Introduction
This report will discuss the fund’s performance during the year ended 28th February 2019 and give a summary of the outlook for the coming year. For brevity, the TB Wise Multi-Asset Growth fund will be referred to as Wise MAG in the remainder of this report.
Investment objectives
Wise MAG aims to provide growth over the medium to long term in excess of the BATS UK All Companies Index and in line with, or better than, the rate of UK inflation (based on the Bank of England’s preferred measure of UK inflation, which is currently the Consumer Price Index (CPI)). In other words, Wise MAG aims to deliver returns better than cash and shares over the medium to long term. An unlimited proportion of the fund can be held in cash at times when other assets look unattractive. Wise MAG can invest anywhere in the world, with no geographical or sector restriction. Wise MAG is a fund of funds. Most funds of funds invest in open-ended funds (unit trusts and OEICs). A much smaller number invest in closed-ended funds, commonly known as investment trusts. Wise MAG does both, choosing funds on the basis of the quality of the managers, and on the value of the assets.
In order to achieve the fund’s objectives, we are looking for markets and sectors where we can see value and/or significant growth potential. Within these, we focus on managers with a disciplined, easy-to-understand investment process and with a similar level of dedication to ours. We tend to know our managers well, which allows us to allocate to the best asset classes managed by the best managers at times when their styles are often out-of-favour with other investors.
Open-ended and closed-ended funds
The main difference between the two types of investment vehicles is in the way they are priced. An open-ended fund is valued by the company that administers it. The price of the unit is calculated each day and accurately reflects the market value of the assets the fund holds. Closed-ended funds (otherwise known as investment trusts) are traded in the stock market, and their prices are determined by supply and demand. So, an open-ended fund with assets worth £1.00 per share will always be priced at £1.00. An investment trust with assets worth £1.00 per share might trade at £1.20 if the assets are in great demand, or the fund manager is highly regarded. Conversely, the fund might trade at 80p if investors are worried about the asset class or the managers of the trust have performed less well than their peers.
When an investment trust’s assets are worth £1.00 per share, and its shares are trading at £1.20, then it is said to be at a 20% premium. When its assets are worth £1.00, and its shares are trading at 80p, then it is said to be trading at a 20% discount. Investment trust discounts change over time. We aim to buy good investment trusts when they are trading at wide discounts, which look unjustified to us. Over time, discounts on good trusts tend to narrow, and sometimes investment trusts go from discounts to premiums. For example, we can sometimes buy a fund with net assets of £1.00 for 80p. A few years later, the assets may have risen to £1.40 in value, but meanwhile, if the trust has become fashionable, it may trade at a premium price of £1.60. In a unit trust, where the price reflects the value of the assets, investors would make a return of 40%, as a result of the asset value increasing from £1.00 to £1.40, but in an investment trust, due to the combination of the asset price rising and the discount turning into a premium, investors would make a 100% return. For this reason, we prefer closed-ended funds to open-ended ones, when they are of high quality and we can buy them at substantial discounts. However, we need to be patient, because wide discounts can widen further, and sometimes we have to wait a long time before the eventual re-rating takes place.
Another attraction of investment trusts is that, by their structure, they allow their managers to invest in more illiquid asset classes. For an investor to change their position in a trust, they need to be matched by another investor in the market willing to do the opposite transaction. In an open-ended fund, investors can buy or sell at any point, forcing the manager to invest the extra cash they receive or raise cash to meet redemptions. If the fund is invested in illiquid assets, this can be a problem: either the extra cash received cannot be invested quickly -thus creating a drag on performance-, or cash is difficult to raise because it takes time to sell holdings. This isn’t an issue in investment trusts and they are thus a suitable structure to invest in illiquid asset classes such as, for example, private equity, infrastructure, small companies or property. We think it is extremely difficult -if not impossible- to manage fully flexible multi-asset funds like ours without the use of investment trusts.
