F&C Investment Trust PLC ("FCIT")

FAQs - 23 April 2020

Paul Niven, Fund Manager

23 April 2020

Summary and Key Points
  • 22.9% shareholder return, 19.1% NAV return for 2019
  • Recent downturn in equity markets erases 2019 shareholder gains though longer-term returns remain strong
  • We entered 2020 with near 10% gearing and, following the strong recovery in markets from the 23 March low, have recently taken the opportunity to modestly de-gear, repaying some short-term loans
  • We hold the equivalent of over 1.75 years worth of dividends in revenue reserve and the Board have committed to another dividend rise in 2020, our 50th consecutive raise for shareholders
  • There remains tremendous uncertainty over the near term economic and corporate outlook but, from a longer term perspective, listed equities and private equity are likely to deliver attractive rates of return for the patient investor
  • Our robust closed ended capital structure makes us extremely well placed to withstand near term stress and we continue to hold a diversified set of underlying investments.
Frequently Asked Questions

2019 was an excellent year for shareholders with a share price total return of 22.9% and a rise in the Net Asset Value total return of 19.1%. These returns compare to the benchmark rise of 22.3% over the year.

Shareholders benefited from a further re-rating of FCIT over the year and the share price ended 2019 at a premium of 1.5% to Net Asset Value (NAV). While the NAV returns were strong in absolute terms they did, nonetheless, lag those of the benchmark. We made strong gains in absolute terms across all areas of the listed portfolio but Private Equity (PE) was an area of disappointing returns, where FCIT’s overall exposure saw only a small rise in value. Whilst the poor returns in PE were largely driven by the writing down in value of FCIT’s historic holdings, managed by Pantheon and Harbourvest, it is encouraging to note that the most recent investments posted strong returns of 14.6%.

The supportive market backdrop helped all of our individual listed investment portfolios to deliver positive absolute returns for the year and our listed holdings gained by 19.9% over the year. Our exposure to North America produced a 22.8% return while Europe, a laggard in recent years, fared even better with a return of 24.0%. Elsewhere, Japan and Emerging Markets produced returns of 11.3% and 9.3%, respectively.

While our European equity component had an excellent year in relative terms, it was a disappointing year for a number of the other listed strategies and the other major area where returns lagged those of the market was in North America and specifically the exposure to growth stocks. Here, while the allocation to US growth posted gains of 25.5% on the year this was still some way behind market comparators which delivered even stronger levels of return.

Returns over the first quarter have been hit by the extreme levels of volatility in the market and the anticipation of a deep recession and sharp downturn in earnings. Our NAV total returns were -18.4% in the first quarter and, due to a widening in our discount, shareholder returns were -25.2% over the period while the FTSE All World benchmark fell by 16.1% over the equivalent period.

Despite this significant short-term setback, longer term returns for shareholders remain positive to the end of March with a five year total return of 40.4% and a ten year return of 143%, equivalent to 7.0% and 9.3% per annum, respectively.

FCIT has paid a dividend in every year since inception in 1868 and the 11.6p dividend for 2019 represents its forty-ninth consecutive annual increase for shareholders. FCIT’s overriding objective is the delivery of long-term growth in both capital and income for shareholders and, therefore, a rising dividend is one of its core deliverables.

The Board expects 2020 to be an extremely challenging year for FCIT’s revenue account. Indeed, it is likely that there will be a material fall in its income as a large number of companies reduce or suspend their dividends in response to the severe economic contraction which is currently unfolding. In 2009, in the aftermath of the Global Financial Crisis, FCIT’s revenue per share declined by 23% and 2020 is likely to present an even more challenging backdrop.

Despite the expectation of a decline in revenue for the year, FCIT entered 2020 not only with a covered dividend but with a revenue reserve totalling £111.2m. This reserve is equivalent to around 20.5p per share and is available, if required, to supplement any shortfall in revenue when making dividend payments. FCIT is, therefore, very well placed to withstand a downturn in its revenue account while continuing not only to pay a dividend to shareholders but to raise the dividend on the year. Indeed, it remains the intention of the Board to deliver FCIT’s fiftieth consecutive rise in dividends for shareholders for the year ending 31 December 2020.

Our intention is to ensure long-term growth in dividend payments for shareholders which the Board believe is best achieved through a sustainably covered dividend. Indeed, in the longer term it remains the objective of the Board to ensure that our dividend is fully covered by revenue over the cycle, as it has been in recent years.

