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Trust Insider: Foreign & Colonial risks being left behind by investor fashion

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Trust Insider: Foreign & Colonial risks being left behind by investor fashion

I have been writing about trusts for some time now but I have neglected the oldest and one of the largest funds, Foreign & Colonial (FRCL) so I thought this week I would remedy that.

FRCL, which celebrated its 145th birthday last year, is the third largest of the big global generalist funds, behind Alliance Trust and Scottish Mortgage, with net assets of £2.4 billion.

FRCL has had the same manager, Jeremy Tigue, since 1997. It aims to generate long-term capital and income growth by investing in an internationally diversified portfolio of both listed and unlisted equities (up to 5% of the portfolio can be invested directly in unlisted companies but FRCL also invests in private equity funds, combined these will not exceed 20% of the portfolio).

The managers can gear up to a maximum of 20% of shareholders’ funds. There is some expensive gearing in the form of £110 million of debentures carrying a coupon of 11.25% but this is due to be repaid at the end of 2014 – good news as this should boost the income account. They can also use derivatives to boost income and manage currency exposure.

The fund is benchmarked against the FTSE All-World Index. Prior to 1 January 2013, the benchmark had a bias to stocks listed in the UK as it was 40% FTSE All-Share and 60% FTSE World ex UK.

Lagging peer average

FRCL’s long-term performance lags the average of its competitors, up 141% in net asset value (NAV) terms over 10 years against 154% for its peer group, but it is closer to the average over shorter time periods, outperforming by 3.9% over three years and underperforming by just 0.8% over the past year.

It has been using buy-backs to control its discount volatility. This seems to be succeeding as the discount moved in a very narrow range over the past year – between 9.1% and 11.4%, the lowest range of any major fund bar City of London.

The discount is not narrowing, however. FRCL pays quarterly dividends that add up to a yield of 2.2% – slightly more than the average yield for the peer group – and has a record of increasing its dividends in each year for the last 43 years.

Twenty odd years ago, when I started investing in the sector, global generalists were out of favour with investors. The problem was their share registers were dominated by institutional investors and, as these investors had become more sophisticated, a common refrain was that they wanted to make their own asset allocation decisions and therefore they preferred to invest in regional/country specific portfolios or invest directly.

The global generalist sector has been through a painful adjustment as these institutions sold their stakes in the funds but now it is increasingly being embraced, by private investors in particular, as a cheap, efficient way to access a diversified portfolio of equities even for those with a relatively small amount to invest. FRCL says it wants to be a core investment in an investor’s portfolio.

Another thing that has changed over the years is the way these funds are managed. FRCL is differentiated from its peers in one major respect.

If we leave Witan aside as it is a fund of funds, almost every other global generalist fund is now managed as a single portfolio, often with a relatively short list of best ideas in each sector drawn from around the globe. By contrast, FRCL is managed as a collection of regional portfolios with over 600 holdings, which was the norm 20 years ago.

I am increasingly convinced there is no single right way to manage money. However, the arguments for running one global portfolio rather than a collection of regional ones have persuaded most global generalists to go down the global portfolio route.

A simple way of looking at the issue is to pick a sector you might want exposure to, say pharmaceuticals. Does it make sense to buy pharmaceutical stocks in US, UK, Japanese and European portfolios or just buy the pharmaceutical stocks with the best or most profitable products regardless of where they are listed?

Intuitively, you might opt for the latter. But it is asking too much of any portfolio manager to have sufficient knowledge of all the available options in every sector across the globe. He or she must rely on others with expert sector or regional knowledge, collate those ideas and select a portfolio from them. Asking for the best ideas in each region or the best ideas in each sector ought, in the end, to amount to the same thing.

The way FRCL’s money is managed begs another question. With over 600 holdings, is it too diversified?

Cautious approach

FRCL says its diversification is a reflection of a cautious approach to managing the fund, but a counter argument would be that these good stock selection decisions do not have much of an impact on performance.

At the end of November 2013, the top 10 holdings accounted for just 14% of the portfolio and six of these were funds that themselves have a number of holdings. The largest equity positions were BP, HSBC, Glaxo and Shell (all listed in London, which could reflect an ongoing UK equity bias in the portfolio despite the benchmark change).

In FRCL’s asset allocation at the end of November the biggest equity exposures were to the US (28%), UK (21%) and Europe (10%). Private equity investments made up 15% and net gearing was 9% but they had been reducing this.

FRCL is good at disclosing how the regional portfolios have performed against its local benchmarks so it is easy to see where it has been adding value. The European portfolio was doing well at the interim stage and we will get figures to the end of December 2013 in the annual report to be published in March.

In November 2013, British Assets, a stable mate of FRCL, announced it would shift from operating a collection of regional portfolios to using one global portfolio. FRCL’s highly diversified approach is now quite unusual.

I can see how it might still appeal to some cautious private investors, however. It will be interesting to see whether FRCL’s board feels it needs to make a change.

James Carthew is a director of Sapient Research

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