However, given the nature of investment trusts, liquidity may be an issue (it may be difficult to buy or sell shares if there aren’t any other sellers or buyers willing to trade). We are always careful to keep a mix of closed-ended and open-ended funds in the portfolio.
At the end of the year, Wise MAG was invested roughly 63% in closed-ended funds, and 32% in open-ended funds (the remainder being in cash). The proportion of the fund held in closed-ended funds will fluctuate based on our asset allocation, investment ideas and liquidity constraints.
An exercise we like to run periodically is to monitor the premium/discount that Wise MAG trades at relative to the value of its own assets. This, in effect, consists at looking at the fund as if it was an investment trust, adding up the value of all of its investments compared to where their prices are. As explained above, the price of the open-ended funds we invest in (32% of the portfolio) will be equal to the value of their assets. However, given our large allocation to investment trusts, it makes sense to look at where those are trading, in aggregate, relative to their own assets. At the end of the period, the investment trusts we invest in were trading at an average of 10% discount. For Wise MAG, the fund discount was 6%. In comparison, global equity investment trusts trade at a weighted average of 3% discount. So, while Wise MAG’s discount is narrower than in the recent past as a result of market movements, we continue to find unrealised value. This can only be achieved by sticking to our investment process of adding to managers we respect when they are disliked by other investors and gradually exiting positions when the market is coming round to our view.
Some good examples of this discipline would be the Impax Environmental Markets Trust (IEM), of which we completed the sale in July and the TR European Growth Trust (TRG) we started buying last October. Both of these funds are, in their respective areas, managed by excellent managers we respect and trust. IEM is invested globally in companies providing environmental solutions through their products and services. This is an area of huge growth at present with the increasing focus of governments, corporates and individuals on environmental issues. As such, the trust outperformed the broad global equity market by about 20% during our holding period, going back to 2011. As one would expect, the attractive characteristics of this sector and the quality of the manager led to increasing investors’ interest, which led to the discount tightening from around 13% at the time of entry to close to 0% last summer, at which point we closed our position completely. As has often been the case throughout the history of Wise MAG, it is likely that we will reinvest in this trust at some point: we just need the valuations to become attractive again.
TRG is one such example of a trust we bought again 5 years after it was last sold in Wise MAG. This trust has got a fantastic long-term track record but, being invested in small and medium-sized companies in Europe excluding the UK, the performance comes with some volatility. Similarly, as investors turn more optimistic about the region, they often use funds like TRG to boost their returns but then are overly keen to rush for the doors as soon as they get worried. The discount in the trust has moved in a range going from more than 25% to a small premium over the past 7 years. These moves can be quite swift but, as active managers, we keep a close eye on the managers we like in order to be able to take advantage of opportunities. Last year, such an opportunity presented itself when the trust moved from a premium to a 13% discount following a bout of underperformance. This is when we initiated this position and we have added gradually to it since then, following the very difficult markets experienced across the world in December.
We believe that our focus on valuations is in large part responsible for the good performance of Wise MAG over the years. Active fund management gets a lot of bad press nowadays -sometimes justifiably so! – but we think that a disciplined approach like ours should help us continue to outperform buy-and-hold or passive strategies going forward.
Performance
In what turned out to be a difficult year, Wise MAG managed to outperform both of its benchmarks (the CBOE UK All Companies and the UK Consumer Price Index), as well as its peer group, the IA Flexible Investment sector. The B shares (representing close to 98% of our external shareholders) has outperformed the broad UK equity market by close to 22% over 5 years and close to 55% over 10 years, putting the fund in the top 10% of its peer group.
Looking at where this outperformance came from, Private Equity, our International holdings and our Utilities and Infrastructure specialists were the main contributors.
Private Equity is cyclical by nature. We invested heavily after the 2016 Brexit referendum as many top-quality investment trusts in the sector presented some very attractive discounts. We are now in the part of the cycle where underlying portfolios are more mature and we start reaping the rewards of investments that our managers have made over the past few years. The strong performance in our private equity “bucket” comes mainly from realisations that those managers have made at very attractive valuations, as well as them focusing on profitable niches such as so-called platform companies which generate growth by integrating smaller companies and creating synergies by sharing common systems or infrastructure.
