Just over a year ago Elliott Advisors, the activist US hedge fund, caused excitement in investment trust circles when it emerged with a 5% stake in British Empire (BTEM).
However, anybody expecting Elliott to have a tilt against the 128-year old investment trust in a repeat of its successful campaign against rival global fund Alliance Trust (ATST) is likely to be disappointed.
Earlier this month British Empire issued a stock market announcement revealing Elliott had reduced its stake held through contracts for differences to below 5%. Elliott declined to comment on the trade today but it looks like the firm is pocketing its 35% gain and moving on.
My understanding is that Elliott picked up the holding in British Empire after Aviva sold its stake, along with several other global trusts the investment giant exited last year. It did not consider it an activist position and never contacted the board.
Elliott, which now knows the investment trust sector well, presumably jumped at the chance to buy British Empire shares on their then 16% discount to net asset value (NAV). It would probably have liked the £900 million portfolio which is stuffed with stakes in undervalued investment companies such as Swden’s Kinnevik and family controlled businesses such as Hong Kong’s Swire Pacific.
With the discount having narrowed to just under 10% after its first sustained rally in four years it appears to be doing what many value investors, including British Empire itself, would do.
Time to move on?
Which leaves British Empire and its manager Joe Bauernfreund in a somewhat delicate situation. On the one hand there is relief to see performance improve after a tough few years for investors.
Twelve months ago British Empire shareholders had seen a total return of just 8% in the previous five years as value investing languished in the post-financial crisis bull market. Today, the five-year return has swelled to 88% after a bumper year boosted by the impact of the weak pound and increased corporate activity.
While that still leaves the trust near the bottom of the AIC’s Global sector – where the average return has been 147% - it clearly takes some of the pressure off the manager, who works for Asset Value Investors, and the board chaired by Strone Machpherson
But should investors follow Elliott’s lead and either sell the shares, if they own them, or not buy them if they don’t?
Not necessarily. Although British Empire’s discount is the narrowest it has ever been in the past 10 years, according to Morningstar, investors need to also consider its ‘look through’ discount. This takes into account the fact that the shares British Empire buys in other companies are themselves undervalued and trade at a discount to NAV. In other words British Empire shareholders are exposed to a double discount. On the ‘look through’ measure the portfolio discount is 24%, making it a potential bargain at a time when many investment trusts look fully rated.
There is a bit of a cycle in the look-through discount to consider as well. At the stock market peak in 2006 British Empire stood on its narrowest-ever combined discount of 5%. In the grim years after the financial crisis it widened to 43%. Since then investors have woken up to the value plays British Empire likes to exploit and the look through discount has narrowed to half-way between the two.
Bauernfreund (pictured), who took over from John Pennink in September 2015, said: ‘It [the look-through discount] is narrower than it was but it still has a way to go to 2006,’ before quickly adding, ‘but it’s not definitely going back to this level.’
The manager is aware that benign market conditions have helped the trust’s recent revival and that a period of rockier trading could see some of its gains unwind.
Bauernfreund’s response to that potential threat is to step up its shareholder activism, which is somewhat ironic in light of Elliott’s apparent retreat from the stock. The manager believes he and four investment colleagues should seek to control what they can and push for shareholder value where it is needed.
‘On discounts we used to hope they would narrow, now we do something about it,’ he summarised.
Picking on Pershing
In recent years Asset Value Investors has successfully pressed for change and unlocked hidden value at several investment companies: for example, it aggressively pushed for the wind-up and break-up of closed-end fund Vietnam Phoenix and, less forcefully, encouraged NB Private Equity (NBPE) to introduce voting rights for shareholders. This saw the shares re-rate 37% over the past year, partly in anticipation of the company’s switch to a premium listing on the London Stock Exchange in May.
This focus on investment companies continues with the company revealing this month it had opened a position in Pershing Square Holdings (PSH), a hedge fund investment company run by star fund manager Bill Ackman. The fund’s performance has been battered by a disastrous investment in Valeant Pharmaceuticals but looks interesting to Bauernfreund with its shares on a 15% discount and its portfolio’s huge 40% exposure to snacks giant Mondelez, which is widely regarded as a natural bid target for Kraft Heinz (the US predator that failed in a bid approach for Unilever (ULVR) this year).
Pershing Square has been busy buying back its shares to reduce the discount but Bauernfreund clearly expects more action to be taken to improve its rating. In this month’s fund commentary the manager said it was ‘untenable’ for Ackman to preside over a wide discount given his long record as a shareholder activist.
This interest in corporate governance and engagement has led British Empire to up its investments in Japan, which now accounts for 16% of the portfolio, up from 9% last September (by comparison it has 21% in North America, 33% in Europe, 18% in Asia and 7% in Latin America).
Bauernfreund has detected a big shift in corporate Japan with an increased number of independent non-executives and shareholder friendly legal decisions making it a more conducive environment for investors, he said.
Earlier this year – in an unusual move for British Empire – the team invested 4% of the portfolio in a basket of eleven ‘net cash’ Japanese stocks which it says are good businesses but which were sitting on far too much money that needed to be used well or returned to shareholders.
One of these was Toshiba Plant Systems & Services, whose cash pile accounts for 60% of its stock market value. The company was successfully sued by investors this year after it previously granted its 51% shareholder, Toshiba, a low interest loan of just 1%.
‘There are signs that [Japanese] boards are not being allowed to get away with ripping off shareholders,’ Bauernfreund said.
While this is certainly not an accusation that can be levelled at British Empire, particularly in light of the past year’s recovery, it will be interesting to see which way the stock goes in light of Elliott’s declining interest in the trust.