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Investment Trust Insider: explaining the mispricing opportunity of LawDeb

Investment Trust Insider: explaining the mispricing opportunity of LawDeb

Continuing with the theme of the past few weeks of looking at 2012’s losers and winners, one global growth trust sticks out as a winner: Law Debenture. It is an unusual fund in that it has a large trading subsidiary and this puts off some investors but this business has been a source of strength in recent years.

Law Debenture (LWDB) has a market cap of more than £500 million. It trades on a large premium to net assets – 12.5% at present (though the premium can be volatile and when it is trading close to asset value, it is usually a good time to pick up stock). The premium is justified by its trading subsidiary – an independent fiduciary business, which should be worth a lot more than its net asset value (NAV) to anyone who wanted to acquire it.

LWDB has a decent yield just over 3% (dividends are paid semiannually), and it is the best performing UK listed global growth trust over the past three years, in both NAV and share price terms. The base fee is quite low, just 0.3% on the net assets outside the fiduciary business, and so it has one of the lowest ongoing charges ratios of any trust at under 0.5%.

Gearing comes via a £40 million 35-year debenture issued in 1999 and repayable in 2034. The coupon on this is 6.125%. At the end of December, this gearing was offset by a 7% weighting in short-dated UK gilts – a clear mismatch in income terms if not in risk (a good example of why I generally do not like long-term debt).

The equity portfolio, benchmarked against the FTSE All-Share, has been managed by James Henderson at Henderson Global Investors for almost a decade. His asset allocation shows a bias to the UK – around three quarters of the portfolio, which is fairly diversified with almost 150 holdings.

Henderson’s portfolios are often biased away from the largest stocks and LWDB has a distinct mid cap bias. The largest holding is in Senior Engineering, which has risen almost tenfold over the past four years. Henderson’s performance has been consistently good, with 2008 the only recent year in which the NAV underperformed the benchmark.

Henderson has been more optimistic than most on the prospects for quoted companies, taking the view there are plenty that could prosper despite the generally poor macro environment. The core of the equity portfolio is in ‘genuine growth stocks’ and he believes that although many of these are highly rated, they can continue to outperform.

Geographic diversification is, in part, achieved through investment in pooled funds; LWDB has investments in Henderson’s Asia Pacific and Japanese funds (the fees on these are rebated) and also holds Baillie Gifford and First State Asian funds. LWDB also has a stake in Herald Investment Trust as a technology sub-contract.

The European portfolio is managed by Tim Stevenson, who is also manager of Henderson Eurotrust.

The fiduciary business is headed by Caroline Banszky. As far as trading subsidiaries in the investment company sphere go, it is large with revenues exceeding £30 million and over 100 staff.

Its contribution to the revenue account has almost tripled over the past decade – in 2011 it generated profits of £8.5 million and although Banszky was cautious about the outlook for 2012, at the 2012 half-year stage net revenues were 3.45p vs 3.55p for the first half of 2011.

The fiduciary business has operations in the UK, US, Channel Islands and Hong Kong. It is a trustee for a number of bond issues (a business that suffered when there was a dearth of new bond issues post the credit crisis, although this was offset by fees associated with bond restructurings); an operator of escrow accounts; a trustee of many pension funds, including the BT pension scheme, which is the largest in the UK; and a provider of company secretarial and other support functions for special purpose vehicles. It also operates a whistleblowing service, Safecall.

Net assets attributable to the fiduciary business were £15.5 million at the end of June 2012, after allowing for a £2.8 million deficit on their defined benefit pension scheme – another rarity among investment companies.

Deciding whether Law Debenture is attractively priced requires you to put a value on the fiduciary business. Many brokers don’t try but Oriel Securities reckon as a rough guide, 10 times earnings should do; that is, you can add 71.5p to the NAV, which would put LWDB on about a 5% discount – a little narrower than the average global growth fund but about right given the performance record and cheaper than Henderson’s Lowland trust, which is on a 3% discount. (LWDB is also trading on a higher yield than Lowland.)

LWDB is no bargain but it could be worth a closer look if the premium decreases from here.

James Carthew is a director of Sapient Research

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