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4. Uncovering Trusts – The Merchants Trust
49 Plays7 months ago
Today Milosz dives into the long heritage and disciplined approach to stock selection of The Merchants Trust. He discusses the trust’s opportunistic and contrarian style aimed at building a high-conviction, reasonably concentrated portfolio. He also highlights the trust’s AIC dividend hero status and its commendable performance record. He concludes by commenting on UK equities as an interesting investment opportunity.
About ‘Uncovering Trusts’:
'Uncovering Trusts': is a podcast run by Edison analysts released every two weeks. Subscribe to hear analyst interviews on how investment trusts maximise returns while managing risks for investors.
About Edison:
Edison is a content-led IR business. We believe quality investment content should inform all investors, not just brokers. Our mission: engage and build bigger, better-informed investor audiences for our clients.
Edison covers 50+ investment trusts, read about them here: https://www.edisongroup.com/equities/investment-companies/
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Transcript
Introduction to 'Uncovering Trusts'
00:00:06
Speaker
Welcome to Uncovering Trusts, a podcast by Edison Group, a content-led IR business integrating analyst content, digital targeting, and investor engagement. Each episode will uncover the distinct features and the latest developments of a selected listed investment company. So tune in to find interesting investment ideas and to stay on top of what is happening in the investment company sector.
Guest Introduction: Milos Pabst
00:00:30
Speaker
I'm your host, Suki Thompson, Director of Marketing at Edison. And today I'm joined by Milos Pabst, Director of Investment Trust Content at Edison Group, who will take us through the Merchant Trust, ticker MRCH.
History and Evolution of Merchant Trust
00:00:43
Speaker
Milos, thanks for joining us today. Hi, Suki. Thanks for having me. Please, could you start by discussing the Merchant Trust's history for those listeners less familiar with the fund?
00:00:55
Speaker
Sure, let's maybe start with the fact that merchants has a long heritage. The trust was established in 1889 to provide investors with an opportunity to benefit from some of the growth industries of the day. So in that respect, merchants' focus has changed little over the last 135 years.
00:01:12
Speaker
At launch, the trust aimed to deliver around 5-6% dividend yield and capital growth by investing in the expansion of North American railroads and other industries across the globe. Given its long history, the businesses invested in have changed considerably over time, and the trust's managers have had to navigate many conflicts and crises.
Objectives and Investment Approach of Merchant Trust
00:01:32
Speaker
Indeed, the current manager, Simon Gergel, joined Allianz Global Investors and took over management of merchants in 2006, so shortly before the global financial crisis.
00:01:43
Speaker
Well, and returning to the here and now, what is merchant's objective? So the aim is to provide an above average level of income and income growth and long-term capital growth by investing in a portfolio of primarily UK companies, although up to 10% of the fund may be held in overseas equities. So how does the manager seek to achieve this?
00:02:08
Speaker
Simon employs a disciplined approach to stock selection, which he has stuck to even during difficult performance periods. His strategy is based around three pillars. Number one is fundamentals, which focuses on the company's competitive position, financial metrics and ESG factors. Number two is valuation, which is considered in absolute and relative terms, including dividend yield. Number three is themes, which involves analysis of industry and secular issues, the macroeconomic outlook and the state of the business cycle.
Portfolio Strategy Breakdown
00:02:38
Speaker
While over the long term, higher yielding stocks have outperformed those with lower yields, the manager is keen to stress that he considers a company's total return potential rather than just dividend yield. I would also note that Simon is able to draw on the broad resources of Allianz Global Investors investment team when required, which includes equity and credit investors, macroeconomic research analysts, sustainability specialists and the proprietary grassroots market research operation.
00:03:09
Speaker
Great, and now might be a good time to learn more about merchant's portfolio. Yes, I agree. Simon employs an opportunistic and contrarian approach to build a high-conviction, reasonably concentrated portfolio of 40 to 60 stocks. Because he invests for the long term, the structure of the fund does not usually change meaningfully from month to month. The majority of the portfolio, around 55%, is held in large-cap stocks with a balance in mid- and smaller-sized companies.
00:03:37
Speaker
The top 10 holdings make up around 35% of the portfolio and there is diversified sector exposure, although the manager is not constrained by benchmark allocations and therefore sector weightings are the result of bottom-up stock selection.
00:03:52
Speaker
At the end of 2023, the largest allocations were around 20% each in financial and industrial stocks. Financial holdings include traditional banks such as Barclays, along with more specialized businesses, including the online trading platform IG Group Holdings. Merchants industrial holdings include industrial services companies DCC and Grafton Group.