The second largest contributors to performance were our International holdings. Unlike the previous year, the move in the pound was a tailwind for global investors this year as it fell by around 5% relative to the US Dollar. When investing abroad and repatriating assets back to the UK, a weaker pound helps boost returns. However, most of our global managers added value in their own right and the currency tailwind was a bonus. Our best performing fund in the sector was also our largest allocation, Caledonia Investments, which managed to grow its net asset value steadily throughout the year but, more importantly, succeeded in protecting its gains during the downturn of the fourth quarter 2018. The turbulent year experienced in 2018 was a great illustration of the importance of having a diversified portfolio with a mix of asset classes and strategies. Having managers able to protect capital on the downside can prove vital in times of increased risk aversion.
Our final top contributing asset class fits in that category. We ended the year with 4.6% in Specialist Utilities and Infrastructure funds. Our reasoning for allocating capital to this sector is primarily to add steady growth exposure in the portfolio. Our managers focus on global companies that have high barriers to entry and fulfil a critical need in their respective markets. Far from being boring, the best of those companies are able to grow at a steady pace, either because of increasing demand for their services (for example on the infrastructure front given the poor state many developed countries are in and how fast some emerging markets are growing) or helped by a regulatory regime that allows them to increase their prices in line with inflation. They also get exposure to some of the fast-growing areas using renewable energy, while still offering better downside protection when sentiment turns. The Global Utilities sector outperformed the rest of Global Equities by 20% in Q4 of 2018, so that exposure in Wise MAG was most welcome.
In the sector, performance was also helped by the 94% return for the year in the EF Realisation Trust which was a special situation, uncorrelated to equity markets. This investment trust was set up in September 2016 to hold, manage and realise the illiquid assets previously owned by the Ecofin Water and Power Opportunities Trust. This was a very specialised vehicle with a set lifetime of 2 years (extensible if necessary by shareholders’ approval). We used to invest in the Ecofin Water and Power Opportunities Trust so have known the managers for some time and are also now invested in the Ecofin Global Utilities and Infrastructure Trust which holds the liquid assets of the original trust. There were two main drivers that made the EF Realisation our strongest performer last year. The first one was its large position in LoneStar Resources, a small US listed resources company specialised in the acquisition, development and production of unconventional oil and natural gas properties. The company announced a strong increase in their production numbers which helped its share price dramatically. The second driver of performance was the expectation that, as one got closer to the 2-year lifetime of the trust, the board would have to make an offer to shareholders to realise their investments. As it happened, in early September, a proposal was put forward by the Board to close the trust as expected and give the option to shareholders to realise their assets at more than 20% premium to the trading price. The “catch”, however, was that the realisation wouldn’t be done entirely in cash but by receiving in specie shares in LoneStar. This caused an issue to us because owning an illiquid, US-listed stock we haven’t researched ourselves would certainly add an unreasonable amount of risk to our portfolio. We thus decided to take our profits before the vote and found a buyer willing to purchase our shares at an attractive price (since the upside was obvious for an investor better able to research US companies). This example shows how one can find attractive opportunities when one is prepared to look beyond the obvious areas many investors focus on.
On the negative side, our allocation to European equities was the largest detractor. Europe went from disappointment to disappointment on the economic front, unable to generate sustainable growth and trailing the likes of the US or, even the UK. Political uncertainty continued to weigh on the region whilst demand, in general, remained tepid despite the European Central Bank’s best efforts to rekindle the economy. Specific issues in the auto sector with the diesel scandal, also had significant ramifications given how important the sector is to Germany, the traditionally reliable European engine. At the end of the period though, we note that the data stopped getting incrementally worse and that, while still bad, it started surprising consensus on the upside. We think that the negative sentiment towards the region might now be overdone and provides attractive opportunities to strong stock pickers.
