My last article speculated on the likely effect a change of investment manager would have for the Pacific Horizon fund. There has also been a recent management reshuffle for the Scottish Investment Trust (SCIN).
On 18 July, SCIN announced that John Kennedy, manager of the fund since January 2004 and an employee of the firm for 21 years, had stepped down. He is being replaced, for the time being, by his assistant Alasdair McKinnon, who has been named acting manager.
The announcement gave no reason for Kennedy’s abrupt departure, though some people speculated it was a consequence of SCIN’s underperformance in relation to the peer group over the past few years. Kennedy himself said that, after 21 years, he felt it was the right time for a change.SCIN is a self-managed trust with a long history. It trades on just wider than a 10% discount and, though the rating tightened up for a while at the beginning of 2014, this seems to be its normal level.
The board said it would prefer the fund to be trading at a 9% discount or tighter, and bought about 1.7 million in shares over the past 12 months and about £450 million worth over the past 10 years.
This steady shrinkage of the fund has offset performance so that it is now about the same size as it was 10 years ago. It is still a reasonable size, however, with a market capitalisation of £636 million and gross assets of £830 million.
The discount target was introduced in 2006 after a long campaign to help tackle its discount. In February 2001, SCIN bought off arbitrageur Sierra Trading, which had built up a stake in it. The deal was struck at a 9.5% discount, which was a significant premium to the then prevailing price.
Unfortunately, taking out Sierra triggered an attempt by Hermes Focus fund to change SCIN’s entire board, disgruntled that SCIN had not offered to buy back all of Hermes’ stake at the same price. SCIN fought off the attack and, in September 2004, Hermes sold its stake.
Shareholders kept up pressure for some form of discount control, however. In 2006, SCIN carried out a 40% tender at a 9% discount. It said it would use its buyback powers to target a 9% discount thereafter.
Kennedy took on the fund in the middle of this turmoil. He succeeded Ian McLeish when he retired, having been manager of the fund since 1986. At the time, there was a feeling SCIN’s performance had been disappointing and something needed to be done about this.
Kennedy set about restructuring the fund’s portfolio straight away. SCIN was an early adopter of the move to manage big global generalist funds using a single global approach rather than as a collection of regional portfolios.
The number of stocks in the portfolio was reduced but the portfolio remained fairly diversified. It had 111 holdings at the end of June 2014, the largest of which was a 3.1% weight to Finnish insurance and banking company Sampo.
Kennedy also revamped SCIN’s stock selection process, making it more disciplined. He is a risk-averse stockpicker who prefers companies with high returns on capital and positive earnings momentum. The construction of the portfolio is based on merit rather than index weightings. SCIN has not tried to add value through asset allocation.
Kennedy had to cope with a headwind when generating returns for the trust as, in 2000, the board, under the previous chair, decided to borrow £150 million of 30-year debt at an interest rate of 5.75%. At the time, this might have looked attractive compared with some of the egregious interest rates other funds were paying on long-term debt taken out in the 1980s and 1990s but nowadays it is pretty expensive.
As an example, Alliance Trust has been running with gearing in the form of short-term bank debt for some time, which cost it 1.81% in 2013 and 1.57% in 2012. Kennedy has been running to stand still.
SCIN has not really been using its gearing either, for fear that markets are excessively valued on the back of easy money in the form of quantitative easing.
I do not have the data to hand to look at Kennedy’s performance since he took on the fund but it is probably reasonable to use 10-year performance figures as an approximation. The effects of the portfolio restructuring back in early 2004 would have taken a little time to kick in.
Over 10 years, SCIN has generated a return of 141%, putting it just ahead of the FTSE All-Share index, up by 138.7%, and the MSCI World index, up by 140.3%. The average global growth fund has delivered a return of 160.6% over that period, meaning SCIN ranks 16th out of 23 funds in the sector.
The five-year figures look much worse, with underperformance versus both indices mentioned above the sector. But again, as I noted in the Pacific Horizon article, the five-year data is skewed by the credit crisis. Having a bias to stocks with high returns on capital meant SCIN did not hold the riskier companies that see-sawed more in the crisis.
Watch this space to see whether the board confirms McKinnon as manager of the fund or if another of his colleagues or an outsider is selected.
It will also be interesting to see whether there is a wholesale rethink about the way the portfolio is managed. However, I would be surprised if SCIN went down the path of adopting a higher risk strategy, given its largely retail shareholder base.
James Carthew is a director at Marten & Co