00:04:16
Speaker
Reflecting the wealth of opportunities available in the UK market, more of that later, there's less than the permitted 10% of the fund invested overseas companies. Now, looking at the merchants largest holdings within the 10 biggest positions, the companies have a range of dividend yields with pharmaceutical firm GSK for example at 3.5% versus nearly 10% for British American tobacco.
00:04:39
Speaker
Considering the whole portfolio, there are three investment categories. The first is classic value, which are fundamentally sound businesses that are, well, unloved, under-owned or misunderstood. However, Simon stresses the importance of avoiding so-called value traps, which are shares that appear inexpensive, but whose valuation is warranted due to a company having structural challenges or operating in an industry that's facing disruptive threats.
00:05:07
Speaker
Now the second category can be classed as franchise, which are quality companies with sustainable competitive advantages that offer long-term potential growth. In keeping with his investment process, the managers obviously care for not to overpay for growth.
00:05:23
Speaker
Special situations make up the balance of the portfolio. These companies are in unique situations with unusual share price drivers that are often uncorrelated to the economy or financial markets.
Recent Investment Activities
00:05:35
Speaker
These firms may include turnarounds, companies that are restructuring their balance sheets, or counter-cyclical businesses.
00:05:41
Speaker
Wow, that's super helpful. Could you provide some examples of recent portfolio activity? Yes, of course. I understand that this would be helpful. In December 2023, Simon initiated a position in Nashura, which is a developer and owner of healthcare property, mainly GP surgeries in the UK and Ireland. Industry fundamentals are positive, helped by a shortage of suitable buildings, rising demand from an ageing population and favorable contract terms.
00:06:09
Speaker
Azure's shares derated because the company has had to slow down its expansion plans, partly due to higher interest rates, which coincided with falling property values due to rising yields. This provided an attractive entry point at less than asset value and a dividend yield of around 7%.
00:06:28
Speaker
Back in November 2023, Simon sold merchants holding in St. James's place. This was a difficult decision for the manager, but he considered it to be the right response as there was a change in the investment thesis. St. James's business is strong as the company has a leading position in the wealth management industry and a large network of financial advisors.
00:06:50
Speaker
However, Sander James has announced a major change to its charging structure, which Simon believes will have a significant negative impact on the company's future profitability. Another name that exited merchants portfolio last November was the French pharmaceutical company Sanofi. The firm announced an unexpected major increase in research and development spending, which was not clearly justified according to the Merchants Manager.
Dividend History and Performance
00:07:15
Speaker
Also, Sanofi's valuation was fair, so the stock was sold.
00:07:20
Speaker
And as income is such an important element of the trust, let's maybe focus on merchants' dividend history. Sure. The annual dividend has increased every year since 1982, which has earned merchants the 12th place in the AAC's list of 20 dividend heroes. These are funds that have at least 20 consecutive years of higher dividends.
00:07:42
Speaker
During COVID, when merchants' income understandably dipped, the board was able to utilize part of the trust revenue reserve to maintain the dividend records. Although the annual results, which ended on the 31st of January, are yet to be released, last year the dividend was fully covered and earnings at the end of the first half of 2024 were up by 9%, which bodes well for the continuation of that record.
Performance Review and Market Comparison
00:08:07
Speaker
Merchants attractive above 5% dividend yield is consistently above the yield on the UK market.
00:08:13
Speaker
Wow, and how about Merchants Performance Record? Merchants has a commendable performance record as it has outperformed the broad UK market over the medium and long term. The Trust is a member of the AAC UK equity income sector and has performed better than the majority of its peers over the last three and five years.
00:08:32
Speaker
merchants' favorable performance has not gone unnoticed by shareholders, as during the current risk-averse environment, when many trust discounts are wider than average, merchants regularly trade at a premium and there is regular share issuance. In FY23, for example, the company's share base grew by nearly 10%.
Market Opportunities and Valuations
00:08:50
Speaker
Wow, and just to wrap up, things are looking pretty good at merchants, but how about the UK market?
00:08:57
Speaker
Mm-hmm. UK equities look like an interesting opportunity. This asset class has been out of favor with global investors in recent years, resulting in very attractive valuations in both absolute and relative terms. To add some more color, Simon has highlighted the valuation dispersion within the UK market, as measured by forward P multiples. There are companies trading at the high and low end of the range, with relatively few in between.
Conclusion and Further Information
00:09:23
Speaker
Hence, the manager is genuinely excited about the amount of reasonably priced businesses available that can be considered for inclusion in merchants portfolio. Great. And thank you for this interesting discussion about one of the UK's oldest investment trusts. Thank you. You've been listening to Uncovering Trusts, a podcast by Editing Group. If you want to find out more about the Merchants Trust and other investment companies we cover, please visit www.editinggroup.com.