Thank goodness for the Scottish Mortgage Investment Trust. I’m a natural value investor – as is John. We have both long been worried about the valuations in the growth and tech orientated trust (while simultaneously loving the effect of those valuations on our SIPPs). But we are also both well aware that the trust’s managers have a stunning record of stock picking and performance. So we have long hedged our value investing bets by holding Scottish Mortgage too.
Look at Moneyweek’s investment trust portfolio and you will see the results. Since 1 April this year the six trusts – Caledonia (LSE: CLDN), Law Debenture (LSE: LWDC), Mid Wynd (LSE: MWY), Personal Assets (LSE: PNL), RIT Capital Partners (LSE: RCP) and Scottish Mortgage (LSE: SMT) – have returned an average of 45.2% against the Morningstar IT Flexible index return of 26.63%.
Without Scottish Mortgage that falls to 28.7%. Without Scottish Mortgage and Mid Wynd (the second best performer and the pick that replaced poor Temple Bar mid crisis) it falls to 18%. Let’s never hear another word against diversification.
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So what next? We still like this portfolio as a good one-stop shop for anyone wanting a UK biased but still very global portfolio invested across a range of styles. However, we also think that it is worth a quick look at the worst performer of the lot, Law Debenture – just to be sure we want to keep it.
Why Law Debenture isn’t as bad as it looks
The trust has managed a mere 3.71% return since April and is down slightly over one year and three years. It only begins to look good if you look back ten years (127%, which makes it the third best performer in the portfolio but isn’t much good to most of us today).
However, if you think that there is even the slightest chance that the UK will soon look less unpopular than it does today (I do, see last week’s column on the matter) – and that value investing is overdue a return to fashion, there is definitely still something interesting about Law Debenture. This week, Peel Hunt, a UK investment bank, initiated coverage on the trust – and pointed out a few of those interesting things.
There are two parts to the fund. Around 17% of the net asset value is made of the Independent Professional Services Business (IPS) which offers various pension trust and corporate services. It sounds like a fairly dull business – and it is. But it also provides regular recurring revenues; has solid defensive qualities (pandemics make little difference to it); and is arguably undervalued in the trust’s net asset value calculation (Peel Hunt calls its valuation “conservative”).
The rest is an investment portfolio run by James Henderson and Laura Foll. This is unconstrained – it can invest in any size of company; fairly valuation sensitive (which is why we liked it in the first place); and mostly (80%) invested in the UK with a current focus on financials (29%) industrials and energy. And inside the parameters of the UK equity income sector it performs pretty well.
Law Debenture has nonetheless outperformed its benchmark index – the FTSE All Share – over one, three, five and ten years and sits in the top quartile of its UK Equity Income peer group. It also has what Peel Hunt calls a “compelling” dividend story.
Helped by the regular revenues from IPS (which has provided about 35% of the dividend income over the last ten years) it has a 41-year record of raising its dividend and a ten-year dividend compound annual growth rate of 8%. The shares offer a 5.2% prospective yield (amazing in this market) and that yield is backed by the highest revenue reserve cover in the sector.
The idea of revenue reserves is a bit of an accounting trick – they simply consist of income earned in the past and not yet paid out. But still, the idea that you can keep getting your dividends even if the dividend needed to pay them stops coming in from the portfolio’s equity holdings is reassuring. Another plus is low costs – 0.48% vs a sector average of 0.9%.
Why we’re hanging on to Law Debenture
Overall, there is, say the Peel Hunt analysts, “value and upside on both sides of this trust.” Law Debenture’s managers agree.
The team “is convinced that UK equities look cheap on almost every metric and relative to other asset classes” such as UK gilts. If they are right, and a rotation into them begins (perhaps with the catalyst of a Brexit trade deal or perhaps not until January when the world does not end with the lack of one) this is one of the trusts everyone will want to own.
We agree on the cheapness of the UK – and with the idea that it isn’t sustainable for much longer. So we will be keeping Law Debenture. Fingers crossed we are all right on this one: we surely can’t rely on Scottish Mortgage to carry the investment trust portfolio single handedly for much longer.
Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).
After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times
Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast - but still writes for Moneyweek monthly.
Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.
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