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Investment Trust Insider: Mo' Monks, Mo' problems

Investment Trust Insider: Mo' Monks, Mo' problems

The worst-performing generalist in net asset value over the past year also happens to be the one I have most money invested in: Monks.

It is not that it has been a complete disaster, just that it has barely moved in a year, while the average generalist is up by 10%. To compound the problem, its discount has widened by about 7% over this time.

Monks has been managed by Gerald Smith since May 2006. In April 2011, he became chief investment officer at Baillie Gifford. Monks’ benchmark is the FTSE World Index. It holds a mix of equities and bonds but the bond portfolio has been reduced over the past year.

In keeping with the Baillie Gifford house style, the investment approach is based on long-term stock selection, and this determines the asset allocation.

The portfolio is more diversified than many of its stable mates, notably Scottish Mortgage and Edinburgh Worldwide, with 133 holdings and the top 10 accounting for 21% of the fund. In a period where investors have sought out defensive stocks and yield plays, Monks’ focus on investing for growth has been out of favour.

Mixed results

Baillie Gifford is cautious on markets for the reasons you would expect. In particular it does not think politicians have the guts to tackle eurozone, UK and US government debt.

The European weighting is low. It thinks many banks are still undercapitalised, a view recently echoed by Bank of England governor Mervyn King, and Monks is underweight financials.

The manager still believes in the long-term bull case for emerging markets, and this is reflected in the portfolio. He sees the situation in China as a cyclical rather than a structural slowdown but has lower exposure to Asia than many funds in the peer group.

The biggest investment, 3.1% of the portfolio, is in IP Group, a fund that invests in early-stage technology as joint ventures with a number of UK universities.

IP had a great run as its share price tripled over a year on the back of good news from a number of its holdings. Since July, however, the share price is down by about 20%.

IP is just one of a number of holdings in investment companies in Monks’ portfolio, including Doric Nimrod, Burford, Juridica, Biotech Growth Trust and Better Capital. Together they account for 10% of the fund.

Other holdings in the top 10 include Aggreko, which was doing well before a recent profit warning hit the share price; Samsung Electronics, another good performer but not a huge position in the portfolio; OdontoPrev, a Brazilian dentistry firm that has been outperforming a lacklustre Brazilian equity market; and Eldorado Gold, a Canadian gold mining company with operations in China and Turkey.

Interestingly, given how well received its results were, it has also been building a position in Facebook. Monks had a poor experience with a couple of Chinese investments last year. It got badly caught out by Sino Forest and what used to be a big holding in Vision Opportunity China.

Derivatives strategy

Monks uses derivatives to help manage its gearing levels. In June this year, its £40 million 11% debenture matured and this has cut the fund’s interest bill substantially. It still has a 6.375% £40 million debenture that matures in 2023, however. Monks also had two short-term £40 million facilities with Scotiabank.

The fund was about 9% geared at the end of September but in recent weeks it reduced its effective gearing to around zero, repaying one of the £40 million Scotiabank loans, mostly from existing cash, and using derivatives to offset the other borrowings.

It has also been using derivatives to protect the portfolio from sharp drops in markets. Last summer it sold futures in UK, US and European indices, and in February 2012 switched the US futures contracts into contracts on the Brazilian and Hong Kong markets.

The managers reckon this strategy benefited the fund by 1.2% in the year to end April 2012. Of course, when markets are rising, this strategy is a drag on performance.

Monks is a decent size, its market cap is £767 million. The discount now is 14.7%, which is at the upper end of its range over the past five years. To tackle this problem, the fund has been buying back and cancelling shares but could maybe be more aggressive in its buybacks.

Monks aims to generate capital growth and the dividend is just a by-product. Consequently, the level of the dividend has fluctuated over the years. It yields 1.3% – the average for its peer group is about 2.4% – not good when investors are paying up for income. However, the total expense ratio at 0.6% is well below the average for the peer group, which is closer to 0.8%.

I will hang on to my holding. It will not shoot the lights out when markets recover but it won’t be crushed if they take a turn for the worse. Since I can’t make up my mind which is more likely, it seems sensible to sit tight.


James Carthew is a director of Sapient Research 

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