Investment Trust Insider: performance problems but sun unlikely to set on British Empire

One fund that seems to have suffered a dramatic reversal of fortune recently is British Empire . For some time it was among the best performing funds in the global growth sector and consequently it attracted a substantial retail fan base. This had the effect of driving up the fund’s rating excessively.

Poor performance over the past few years has eroded confidence and the fund now sits on a discount of more than 11% – enough, I fear, to start to attract the attention of the arbitrageurs once again (British Empire was targeted by Millennium Partners back in 2001 when the discount was around this level). However, the trust has a record of delivering bursts of outperformance – might it be worth a closer look?

British Empire is all about exploiting discounts – it holds a portfolio of investments it believes are valued at less than the sum of their parts. In the past this has included many investments in closed-end funds and, as I appreciated back in the days of managing Advance UK, it is hard to have a go at other funds for trading on wide discounts unless your own house is in order.

Nowadays, though, British Empire’s portfolio has few traditional closed-end funds within it. Instead, as has been the case for many years, it is dominated by holdings in conglomerates, especially family-controlled investment vehicles, and it is more of a passive investor in these companies.

The £630 million market capitalisation fund has been managed by John Pennink of Asset Value Investors since the end of 2002 and over the past decade, even after the disappointing returns of the past few years, the fund ranks as the fourth best performing global growth fund (behind RIT , Capital Gearing and Establishment ).

There is not much gearing on the fund. There is a £15 million 81/8% debenture that matures in 2023 and a small amount of equity index linked loan stock (an unusual instrument) that will go next year. The board has said it is not looking to introduce any more long-term borrowing into the structure and I think this is good news.

Management fees are relatively low at 0.6% of net assets. There is a performance fee set at a fairly modest rate of 4% of the excess return over the Morningstar IT Global Growth Funds Index and capped so that overall fees cannot exceed 1% of net assets in any one year.

There is a distinct bias to Europe within the portfolio. This is in marked contrast to every other global growth fund and, given how out of favour Europe is, this may account for some of the recent poor performance. The largest holding is a stake in Vivendi Universal, which accounts for just under 9% of the portfolio. It believes this media and telecoms giant trades at more than a 40% discount and it might be reasonable to hope that someone will seek to unlock this value.

The rest of the top 10 includes Norwegian conglomerate Orkla, the Keswick family vehicles Jardine Strategic and Jardine Matheson, Swedish industrial holding company Investor AB, another Norwegian company Aker, which is heavily into the oil and gas sector, a couple of Belgian holding companies – Sofina and Albert Frere’s Groupe Bruxelles Lambert  – and two Hong Kong listed conglomerates, Shun Tak and Wheelock. Collectively these account for about half the fund and comprise investments in many different industries in many different geographical locations.

At the end of March it estimated the average underlying discount to net asset value was 35% – this compares with 39% six months earlier, which they believed was the widest discount they have recorded. This represents a great deal of latent value, some of which needs an improvement in investor sentiment before it can be realised, but some may be released through mergers and acquisitions activity.

Is the fund really vulnerable to arbitrageurs? The shareholder base is, with a couple of exceptions, fairly fragmented. Caledonia is the largest shareholder, with about 20% of the equity. It has been selling down its stake and, as I have written in the past, I think this is the right thing for it to do, but perhaps not at this rating. Caledonia would be extremely unlikely to support an attack on the fund.

The faith of the retail investors who make up the bulk of the register may be waning, but mobilising them is hard work. This does not mean that British Empire can afford to be complacent, however, and I find it strange that it has not been buying back shares – though it says it is keeping this under review.