Allocation changes
The past year was an active one on the research front for us. Key to our investment approach is to spend a lot of time meeting, understanding and building relationships with our managers. Only then can we get the confidence and trust to allocate our clients’ money to a fund. This process is also critical in helping us form our macro view and decide the most appropriate asset allocation for the portfolio. The team had meetings or calls with 220 fund managers or companies during the period. Beside being a cornerstone of our investment approach, meeting other fund managers, exchanging ideas with them and analysing styles that may be different from ours is also one of the most enjoyable parts of our job and we are fortunate to have the access we have.
It shouldn’t come as much of a surprise that we made a number of changes to the portfolio last year. Our valuation discipline combined with highly uncertain and quickly moving markets contributed to shifts in our asset allocation as well as individual changes.
Similar to previous reports, we find it helpful to classify those changes under the categories below:
· Profit-taking: as part of our investment process, we constantly monitor our holdings and try to be disciplined about taking profits when performance is working in our favour. This process is more of an art than a science, but we use several indicators such as our macro-economic view, conversations with managers, sentiment surveys or flow data in order to assess when a theme, a style or a manager is getting close to the top of the cycle. Given that we still haven’t found a magic formula that would tell us the exact exit or entry points, we tend to exit and enter positions gradually -unless of course the investment rationale has changed completely. We also do not see profit-taking as a black and white process and haven’t got any issue with adding back to a position after having trimmed it. In our mind, this is part of an active management of the portfolio and we think value can be generated by using opportunities that the market throws at us.
o Private equity: this is an area that we have mentioned several times in previous commentaries and have been gradually reducing in the portfolio. While private equity as an asset class remains small in the scale of global financial markets (an estimated 3.4% of the total according to Prequin), it is seeing an increased interest from investors thanks to attractive long-term returns and a continued decline in the number of publicly listed companies (the number of global publicly listed companies has dropped by 41% over the past 20 years according to Prequin again). There is talk of a wall of money waiting to be invested in private equity which drives valuations higher, possibly to unsustainable levels. In this context, our managers are able to take advantage of these high valuations to sell some of their assets. They are very experienced and have built their current portfolios over years, which means that they are able to realise attractive returns. We still have a strong conviction in the asset class and our managers -hence why this still represents one of our largest allocations-, but continue to take profits gradually. While the sector represented 26% of the fund 3 years ago, it is now down to 11%. Over the reporting period, we reduced our positions in the HG Capital Trust, ICG Enterprise Trust and the Pantheon International Trust. On the other hand, it is worth mentioning that we added to our position in the Woodford Patient Capital Trust. This portfolio is composed of early stage companies, many in the UK, which differs from the larger and more developed companies our other private equity managers focus on. The valuation on this trust remained very attractive so we took the opportunity to build our position up.
o Alternative Energy: as previously mentioned, this has been a sector in high demand from investors recently, for good reason given its attractive and sustainable growth prospects. This attractiveness was reflected in the price of the Impax Environmental Markets Trust however, with its discount practically disappearing in the second quarter. On valuation grounds, we thus decided to exit our position.
o UK Growth: after a strong period of performance from the fund’s launch in 2017 until Q2 2018, we trimmed our position in the Polar Capital UK Value Opportunities fund. This proved prudent as the fund then had a difficult end of the year, although it has recovered well since.
o Property: we reduced our allocation to the TR Property Trust as its discount turned into a premium in the second quarter of 2018.
· Addition on weakness: the natural corollary of trimming positions on the way up is to be prepared to deal with positions that don’t perform as expected. If, after having reviewed our investment case, we still have conviction in our views, we should be prepared to back them up and add on weakness. If the market, for whatever reason, is offering us opportunities to add to a position at an even more attractive price than when we initiated the position, we would be foolish to pass on the offer. This isn’t an easy thing to do, however. As fund managers, we spend our time questioning not only our fundamental views on an asset class or a particular fund, but also questioning what is going through other investors’ minds. We will never be able to know everything that is going on, so we need to tread with caution. Therefore, we tend to add cautiously on weakness when we still think that we should hold on to an underperforming investment. It is great if we pick the bottom but, more often than not, this will involve several iterations when we keep adding at lower and lower prices. The same process is at play when adding a brand new holding to the portfolio.