We continue to focus on total return for shareholders and seek to avoid buying high yielding stocks solely for their income. Indeed, a number of our holdings, such as Amazon and Delivery Hero, both of which advanced in sterling terms in the first quarter, do not pay a dividend and stocks such as these provided relatively good returns as they were well placed to benefit from consumer trends in the lockdown, which involved a move to more online activity.

ESG is an area of increasing focus for investors and recognising this trend, in recent years, additional detail has been included in the Annual Report and Accounts covering FCIT’s activities in this area. This includes an overview of engagement activities with the companies into which it invests, its voting record as well as the carbon intensity of the listed investments relative to market benchmarks.

The Manager of the Trust, BMO Global Asset Management (BMO GAM), is a founder signatory of the United Nations supported ‘Principles for Responsible Investment’ (PRI) and the Board supports the Manager in their belief that good governance and sustainability practices create value. As well as BMO GAM, all of FCIT’s underlying managers are signatories of the PRI.

In terms of engagement, in 2019 BMO GAM contacted 169 companies on the portfolio to encourage stronger policies and disclosure on a range of ESG issues. As responsible stewards of capital FCIT takes its voting responsibility seriously. The Manager takes all voting decisions across the portfolio and, therefore, ensures a high and consistent standard of scrutiny in governance oversight. It has an in-house voting policy and seeks to use the vote as a tool to press companies for better practices on issues such as pay and climate change, in line with the engagement undertaken.

Globally, governments have responded to the threat of Covid-19 and attempted to safeguard the health of their citizens through the implementation of social distancing measures. In practical terms, this has led to lockdowns and huge contractions in economies across the world driven by a simultaneous hit to both supply and demand.

Asset markets have displayed unprecedented levels of volatility and global equity markets fell by around a third from their peak in February. Investors were anticipating a sharp reduction in corporate profits and rising defaults in credit markets and there appeared to be a significant risk that a human and economic crisis would transform into a systemic financial crisis. The rapid and forceful response of policymakers and signs that the virus may be peaking has led to some optimism that economies may soon reopen, and that lasting damage may be limited.

FCIT suffered a 25.2% decline in total shareholder return and an 18.4% decline in NAV over the first quarter. This compares to the benchmark return fall of 16.1%. FCIT lost value in absolute terms as markets fell sharply over February and March and shareholder returns were negatively impacted by a widening the share price discount to NAV. Having started the year at a premium rating FCIT fell to a discount of 7% at the end of the quarter as part of a widespread derating across the sector in a flight from risk by investors.

FCIT’s relative performance was negatively impacted by the direct and indirect impact of the decision to have gearing. Underlying portfolio performance was modestly ahead of benchmark returns over the period but gearing detracted from returns as did the increase in the fair value of debt. These two factors were negative for our short-term returns.

On our listed portfolio we benefited from exposure to a number of stocks which performed well during the downturn. Some, such as Amazon and Delivery Hero, are exposed to positive trends from the move to online consumption. Our holding in Dollar General, the discount US retailer, also performed well while a number of our pharmaceutical and healthcare company holdings, including Novo Nordisk, Vertex Pharmaceuticals and Ping An Healthcare & Technology produced pleasing returns. Conversely, a number of major detractors were our limited holdings in the travel and airline stocks which fell sharply. Wizz Air, the European low-cost carrier and Royal Caribbean Cruises (which was sold during the period) were particularly hard hit. In addition, energy holdings, from our US value portfolio, also performed poorly, with Hess and Phillips 66 almost halving over the period.

The marked declines in oil prices in recent weeks, with certain contracts declining into negative territory for the first time in history, is creating further pressure on the energy sector. Implied yields appear very attractive but, as with a number of other areas in the market, investors are questioning the sustainability of dividend payments. We hold less than 2% of our listed equity exposure in oil & gas stocks.

After a sharp rally in markets from the low reached on 23rd March 2020, FCIT has modestly reduced gearing levels around the middle of April and redeemed some of its short-term loans. In early February, before the crisis unfolded, exposure to higher yielding equities was reduced through a sale from the income strategy along with some reduction in European equity exposure. Exposure was funded to two new strategies, one focused on Sustainable Opportunities investing globally into high quality growth-oriented businesses, and one managed by Pyrford who run a portfolio with a valuation focus looking for strong and consistent business franchises. In addition to these moves, exposure to Japanese equity and the number of holdings were reduced while exposure to US value, managed by Barrow Hanley, has since been reduced. Engagement with all the managers has continued with support and appropriate challenge during this difficult time.

