November 2020 update: how the MoneyWeek investment trust portfolio has fared

Thank goodness for the Scottish Mortgage Investment Trust. Most of us at MoneyWeek are natural value investors. We have long been worried about the valuations in the growth and tech-orientated trust. But we are also 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 model investment trust portfolio and you will see the results. From 1 April this year up to 24 September, the six trusts – Caledonia Investments (LSE: CLDN), Law Debenture (LSE: LWDB), Mid Wynd (LSE: MWY), Personal Assets (LSE: PNL), RIT Capital Partners (LSE: RCP) and Scottish Mortgage (LSE: SMT) – returned an average of 45.2% against the Morningstar IT Flexible index return of 26.63%. Without Scottish Mortgage that return falls to 28.7%. Without Scottish Mortgage and Mid Wynd (the second-best performer and the pick that replaced our previous holding, Temple Bar, mid-crisis) it falls to 18%. Let’s never hear another word against diversification.

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 (see box below for more details). 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.

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Law Debenture isn’t as bad as it looks

The trust managed a mere 3.71% return between April and late September 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) – and that value investing is overdue a return to fashion, there is definitely still something interesting about Law Debenture. Peel Hunt, a UK investment bank, recently initiated coverage on the trust – and pointed out a few of those interesting things.

There are two parts to the fund. Around 17% of its net asset value (NAV – the value of the underlying portfolio) consists 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 NAV calculation (which Peel Hunt describes as “conservative”).

The rest is an investment portfolio run by fund managers 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 also 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 prospective yield of just under 5% (amazing in this market) and that yield is backed by the sector’s highest revenue reserve cover.

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% versus a sector average of 0.9%.

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), then 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.

Listen to Merryn’s recent interview with Denis Jackson and James Henderson of Law Debenture on the MoneyWeek podcast here, and with Laura Foll here.

What’s in the portfolio?

In 2012, in response to requests for ideas for a low-maintenance portfolio of funds that might be suitable for long-term investors, we put together a model portfolio of six investment trusts, with the help of a few experts – Simon Elliott from Winterflood Investment Trusts, Alan Brierley from Canaccord Genuity, and the team from Rossie House, an Edinburgh-based private client manager (where, for the sake of transparency, we should tell you Merryn’s husband works).

Why investment trusts? Because they have a record of beating unit trusts and tend to be cheaper; and because their closed-end structure means they can more easily make long-term value investments (there is no pressure to sell underlying assets if investors withdraw their money, as there is with open-ended funds).

We have made the occasional change since 2012 – three of the funds have been in the portfolio since the start (Scottish Mortgage, Personal Assets and RIT Capital), while the other three have replaced previous holdings. When looking at the table above, the discount/premium refers to whether the trust is trading above or below the value of its underlying assets.