; TB WISE MULTI ASSET GROWTH YEAR END 2017-8 REVIEW | Wise Funds

TB WISE MULTI ASSET GROWTH YEAR END 2017-8 REVIEW

Written by Vincent, 17 April 2018

Introduction

This report will discuss the fund’s performance during the year ended 28th February 2018 and give a brief 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. Also, 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 35% 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 (35% 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 12% discount. For Wise MAG, the fund discount was 7%. In comparison, global equity investment trusts trade at a weighted average of 4% discount. So, while Wise MAG’s discount is narrower than what it has been in the past as a result of market movements, we continue to find unrealised value. This can only be done by sticking to our investment process of adding to managers we respect when they are disliked by other investors and gradually getting out of positions when the market is coming round to our view.

A good example of this discipline is the new investment we made at the end of the period in the Woodford Patient Capital Trust managed by Neil Woodford. The trust was launched in April 2015 and, over the next few weeks, due to the manager’s stellar track record and reputation in the UK, the trust went on to trade at a close to 20% premium by the summer of that year. The trust focuses primarily on funding small unlisted companies in order to nurture them to grow over time. This is a very sensible approach and we believe that Neil Woodford and his team have a real edge in that part of the market. The UK unlisted market isn’t nearly as developed as those of the US or Europe and thus, is full of untapped upside potential. While we like the approach, we certainly weren’t willing to pay a 20% premium to access it 3 years ago. Fast forward to 2018 and, due to combination of a few poor investment decisions, continued bad press and a seemingly poor understanding of the strategy by many initial investors, the trust was trading between 10 and 13% discount! This certainly got us interested. After meeting with the manager, not only became it clear that this is the wrong price for the trust, but we got conviction that the assets themselves in the trusts were mispriced. Since the bulk of the trust is invested in unlisted securities, the manager has to rely on an external company to value these assets (for a listed company, the market itself is fulfilling that role). In order to be impartial, these valuation criteria are quite stringent and tend to be on the conservative side. Thus, only when a transaction such as an IPO, an acquisition or a new product gaining approval to come to market, are the assets revalued. We believe that the Woodford Patient Capital Trust is thus likely to benefit from a double re-rating at some stage, both from the value of its assets itself (when its underlying holdings announce some good news) and from the share price of the trust (when investors realise that the discount is unfair). We obviously cannot guarantee that our view will materialise but we know that this value discipline has served the fund well over the years, hence why we continue to abide by it.

Performance

We are pleased to report that Wise MAG delivered returns well above the market and its peer group for the year ending in February 2018. The B shares (representing close to 99% of our external shareholders) returned 11.6% over the period while the BATS UK All Companies index returned 4.4% and the IA Flexible Investment sector 6.6%. This puts the fund in the top 8% in the IA Flexible sector over 1 year, in the top 3% over 3 years and in the top 11% over 5 years.

Looking at where this outperformance came from, our top three sectoral allocations on average over the period (Private Equity, UK Smaller Companies and International) were our top contributors to return. Theoretically, this should always be the case: our top conviction ideas should be the ones that perform the best. Unfortunately, though, this doesn’t always happen in practice so we are pleased that this was the case over the past 12 months. This doesn’t mean that those sectors were the top performing sectors in our portfolio (some others have performed better but, with a smaller weight, didn’t contribute as much) but it means that none of our top conviction ideas have been wrong.

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. A good example comes from our largest holding over the period, HG Capital Trust, which confirmed our view that the trust’s management is particularly astute in timing its market and selecting great investments. On average in 2017, the trust realised exits at a 40% uplift to carrying value. This means that those holdings in the trust were sold by HG Capital at a 40% average premium to the value they were marked at in the fund. This obviously benefitted not only the asset value of the trust but also its share price when other investors started to gain interest.