FCIT entered 2020 with a net gearing level of 9.9% which is around the average level of recent years. Such a severe downturn was not expected and, therefore, gearing has been detrimental to FCIT’s returns over the short term. Market exposure had been maintained and gearing levels were held through the period of volatility but, after a near 30% rise in US equity markets from their recent lows the opportunity was taken to reduce gearing modestly and repay some of the short-term debt. Nonetheless, FCIT’s gearing level at the time of writing is slightly higher than at the start of the year, due to falls in underlying asset values. 

In recent years, we have taken the opportunity to extend the maturity profile of our debt while maintaining a diversified range of borrowings. Our debt is largely long-dated which provided surety for our funding needs and we have locked in historically low rates of interest. Indeed, FCIT pays low rates of interest on its borrowings (averaging around 2.2%) which creates a low hurdle rate from which value can be added through gearing. In addition, we have access to short-term borrowing facilities which provide flexibility in our borrowing arrangements and access to short-term liquidity as required. Furthermore, we have negotiated loan covenants which provide substantial headroom and additional comfort that our gearing levels are sustainable. In addition, with the exception of our small perpetual loan, all of our borrowing is unsecured and we invest the vast majority of our assets into liquid, listed, securities.

While current market volatility may well create some opportunities to adjust gearing levels on a short-term basis, shareholders can be reassured that FCIT will continue to take a long-term approach. Provided that asset returns exceed the cost of borrowing over the term of the loan then the Board believes that gearing will continue to prove accretive to long term NAV returns.

There is tremendous uncertainty over the economic and corporate outlook at present. The global economy faces the sharpest contraction since the Great Depression as a result of lockdowns which are designed to contain the spread of Covid-19. The longer that the lockdowns persist, the greater will be the permanent damage to the economy and the weaker will be the subsequent recovery.

There are signs that lockdown measures will be lifted gradually in major economies in the weeks and months ahead but it will take some time before full economic activity can resume. Indeed, while we may have endured the first wave of infections it is likely that there will be further waves to come. At present, a full repeat of the current extreme measures to contain the spread of the disease is regarded as unlikely but there may well be ongoing disruption to economic activity for some time. Indeed, until there are more effective treatment options for Covid-19 or ideally, a vaccine, the world may well continue to suffer sporadic outbreaks resulting in weaker growth than otherwise would have been the case.

At present, despite these uncertainties, it does appear that there will be a return to growth in the latter part of 2020 and into 2021 but there will, undoubtably, be some permanent loss of output to the global economy. The extent of the lasting damage will largely be a function of the length of the lockdowns and whether further waves of infection require significant social distancing measures, resulting in more economic disruption.

While the economic contraction will be severe the action of policymakers in tackling the crisis has been significant. Monetary policy has been eased and large fiscal programmes, representing a large share of country’s GDP, have been implemented very quickly. Indeed, the speed and scale of the response has been far greater than that seen in the Global Financial Crisis over a decade ago. This is appropriate, given the tremendous hit to growth, but also encouraging. Policy will not be able to save every job or every business, but aggressive monetary and fiscal action is intended to reduce the lasting impact of this crisis and prevent a deep recession from turning into a lasting depression.

As shareholders will know, over 152 years, FCIT has withstood two world wars, numerous recessions, the Great Depression as well as a number of global pandemics. Each challenge is unique but the lesson from history is that, in time, they will pass, and the economy and corporate profits will continue to grow over the longer-term. For this reason, it is the Fund Manager’s view that listed and unlisted exposure to equities will provide good levels of real return in both capital and income for the patient investor.

While we remain in the midst of the crisis, it is too early to say with confidence what the lasting implications of this crisis will be. Longer term implications will be driven, to a great extent by the depth and length of the downturn which, in turn, relates to the veracity of subsequent waves of the virus.

The actions of policymakers have gone further than any seen in living memory. Monetary and fiscal policy have been deployed in such scale and in a manner where central banks will effectively be funding fiscal largesse. The economic shock can be expected to be significantly deflationary in the short term but there is potential for a seismic change, on a longer-term perspective, on the outlook for inflation and a potential end to long running secular stagnation. At present, this is only a risk, but much larger government spending, financed by ‘money printing’ is likely to become a permanent feature and, in time, this may well alter the investment landscape.

For the time being, with a deep recession unfolding, history would suggest that the positions of companies with stronger financial and market positions will become more entrenched against companies with weaker balance sheets and competitive positions. In that sense, ‘winner takes all’ is likely to continue as a dominant theme across and within sectors. A number of our holdings, including the tech giants Amazon, Microsoft, Alphabet and Facebook remain well placed to capitalise on these trends.

