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Lindsell Train: fund manager stake could hurt us if markets crash

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Lindsell Train: fund manager stake could hurt us if markets crash
Lindsell Train (LTI), the UK’s best long-term performing investment trust, has warned its stellar returns, already under pressure from the unwinding of its share price premium, could be further threatened by a downturn in its largest holding – Lindsell Train Limited (LTL).
 
Chairman Julian Cazalet has cautioned shareholders that LTL, the private fund management business owned by the investment trust’s fund managers Nick Train (pictured) and Mike Lindsell which has contributed to its 453% shareholder return over 10 years, could see its fortunes reversed if stock markets fall significantly. This could pose a risk to performance because it was the trust’s top-performing investment over the year to April 2017, the chairman noted in Lindsell Train’s annual report.
 
LTL accounted for 37% of the £130 million portfolio at the end of March having seen its valuation soar 53% in the previous 12 months. LTL’s dividend increased by 54%, contributing a little under three quarters of the trust’s revenues.
 
This strong performance played a big part in Lindsell Train’s 35.1% increase in net asset value (NAV) over the year. The portfolio total return was boosted by a 90% hike in the dividend to £15.45 (Lindsell Train shares trade at £787.50 each). A much lower special dividend of 35p is also proposed, down from 80p last year.
 
Although LTL had a successful year with a record net £1.6 billion of new investments into its four pooled funds due to their impressive long-term returns, Cazalet pointed out its funds had underperformed in 2016/17  as the managers’ focus on high quality growth stocks fell out of favour as investors switched to cyclical and value stocks instead.
 
Cazalet said this ‘somewhat disappointing’ performance could become a problem it it continued or if stock markets retreated. 
 

‘While Lindsell Train is susceptible to stock market weakness through its exposure to listed equities and funds, its unquoted stake in LTL could amplify any losses. This is because falling valuations of the equities it holds on behalf of clients would hit its revenues,’ said Cazalet.

Given the significant contribution that LTL’s dividend makes to its profits, Cazalet warned that investors must be prepared for the possibility that the dividend could fall or stagnate from here.

 

‘Now that LTL represents 37% of the Company's NAV, any fall in its price could amplify the negative effect that falling markets might have on the Company's own quoted investments,’ added the chairman.

Premium warning

Cazalet once again warned on Lindsell Train’s persistently high premium, given that the trust is vulnerable to any significant stock market declines. The shares currently stand at a 23% premium to their NAV per share of £650.68. That premium is down from a peak of 76% last year after index-tracking funds snapped up its shares following its inclusion in the FTSE All-Share.

Shareholders in the trust have enjoyed a 43.7% total return over the year to April. However, the erosion of the premium has hurt shareholders this year: in the first five months of 2017 they have seen the value of their inflated shares fall by 13.5% even though the underlying portfolio has gained 17% in value.

‘The directors have a concern that this level of premium is probably unjustified and is therefore unlikely to be sustainable. On that basis, I repeat again my warnings to any new shareholders who buy shares on an elevated premium to NAV. The company could be especially susceptible to materially declining stock market values,’ the chair noted.

Although many investors expect cheaper cyclical stocks to perform better than those with quality growth characteristics, Train remains positive on the portfolio.

He says Unilever’s (ULVR) rejection of a bid from Kraft Heinz indicates the potential for further M&A activity - even amongst large caps. He remains positive on Unilever, which is the third largest position in the fund, alongside other companies with exposure to emerging markets.

‘The weakness of the oil price in 2017, down nearly 14%, is very bullish for consumer expenditure around the world and particularly so for emerging market consumers, where lower energy costs can quickly translate into greater disposable income,’ he added.

In spite of the collapse of the merger between London Stock Exchange (LSE) and Deutsche Börse after it was blocked by European competition authorities, Train is pleased to see the resilience of LSE’s shares. Since the news broke, they have hit all-time highs. He puts this down to the strength of the underlying business and its chief executive Xavier Rolet.

‘On behalf of LTIT shareholders we are grateful for his acumen and look forward to what comes next,’ he added.

Fee cut

Citywire AA-rated Lindsell and Train, who is AAA-rated, were awarded a management fee that was 1% lower than the previous year, after a decision was taken last year to adjust the way it is calculated.

Under the previous investment management agreement LTL had been paid an annual fee of 0.65% of the investment trust’s adjusted market value, which included the premium on the share price. Given that this has been persistently high, the fee is now based on the fund’s net asset value, or, if lower, its market value.

Together with a fall in Lindsell Train’s operating costs, this reduced the trust’s ongoing charges figure (which excludes the performance fee) from 1.2% to 0.9% of net assets.

Train and Lindsell receive 10% of any growth in the lower of the NAV or market value of Lindsell that is above the average running yield on the 2.5% consolidated UK government bond. Growth that is generated by an expanding share price premium is held back until the following year and is paid only if there has been a rise in the NAV. Over the year to April, strong NAV performance against a low benchmark return of 4% resulted in a performance fee of £2.8 million, up significantly from £0.4 million the previous year.

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