equity sector and has a strong long-term performance record. Typically, the portfolio is quite focused, with the top 20 holdings accounting for 85% of the value. The management spends time working with investee firms, typically with an enterprise value of between £20m and £500m, to understand their end markets and build relationships. It looks for visible earnings streams, diverse customer bases and business-critical services with strong cash generation. Use of technology is a common theme, as is predictable subscription-based revenue streams. The portfolio is more highly rated in terms of valuation than others in the sector, but the growth rate also tends to be higher. With an increasingly mature portfolio, prospects for realisations which drive growth in net asset value look attractive for 2017. Its shares trade on a 5% discount to net asset value.