Over the reporting period, we thus added to the following asset classes:
o Asian equities: the region was hit badly by concerns over the escalation of the trade war between the US and China but also, more fundamentally, by a slowdown in the Chinese economy. Finally, the general weakness in emerging markets dragged the region down. We believe that those concerns are overblown and still see Asia as a significant driver of global growth going forward. We continue to stay away from the large technology names that have stolen the headlines recently, however, and gain exposure through small and mid-cap managers (Aberdeen Standard Asia Focus Trust and Fidelity Asian Value Trust). In January 2019, after a close to 30% drop in the country’s equity market, we also added a new holding in the Fidelity China Special Situations Trust. Irrespective of what happens to the trade negotiations with the US, we don’t think that one can ignore the amount of stimulus the Chinese government is pumping into its economy in order to encourage domestic consumption. This should provide a very strong tailwind to its domestic companies.
o European equities: this is an area we already mentioned both from a performance standpoint and from a trust specific standpoint. We took the opportunity to add a new position in the TR European Growth Trust on weakness in Q4 2018 and have added to the position since.
o Value style: global markets have remained extremely polarised for a few years now. This is particularly clear when looking at investment styles, in particular Value vs Growth. In general terms, Value investors look for companies that trade below their “intrinsic value”, that is what the company is worth based on its net assets. There are many reasons why a company might trade below its intrinsic value and it is up to the Value investor to determine whether these reasons are valid or not. At the opposite end of the spectrum, Growth investors are focusing more on what a company is currently worth based on its prospects. One extreme example would be to look at a start-up company: while the Value investor wouldn’t be interested because the start-up is worth nothing until it starts producing and selling a good or service, a Growth investor would look at what it is likely to produce and how interested the marketplace might be for their new product. Since the Great Financial Crisis, but even more acutely over the past couple of years, investors have preferred traditional Growth stocks (think technology companies) to Value ones. When all is well in the world, it is easier to feel optimistic about the future than be content with cheap, solid investments in the present. Globally, Value stocks have underperformed Growth stocks by around 30% over the past decade. There is no way to predict when this will turn but the anomaly is likely to correct at some point. By allocating to managers with a value bias that still manage to outperform the broad markets, we feel that we are in relatively safe hands. This is why we added to our position in the JO Hambro UK Equity Income fund, the Aberforth UK Smaller Companies Trust, the British Empire Trust and the Schroder Global Recovery fund.
o Utilities and Infrastructure: we mentioned this asset class as one of top contributors last year. The sector was badly hit earlier in the year due to a combination of the increase in bond yields and, in the UK, concerns about nationalisation plans from a potential future Corbyn government. We added to our positions in both the Ecofin Global Utilities and Infrastructure Trust, as well as in the Miton Global Infrastructure Income fund. This helped our performance as they, themselves, performed well in Q4 2018.
· Risk management: a third category of changes can be seen as a risk management exercise. Delivering strong performance is at least as much about not losing money as it is about generating returns. As such, managing risk is paramount to the way we run the fund. Profit-taking, mentioned above, is one form of risk management. Other ones include cutting losses, adding to idiosyncratic risk (i.e. exposures that are less correlated to the vagaries of stock markets) or looking for protection in periods of uncertainty.
o Idiosyncratic risk: we think that there is more upside for risk assets from here (equities, private equity, corporate bonds, etc…). However, the days of the “easy money” are likely behind us. Volatility is also on the rise, suggesting that a more cautious approach to investment is warranted. What it doesn’t mean though is that opportunities to generate positive returns don’t exist. One just has to look a bit deeper in order to find them. There have been several attractive new investment trusts launches in the last year which, to us, fit very well with that thinking. We thus added new positions in the Odyssean Investment Trust, the AVI Japan Opportunities Trust and the Mobius Investment Trust. While each investing in different areas of the world (respectively UK, Japan and Emerging Markets), they share a common approach of trying to generate returns by engaging with companies. This can mean discussing with management new areas of growth for the business or new ways to generate value for investors and distributing it via dividends, share buybacks, etc…They still invest in public companies whose share prices will be influenced by the broader stock markets they are listed on, but we think that their focus on those specific situations should help insulate them from the movements of the headline indices.
