Home is where the heart is for Mercantile manager
Housebuilders have peaked the interest of UK stockpickers since the government pledged to remove red tape around planning during its successful election campaign, as part of a drive to boost homebuilding to record levels.
The government has targeted 1.5 million new homes to be built over the course of the next parliament.
“As an industry, housing volumes are clearly right down at the bottom end of where they’ve been historically, at sub 200,000 [new homes] last year,” says Guy Anderson, co-manager of the £1.7bn Mercantile investment trust.
“The government wants to average 300,000 new homes built over the course of the parliament, so there’s a big gap between where the current house production is and where the aspirations are.”
The UK equity-focused investment trust counts Bellway as its largest holding, making up 4.3% of the portfolio.
Anderson has co-managed the trust alongside Anthony Lynch since 2012.
“I think it is quite notable the government is putting through substantial reform on the supply side, in particular planning reform, to try and remove some of those barriers to housing production that have existed over the years,” says Anderson.
“It is quite interesting that talking to some of the individual housebuilders, there is pretty consistent positive feedback that they think some of these reforms are going to be quite material and are going to help them increase production, which is one-half of their equation.”
However, he adds that housebuilders are facing challenges when it comes to selling homes, with demand being hit by rising mortgage rates.
Demand in the short to medium term is quite heavily linked to mortgage rates, which are still sitting at elevated levels.
“Despite the fact that mortgage rates haven’t really come down as far as perhaps many people were hoping, we have seen an improving trend in terms of sales generally,” he says.
“Rates across the sector have been picking up. Bellway showed pretty decent pick-up in sales rates and little indicators like cancellation rates coming down a couple of hundred basis points in a trading update in February, so the demand side does appear to be normalising.
“If the housebuilders can enjoy the combination of fewer barriers on the supply side, aiding the ability to build more houses at the same time as demand starts to recover, that can lead to quite a nice outcome for them in terms of rebuilding their profitability, because the profits they’re generating today are a fraction of levels they’ve generated over previous years.
“They are at cyclical lows, and as a result of the poor current economic outlook more widely, someone like Bellway is trading at over a 15% discount to its book value.”
Mercantile, which sits in the JP Morgan Asset Management investment trust stable, currently trades at a 9% discount to its share price.
‘We are both poacher and gamekeeper’
With investment trust discounts approaching historically wide levels, the £856m Capital Gearing Trust is eyeing its closed-ended counterparts for opportunities.
“We are both poacher and gamekeeper,” says co-manager and CG Asset Management CEO Alastair Laing, who runs the investment trust’s portfolio alongside co-CIOs Peter Spiller and Chris Clothier.
“We will buy discount opportunities if they emerge for a short period of time, and at the margin, trade those if the discount comes in. If it stays out, we’re happy to take larger stakes and engage with the boards.”
According to the Association of Investment Companies, the average investment trust (excluding 3i) trades at a 15% discount to its net asset value, presenting plenty of opportunities for the team to take up positions in other trusts.
“This style of investing has been very good to us over the years,” says Laing. “The past couple of years have been difficult for investment trusts, but we have a long-running track record of outperforming the investment trust index – which itself has a long-running track record of being in line with the MSCI All World index.”
“We really like well-run trusts trading on a discount,” he adds, “where we have a really good reason to believe that the discount will narrow. A good example at the moment is one of our larger holdings in the Polar Capital Global Financials Trust.”
Polar Capital Global Financials presents tender offers to its shareholders every five years, with the next opportunity to redeem coming later this year. The trust traded at a double-digit discount in mid-2023, which has since narrowed to 4% today.
“We know the money’s coming back later this year,” Laing says. “We’ve built up this position over the past 18 months, typically to double-digit levels. We are not guessing that we are going to get the returns of the financial index. There is a chance the manager dramatically underperforms,
but those are the kind of bankers we absolutely love.
“Those opportunities are not always available in huge scale, but those are the things we’re looking at every day and we’re buying similar examples to that. Mobius Investment Trust would be another example with a fixed-tender date coming up. They are the situations we like the most.”
As a wealth preservation fund, the Capital Gearing Trust has two objectives – to protect shareholders’ wealth and to achieve an absolute total return over the medium to longer term.
Only part of the fund is made up of its investment trust holdings, with the largest slice of the portfolio – almost 40% – in index-linked government bonds. A further 29% is placed into funds and equities, while 20% of the multi-asset offering is in conventional government bonds.
To avoid trading at a wide discount themselves, the trust has a discount control and premium control mechanism, which sees the board buy back or issue shares to ensure the share price trades as close as possible to the underlying value of the trust’s assets.
Currently, it trades at a 2% discount to net asset value.
Nish Patel on flying in the face of tariffs
With tariffs causing market chaos in April, Columbia Threadneedle and Global Smaller Companies Trust portfolio manager Nish Patel is looking for resilient businesses that can weather the storm. The £800m trust, which launched in 1889, seeks to buy higher-quality small caps when they are out of favour and available at a significant discount.
“Smaller companies aren’t likely to be as affected [by tariffs] as larger companies in some regards,” he says.
“They don’t have complicated global supply chains. Small caps have already been hit quite hard, so the valuations are low compared with larger companies, and if sentiment does improve in any way, then they can benefit. They tend to benefit quicker and in greater magnitude than larger companies.
“We’re sticking to the investment philosophy, looking for high-quality companies through a valuation discipline. We are taking advantage of any volatility as and when it presents opportunities to buy into these companies.”
One such company is Curtiss-Wright, a US manufacturer created through the merger of the pioneering Wright brothers and the Curtiss families’ respective aviation businesses in the 1920s. Today, the company makes mission-critical components for aircraft, Navy ships and nuclear reactors. “They will make a coolant pump that goes into a nuclear reactor that is involved with cooling down the core of the reactor,” Patel says.
“Clearly, you do not want this piece of the kit to fail, otherwise you could have an incident at a nuclear plant.
“The customer generally doesn’t take any risks with choosing their suppliers. They tend to sole-source and only go with Curtiss-Wright. Curtiss-Wright makes the actuation systems on an aircraft that Boeing and Airbus will build and the actuation system will control the wings of the aircraft during take-off. Again, you do not want to compromise on that.
“They tend to be involved in very highly specialised components customers don’t compromise on and that creates barriers to entry into this industry.”
Despite Curtiss-Wright’s long history, Patel says the company has a long runway for growth due to its exposure to the defence, energy and commercial aerospace sectors, which are seeing increased investment as a result of governments ramping up defence spending.
“They make high margins and it’s very resilient because of its sole source positioning,” Patel adds. “It is positioning in the end markets that are growing over the longer term. They tend to grow their revenues even in difficult times. Even in 2009, revenues were still resilient. They still grew cashflows and the end markets are very favourable.”
The Global Smaller Companies trust is the top-performing investment trust in the AIC Global Smaller Companies sector over five years, returning 42.8% in that period.
This article first appeared in the May issue of Portfolio Adviser magazine