The crisis is likely to accelerate a number of existing trends including the move to online retail and the experience of virtual working will likely lead to a lasting change in practices of businesses globally. Resultant reduction in demand for both retail and commercial office space may well have profound and long-lasting implications for the property market. The travel industry may see consolidation and a permanent reduction in demand. Despite industry challenges in these segments, stronger positioned companies will be well placed to consolidate their power, once we emerge from the crisis and demand improves.

In addition to these points, the experience of the pandemic may well encourage businesses to shorten supply chains and to seek more control over factor inputs to production. This may well be linked to a general move towards a more introverted and less global world politically and more nationalistic policies.

The Eurozone has once again been exposed as relatively ill prepared to deal with a crisis. Lack of a fiscal union and political resistance to mutualisation of credit risk across member countries continues to be a source of stress within the area and Italy remains a key source of risk for the whole political and economic project.

Markets have adjusted rapidly to price in a new normal for a post Covid-19 world. Inevitably, while some industries will be challenged, there will likely be longer term winners even within those areas where stress currently appears highest. For this reason, and because valuation in certain areas has reached historic extremes, the Board believes that it remains appropriate to remain balanced within its approach to equity exposure. Furthermore, yields on government bond markets have fallen to new historic lows. Prospective returns from fixed income assets have diminished and, while central banks are underwriting credit risk to a certain extent, the Board believes that equity markets will provide attractive long-term returns.

FCIT remains focused on listed and unlisted exposure to equities which provide exposure to long-term growth opportunities and, through its managers, identifying those companies with sustainable business models. The Trust remains balanced in its approach to equity market exposure, seeking to deliver growth in both capital and income from a range of strategies which are diversified geographically and by style and sector.

Discounts in the global growth sector have been extremely volatile over recent months and FCIT has seen its rating move from a premium out to a discount of close to 20% in the first quarter before ending the period at a discount of 7%. Many other large and liquid Trusts suffered disproportionately as investors sold what they could in a disorderly market fall.

The Board is committed to using buybacks in normal market conditions to reduce volatility in the discount. The Board has been greatly encouraged in recent years by a persistent narrowing in the discount level to the point where FCIT achieved a premium rating and was able to grow through issuance of shares. While recent markets have been disorderly and far from ‘normal’, the Board did buy in shares during the period of weakness in the discount as this is accretive to shareholders due to the enhancement of the NAV per share. The Board will continue to act judiciously in using buybacks in order to add value for shareholders.

Many of the best performing names of the long bull market, such as US growth stocks, have also delivered relatively strong returns year to date. The recent performance of a number of these companies reflects the dominant positions which they occupy in their sector, low levels of leverage and a perception that their revenues will prove to be relatively resilient to the economic downturn.

FCIT has substantial exposure to many of these strongly performing growth stocks and, indeed, the largest five listed holdings at the end of March were Amazon, Microsoft, Alphabet, Facebook and Apple. Furthermore, FCIT’s largest single allocation, by strategy, is to US growth stocks.

Nonetheless, the Board continues to believe that diversification across geographies, styles and sectors will serve investors well over the longer-term. FCIT invests in a range of strategies, each of which is focused and active, and which diversify returns against each other in order to smooth returns for investors. While disruptive technology stocks have been the dominant performers in listed equities for a number of years and have performed well on a relative basis so far this year, a narrowly based approach carries significantly more risk for investors and, in previous crises such as the Global Financial Crisis, this area of the market has fared poorly.

The private equity exposure is valued quarterly and is subject to audit at each year end. FCIT’s private equity exposure stood at 7.6% as at the end of 2019 and 9.6% as at the end of March. The increased weighting to private equity at quarter end is largely a result of the decline in value of the listed holdings.

Given that private equity is valued quarterly, there is a natural lag to any changes in the valuation of FCIT’s Private Equity holdings in its NAV. The Board has therefore been working with the Manager to understand fully the implications of the crisis on each of the private equity fund holdings and underlying businesses into which FCIT invests. Given the sharp downturn in listed equity markets the Board believes that it is prudent to promptly reflect any resultant adjusted valuations in its NAV for all FCIT’s Private Equity holdings. As at 23 April the Board has considered the total impact of these adjustments as not material at portfolio level. The Board will continue to scrutinise valuations of the Private Equity holdings and will take further action to reflect current market pricing as appropriate.

    

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Past performance should not be seen as an indication of future performance. The value of investments and income derived from them can go down as well as up as a result of market or currency movements and investors may not get back the original amount invested.

If you feel you need specific investment advice that takes your individual circumstances fully into account, please talk to a financial adviser.

Views and opinions have been arrived at by BMO and should not be considered to be a recommendation or solicitation to buy or sell any companies that may be mentioned. 

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