o Gold: we didn’t add to our allocation to gold in the fund but kept it at around 5%. However, we diversified our exposure by adding the Merian Gold and Silver fund to the BlackRock Gold and General fund we already owned. Gold is not only an attractive hedge against sharp falls in markets (as proved to be the case in Q4 2018), it also performs well when expectations for future interest rates fall. If the economy continues to slow, central banks are unlikely to be in a position to raise rates in the short term, meaning that the environment should remain supportive for the precious metal, despite being possibly more difficult for risk assets.
o Cash: all the above changes left us with higher levels of cash at the end of the period than at the start. This gives us some dry powder to allocate to future opportunities.
Outlook
We are now experiencing a finely brewed macro picture with plenty of lurking dangers and idiosyncratic risks. But amid the gloom, there are reasons to be optimistic. A trade agreement between China and the US is still on the cards as Trump seeks to land a deal to secure his legacy. Meanwhile, Mergers and Acquisitions (M&A) remains elevated – a number of large deals have been rumoured, from banks to semi-conductors, and we have seen large acquisitions in pharma and gold miners. By aggregating total global M&A transactions over the last two decades, 2018 emerges as the highest in 20 years – and this year, so far, is set to match the record. This buoyant backdrop for M&A should help support equity markets. Global market fundamentals also appear to be on steady footing. For example, not only did 70% of US companies beat expectations in the latest earnings season, 85% of tech companies also surpassed analyst expectations. Additionally, we believe there remains a lot of untapped support for the current rally. Flow data for active and passive strategies show the recent rally has actually had little support. Broadly, investors have sat on the side-lines and have yet to participate; this could well provide another leg to the equities rally.
The crux of the situation for us is, while growth is slowing, there remain opportunities out there. As active managers, it is our job to exploit the relative value which has been created by this uncertain environment. We will continue to look for ways to participate on the upside, while finding strategies that can help us insulate the portfolio from the most violent swings.
General Update
I would like to conclude with an update on our assets and the team. Firstly, our assets under management have come down slightly during the period. We started in March 2018 with £55m and finished in February 2019 with £51m, despite a performance of 2.8% (B share class) during that time. While the fund is gaining increased recognition and we are getting more and more enquiries and regular inflows, our largest investor decided to switch some of their investment from the Wise MAG into the TB Wise Multi-Asset Income fund due to the relative recent outperformance of the former versus the latter. In a way, this is in line with the “take-profit/add on weakness” approach that we discussed earlier for our own portfolio. This switch alone represented a 14% drop in Wise MAG’s assets under management, but we are pleased that the client retains its confidence in our team and process. This drop in assets doesn’t affect in any way how we manage the fund and we are pleased that some of those lost assets have been naturally replaced by new investors in the fund.
Finally, our team went through a period of change since our last annual report with both our analyst, Manasa, and our team assistant, Debbie, deciding to leave. We wish them all the best for their future endeavours. Meanwhile, we recruited two outstanding new members for our team. Philip Matthews joined us in September from Schroder as a Fund Manager. He has been working alongside Tony and myself on both of our funds and his experience will greatly complement the range of skills we already have. Last but not least, Joanna Scavuzzo-Blake also joined us in September as an Office Manager. She is contributing substantially to our overall process and tasks, freeing up our time to focus on managing the funds. We are delighted to have them both on board.
As always, thank you very much for your support. Do not hesitate to get in touch with us directly, if you would like to discuss anything in greater detail.
Vincent Ropers
Fund Manager
Wise Funds Limited
22nd March 2019