Company history and business
British Empire Trust (LSE:AGT, Financial) has been managed by Asset Value Investors (AVI) since 1985. The company’s history even dates way back to 1889. The investing approach from AVI centers around three major themes: Own high quality assets, buy them at substantial discounts to NAV and ensure there is a catalyst to narrow the discount. Shareholder activism is often a strategy it will use to act as a catalyst.
The portfolio is approximately 1 billion British pounds in size, and focuses on investment companies, investment holding companies and asset-backed companies.
It is flexible in searching around the globe for value, rather than being wedded to any benchmark. For example, in recent years this has enabled it to identify many cash-rich companies in Japan to hold.
For the decade ending 2018, the net asset total return of the trust was 10% per annum. Some may consider those returns boring in this current bull market. Here are a few points to put that into perspective.
The culture and investing approach have been true to label for long periods. Going back a further decade shows more consistent above double-digit returns.
Their bias to be willing to search beyond the U.S., and towards deep value situations, hasn’t been fashionable over the last decade. This could easily change going forward.
We can point to evidence of their strong culture and corporate governance. The assets under management have grown to a significant size largely from compounding strong returns over a long period. The ongoing expense ratio is under 90 basis points. It has a prudent buyback program and dividend policy.
I like the idea of buying an investment company that uses shareholder activism on other investment companies. The reason is that it would be hypocritical for British Empire Trust if it didn’t take seriously how its own stock can trade at a discount. We even saw well-known activist Elliot Management Corp. obtain a substantial stake in British Empire Trust in 2016. While it may have reduced this since, other well-known, experienced, specialist, closed-end fund investors are still key shareholders in this fund.
One may think that with many global equity markets near their highs, value may be difficult to come by. The fund’s portfolio, however, is made up of holdings trading at comfortably more than a 30% discount to assets. When we examine this measure throughout their history, that still offers quite good value, especially in terms of the last few years.
Enhancing the value of British Empire Trust is being able to acquire the stock at greater than a 10% discount to its NAV. This implies a “double discount,” as some investors like to call it, of around 40% to assets. There is even an argument to suggest a “triple discount” exists. For instance, some of the portfolio may have lazy cash-rich balance sheets where it could return capital to shareholders. The Japan stocks in the portfolio are a good example. If we value those excluding some of the idle cash, then arguably the NAV there is higher.
Such a discount in this stock may make sense if I saw attributes such as high expenses, weak corporate governance and performance. As I have touched on, I believe the opposite exists. I am surprised the discount is still wide in light of the most recent portfolio manager Joe Bauernfreund taking over in late 2015. Performance has been very good since then when considered in the context of its investing style being out of fashion.
The stock traded at a much narrower discount in the years just after the last global recession. Through 2013 to 215, it was a challenging period for the fund’s performance, and the discount widened. Somewhat surprisingly, we still have a similar discount to NAV, even though the new portfolio manager has overseen some improved performance.
The discount is not the only advantage of acquiring the stock. The fund itself has also added value to the NAV by implementing a regular share buyback. Over the last couple of years, this has added around 50 to 100 basis points of value to the NAV in a risk-free manner.
The company pays a modest regular dividend (1-2%) and uses a small amount of gearing (can use up to 10%). Its dividend history is very consistent.
Consistent above-double-digit investment returns are evident since being managed by AVI since 1985. Further, there have been just the three head portfolio managers over the last 30 years.
In 2003, Aberdeen sold AVI to a small group of executives and ensured plenty of “skin in the game” since. I prefer that to many hedge funds that have fat performance fees as their incentive. British Empire Trust has no performance fee.
Current portfolio manager since 2015 John Bauernfreund is off to a solid start with performance. He has also been with the fund for a very long time prior to taking on this role, having joined the AVI team in 2002.