The second largest contributor to performance were our UK Equity funds. As with Private Equity, we increased our allocation to the asset class following the 2016 referendum and the asset class has had very strong performance since then, outperforming larger UK companies. Because of Brexit, political uncertainty and the relatively strong Pound, UK equities have been as disliked by investors as they can be. The Bank of America Merrill Lynch survey of global fund managers, for example, shows that UK equities are not only, by far, the most hated asset class but also that they are as hated as they were in the depth of the Great Financial Crisis of 2008. There doesn’t appear to be any home-bias from UK retail investors either as the Investment Association data show that UK equities are the only equity market to have seen net outflows over the past 12 months. In this context, we still manage to find some very attractive investments in the country and the good performance of our managers in this field is a testimony of it.

Finally, our International holdings have also contributed strongly to performance, whether they are the ones with a global mandate or regional ones such as in Japan. Although the strength of the Pound was a headwind for most of the year (a stronger Pound means weaker international currencies which, when investing abroad and repatriating assets back to the UK, penalises performance), most of our managers successfully added value.

On the negative side, our allocation to Utilities, as well as Mining and Resources holdings were small detractors. We believe that, after years of cost cutting and under-investment, the end of the negative cycle for the mining sector is in sight and that valuations don’t reflect it. Unfortunately, in the second half of the period, the escalation of the tariffs talks between the US and China penalised the sector indiscriminately and we don’t believe this is warranted. Similarly, the utilities sector continued to be disliked in favour of the technology darlings stocks. From a UK standpoint, the threat of a Corbyn government and a nationalisation program also weighed significantly on sentiment towards the sector. There again, we believe that this is unjustified and we can now get exposure to some great quality assets at very attractive valuations.

Allocation changes

The period has been an active one for us in terms of research and portfolio analysis. In total for the year, we conducted more than 200 meetings or calls with fund and company managers, generating new ideas and helping us formulating our asset allocation views. The ever changing macro environment forces us to review our portfolio with an intensified level of scrutiny as events can easily turn sentiment and markets. This doesn’t mean that we need to react to all or any events particularly. However, it means that opportunities are thrown at us more regularly when good funds get penalised alongside the market due to a macro event. Conversely, for some of our existing holdings, it means that they may reach their potential quicker than we would have initially anticipated so may need to be trimmed or sold.

The main change we made in the portfolio was to take a more cautious positioning, especially from June onwards. Although volatility (a measure of risk) only really started to rise at the end of the period, it was our view then -and still is- that, after a very strong period for financial markets, we are, at the very least, due a setback. Timing the periods of increased volatility will always be extremely difficult but we are minded to err on the side of caution as we are seeing more and more pockets of exuberance combined with an increasing number of inconsistencies between fundamentals and price action.

There are three different ways in which we have slightly altered the shape of the portfolio throughout the year.

1.     Take profits: a number of our holdings have had a great performance over the past few months and it has always been our discipline to take profits on a regular basis. This is what we have done in this period, particularly with the two top contributing sectors we mentioned above, Private Equity and UK Smaller Companies. Although we believe there is still some upside left in both of those sectors, we have reduced our allocations as the cycle matures and, for investment trusts, valuations are getting dearer. The same rationale applied to the reduction of our Japanese equity allocation

2.     Invest in undervalued assets: we have increased our allocation to the Mining and Resources theme for the reasons we mentioned in the Performance section (attractive valuations and now in the attractive part of the cycle). Under this theme, we have also been opportunistic in building up our position in gold through gold miners as the asset class can provide an attractive hedge in the case of increased risk aversion. We also added to our allocation in Utilities. As discussed earlier, this is a sector which we think is very undervalued, clearly under owned and which should perform well not only in the event of a crisis but also in the scenario where the market continues to go up but rotates out of expensive assets into cheaper ones.

