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James Carthew: Invesco and the ‘friendly policeman’ at Capital Gearing

James Carthew: Invesco and the ‘friendly policeman’ at Capital Gearing

Invesco Perpetual UK Smaller (IPU) recently published a circular that details the mechanics of its proposed 40% tender offer under which shareholders can sell their shares back to the company for cash at the tender price.

The tender is to be conducted at a 1.5% discount to formula asset value: ie, the tender price will be IPU’s net asset value (NAV) less the costs associated with the tender.

The trust expects to announce how many shares have been tendered on 19 June but the actual return of capital to shareholders and calculation of the tender price will not take place for a few weeks after that. This should give the manager time to sell some investments and raise enough cash to fund the tender.

Revised promise

Back in May 2012, IPU promised investors the chance, around the time of the 2017 AGM, to cash in all of their investment. At the time it made this promise, its shares traded at a discount of around 20% below NAV. The announcement, and a later promise to use capital to help fund a 4% per annum dividend, helped narrow the discount below 5% (although, in common with many other UK focused trusts, its discount widened out a little in advance of the general election).

IPU has since replaced the promise of a full cash exit with a 40% tender, which could have led to complaints but this was done in the knowledge that most investors have been happy with the fund’s track record over the past five years.

At the time of writing, IPU’s portfolio has generated a 19.4% annualised return over the past five years, with shareholders doing even better with a 22.5% annualised return (the difference being the shares have grown ahead of the NAV as the discount between them has come in).

On an NAV basis, the trist ranks about middle of the UK smaller companies pack: by contrast Strategic Equity Capital (SEC) has managed 21.5% average growth a year and Montanaro UK Smaller Companies (MTU) just 11.5%.

Flexible friend

It seems reasonable that most investors who have held IPU since May 2012 are likely to be pleased with its performance. One fund that was invested is Capital Gearing Trust (CGT). In fact, it may have had a hand in encouraging IPU’s promise of a cash exit in the first place.

Capital Gearing is much admired, yet is smaller than perhaps it deserves to be with a market value of £181 million. It sits in the Association of Investment Companies’ Flexible Investment sector where, once again, over five years its NAV returns are about middle of the pack for the sector. It has returned 5.9% a year over this period, at first glance disappointing compared to a fund such as IPU.

However, Capital Gearing has a very different objective to IPU. It is trying to grow its capital in absolute terms and places strong emphasis on preserving shareholders’ wealth. As markets continue to hit new highs, and the potential for a setback increases, this investment policy could be increasingly appealing to investors concerned about market levels.

Peter Spiller took over as investment manager of Capital Gearing in 1982 (he is assisted now by Alistair Laing and Chris Clothier). He makes the point, in his most recent quarterly newsletter, that for his entire 35-year tenure, the general direction of interest rates has been downward.

At the margin, there could be room for real interest rates (after adjusting for inflation) to become even more negative than they are but we could be getting closer to an inflexion point.

Liquidity squeeze

A question on some investors’ minds is, should this happen, what will the effect be on debt markets, equities and property? Investors, who in recent years have got used to the idea that central bankers will come running to the rescue at any sign of trouble, could struggle to adapt to such a market environment.

CGT’s current asset allocation reflects its view that the best place to be right now is in ‘short duration’ assets which will be less sensitive to rising interest rates. If markets turn decisively, it stands ready to take advantage of any bargains that are thrown up. Just 2% of the fund was in cash, and 1% in gold, at the end of May but 34% was in index-linked bonds, 5% in short-duration conventional government bonds and 22% in zeros and corporate debt.

CGT’s only meaningful stock market exposure is to investment companies, which make up 36% of the portfolio. This has actually increased in recent years. The portfolio is split between funds where the managers like the investment proposition, such as recent issue Civitas Social Housing (CSH), which is now in its top five largest investment company holdings, and funds where the managers feel that the discount is too wide.

Here is where IPU would have come in. CGT isn’t an activist but puts its views on corporate governance and discount control across strongly. It has had a number of successes on this front over the years and is widely recognised as being a firm but friendly policeman in the sector.

James Carthew is a director at Marten & Co. The views expressed in this article are his and do not constitute investment advice.

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