Since Bauernfreund took over, there has been a noticeable tilt to a more concentrated approach, which is thus far delivering improved returns. One feature has been the move to an increasing weight in “cash-rich” companies in Japan. I see this as a potential positive catalyst, as Japan's government has introduced significant new sets of guidelines surrounding corporate governance. It should provide a fertile area for the British Empire Trust and its ability to use shareholder activism as a tool. A more concentrated portfolio overall also enables it to efficiently allocate time towards various activism campaigns.
I also see plenty of value outside of the Japan special-situations bucket. In part, this stems from the trend in recent years toward passive investing in exchange-traded funds. It has arguably become self-fulfilling, where the bull market is powered along by performance chasing. Inflows into a relatively narrow group of larger stocks push prices upward and encourage further buying so as to not underperform. The question then arises: What kind of assets get neglected in this theme?
The British Empire Trust specializes in investing in holding companies that often are led by wealthy families throughout the world. These sorts of companies usually have smaller “free floats.” While the companies themselves may be very large, significant stakes held by the founders may be excluded for benchmark purposes. Usually the other shareholders of these companies also rarely trade the stock, as they are happy to ride along with well-managed businesses. These are the characteristics that are being shunned by investors pouring into ETFs.
This type of exposure represents more than a third of the British Empire Trust and where it sees significant value in global markets right now. In many cases in this area, it is not as crucial that the discount to assets narrow in a hurry. They often have proven track records of excellent compound growth over very long time frames. Value can be neglected in this area because there is little incentive for broker coverage because liquidity is lower.
There are still plenty of opportunities for investing in closed-end funds. These are also out of fashion as in today’s investing world. They are often competing with the demand for ETFs offering similar underlying exposure. This was not as much of a factor a decade or two ago. Many CEFs have been criticized for not adding alpha after fees and as a result are trading at wide discounts to NAV.
The British Empire Trust possesses the scale of funds to be able to obtain key stakes in CEFs. Then they can agitate for necessary changes to close the discount. In this space brokers also often neglect the value. Their incentive is usually only to sell them at IPO stage and forget about them in the secondary market.
From a top-down point of view of the portfolio, there is value in the tilt towards markets outside of the U.S. Many traditional quantitative valuation metrics would show this. Admittedly, the references to tools such as CAPE ratios and the like can have their weaknesses, especially when using them for shorter-term time frames. The British Empire Trust though is the kind of stock one could own for more than a decade. This regional value tilt in the portfolio can be more confidently relied upon to add value over such long time periods.
Below are the recent top 10 holdings for the fund. Note that the Japan Special Situations exposure spans 18 different holdings. Also note that nearly half of the Perishing Square holdings have been hedged out. This means it can make a more significant bet on the discount capture in that situation.
Source: British Empire Trust Update for March 31, 2019
Its value investing approach is clearly out of favor, and this sentiment could easily persist longer than I can imagine. This could see the stock underperform. I remember investing in painfully underperforming value situations in the late '90s and being surprised how long that theme lasted.
It has plenty of exposure across Europe and Japan where there could easily be further structural headwinds in terms of weak economic growth. Even if it has identified value situations in these regions, perhaps it can remain cheap for longer than is warranted. Mitigating the risk, the portfolio manager often targets many quality companies. Even if value is not recognized by the market, it is likely that the businesses it identifies are still growing well. It just may require more patience.
Its Japan exposure relies on the success of shareholder activism there to a degree. This is still a relatively new investment theme it is betting on.
I am reluctant to make overly bullish predictions of any stock ideas given that most global equity markets have had a good run over the last decade. On a relative basis, though, British Empire Trust stands out for value. It offers an efficient structure for investors to ride a return to favor of value versus growth investing.
If you do subscribe to the theory that there are some similarities to the late '90s, then this stock stacks up on a risk-reward basis (I refer to the similarities of the popularity of growth-versus-value investing, and passive-versus-active investing). British Empire Trust delivered very good returns as the tech boom ended in the year 2000 and over the following decade. It is currently positioned in pockets of value across global markets that are becoming increasingly hard to find.
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