3.     Invest in strategies offering downside protection: there are many ways to offer downside protection for a flexible multi-asset fund like ours. Aside from raising cash and looking for a valuation buffer, we can also look for asset classes that, by their nature, are less risky than equities. This is why we invested in the Vontobel TwentyFour Absolute Return Credit Fund. The fund invests in corporate bonds with short duration (no more than 5 years), which limits volatility compared to longer duration bonds. We can also look for managers who, by their nature, tend to be more cautious and have got the flexibility to do so. As such, we took a new position in the Ruffer Equity and General Fund, which takes a very forensic approach to investing in global equities with the flexibility to hold high levels of cash (currently more than 30%). Finally, we can look for managers with tools available to them to mitigate downside risks, either by using derivatives and/or by having a large panel of assets they can choose from. It is in this category that we bought the Fulcrum Diversified Core Absolute Return and the SVS Church House Tenax Absolute Return Strategies funds. These funds are multi-asset strategies with a strong emphasis on managing the downside risk. Similarly, we bought the Henderson UK Absolute Return fund which has the ability to benefit both from share prices going up and down and thus offers little exposure to the direction of the stock market.


  

Sector

Asset allocation as at

28 February 2018

 (%)

Asset allocation as at

28 February 2017

 (%)

Absolute return

8.9

-

Asia

5.6

5.6

Emerging Markets

2.0

-

Europe

2.0

1.2

International

22.3

20.4

Japan

2.1

5.3

Mining and Resources

11.1

5.9

Private Equity

16.6

24.6

Property

2.0

3.5

Specialist – Alternative Energy

1.9

4.2

Specialist – Biotechnology

 

0.9

-

Specialist – Technology

1.5

4.8

Specialist – Utilities

3.2

0.4

UK Growth

6.1

7.0

UK Income

2.5

-

UK Mid-Cap

3.0

2.8

UK Smaller Companies

6.6

11.0

USA

-

1.9

Cash and Other

1.7

1.4

Total

100.0

100.0

Outlook

Early last year, large parts of the financial markets were trading at depressed levels, far below our estimation of their fair value. Many of these assets have recovered a long way, without yet becoming too expensive. On the other hand, some parts of the financial markets do look overvalued to us, in particular the technology sectors, large parts of the US markets, and the ‘growth defensives’ that held up so well during the 2007-09 crisis. The styles that look least attractive to us at the moment are quality, growth and momentum and it is interesting to note that, at the time of writing, some of those styles and sectors are starting to show some febrility. We continue to impose our unwavering value criteria to the holdings in the Wise MAG portfolio, taking profits on those assets which we believe have exceeded their fair values, and are generally continuing to adopt a more cautious approach to the markets in which we invest while trying to take advantage of opportunities.

 General Update

A few general points on the Fund and our team to conclude. Firstly, you will have noticed that the name of the fund has changed from TB Wise Investment to TB Wise Multi-Asset Growth as at the beginning of September 2017. While the new name is far from the simplest, we felt the change was necessary to reflect better what the Fund is all about. To be absolutely clear, the way we manage the Fund hasn’t and will not change as a result but please do not hesitate to contact us if you have any questions.

We feel that the strong performance of the Fund is starting to be noticed and we are seeing an increase in the number of enquiries as well as direct flows, which is very satisfactory. At the start of the reporting period, assets under management were at £49m versus £55.5m currently. Although our aim is to continue delivering good performance for our existing clients, as fund managers, it is pleasing to see our hard work recognised. We would like to take this opportunity to thank our clients whose support means a lot to us.

Finally, you may have noticed a slightly different style in this investment report compared to previous ones. I joined Tony as a co-manager on both of our funds (Wise MAG discussed here and the TB Wise Multi-Asset Income Fund) exactly a year ago to the day. The reason for me joining was that, as assets have grown, it is important that we ensure we have the appropriate resources to continue managing the funds with the high standards that we set ourselves. It has been a real privilege to work with the team over the past year and I very much look forward to continuing the great work we are doing together for the years to come.

Vincent Ropers

Fund Manager

Wise Funds Limited

10th April 2017

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