JANUARY 2024
One of the longest standing UK investment companies - Merchants Trust
The launch date of 16th February 1889 (yes 1889, it is not a typo) makes this one of the longest standing investment companies still available on the London Stock Exchange. Originally it invested in the fixed interest securities of railway companies in the USA, Canada and South America. However, the mandate is now firmly focused upon investing in large or “blue-chip” companies in the UK. The emphasis is upon those that have a higher-than-average rate of dividend yield. In other words, capital growth with an attractive rate of income from a portfolio of UK equities. The portfolio’s top ten holdings are littered with UK household names.
When I first assessed this investment company, more years ago than I care to remember, my first thought was ‘dull’. But on reflection dull is good. Managed by Simon Gergel of Allianz Global Investors for over 17 years, the approach should be considered as steady or a ‘safe pair of hands’; one does not last this long in the cutthroat world of fund management if one is not excellent. The portfolio invests in high quality companies that are not considered overly expensive. This is colloquially called a ‘value’ approach. In other words, price counts. Active blue-chip investing is not as exciting as small company investing but they both play different roles within diversified portfolios of funds. Merchants is the core UK exposure which we build other funds around.
I would dearly love to show the track record from 1889 but each time I entered this date on my performance measurement software, it had a fit. Therefore, December 1968 will have to suffice, albeit one of my analyst colleagues pointed out that this was before he was born (I had to add that it’s before I was born (only just)). The chart below shows the price return in the lower line and the upper line is Gross Return, as in dividends have been reinvested. Therefore, a strong advert for compounding. £1 invested in December 1968 to end December 2023 has provided an uplift to £18.90 in price terms but, when the dividend over the period is added, this rises to £151.60.
The fund is a closed end structure, which pre-dates open ended funds (the first of these was launched in 1931). Closed end funds have benefits, one of which is gearing, this allows the trust to borrow and invest a greater amount than 100%. There are strict limits and the board of the trust, those in place to oversee the manager and ensure the best interest of shareholders are being met, will decide with the manager’s input the best level of gearing. When the manager is optimistic on the outlook gearing can be increased to take advantage of market opportunities and reduced when the outlook weakens. The trust structure offers another advantage with respect to yield or the dividend of the trust. Unlike an open-ended fund which must distribute all its earnings (dividend it receives from companies within which it invests) a closed end fund can hold back earnings (up to 15%) and put them into a ‘reserves account’. This allows the board of the trust the option of dipping into these reserves in years when yield/dividends are weak due to poor economic/trading conditions. Therefore, shareholders in Merchants can rest safe in the knowledge that their income stream is secure and predictable. The trust has such an excellent dividend growth reputation that the Association of Investment Companies (AIC), the trade body for closed end funds listed in the UK, has awarded it their ‘dividend hero’ monicker. This is only awarded to investment companies that have increased their dividends for 20 years or more. Remember that this 20-year period covers the Global Financial Crisis. In the interests of transparency Merchants’ actual track record is of 41 years of dividend growth. Maybe the AIC should create a new category of ‘dividend legend’? Sadly, data limitations only allow charting to go back 20 odd years, but the below should hopefully highlight my point.
But, of course, shareholders could have opted to spend their dividend. Many investors will use equity investing as an input to their income requirements. Merchants has an attractive yield; unsurprising given yield premium and growth is part of its core philosophy.
The following chart highlights the revenue reserves, as discussed earlier. It also points to the years when additional income was received through a special dividend (these are years when yield is plentiful).
Closed end funds are listed on a stock exchange (in this instance, the London Stock Exchange), so are exposed to sentiment in that the price investors are prepared to pay for this pool of assets is determined by the market. More demand means a premium and less a discount to share price. Merchants historically trades around its Net Asset Value, (NAV) as in what the portfolio is worth. The board do not allow a consistent premium seeing this situation as a judicious point to issue new equity, therefore keeping the share price in line with the NAV. When it does trade at a discount, it tends to be small and short lived and, like many other investors, we see this as a good opportunity to top up holdings.
Fees paid for active management are always considered in our assessment, the trust stands out with a very competitive fee structure, cheaper than its open-ended contemporaries.
In conclusion, this is a great investment. The Manager, overseen by the Board, invests in UK blue-chip names, with a focus on not paying too much whilst enjoying an attractive level of income. The fund has a legendary track record of delivering consistent dividend growth. Dull, but dull is most definitely good.
This commentary was prepared by James Calder.
James joined City Asset Management in 2009 and is our Chief Investment Officer, where he is responsible for managing the investment process and chairing the asset allocation, portfolio construction and fund selection committees. He is also a board member. He has 25 years’ experience, including roles at Gartmore, BestInvest and Baring Asset Management, and specialises in multi-asset real return investing. Throughout his career he has been a key mentor for younger analysts and enjoys watching them progress on to their own successful careers. In his spare time, James enjoys clay pigeon shooting, mountain biking and spending time with his family.