“It was luxuries like air conditioning that brought down the Roman Empire. With air conditioning their windows were shut, they couldn’t hear the barbarians coming.
Garrison Keillor

“Look to the past and remember no empire rises that sooner or later won’t fall.
Al Stewart

 

British Empire Investment Trust has been added to my portfolio because it is uniquely positioned amongst funds at the crossroads of a number of themes that appeal to me.

–          Discount to NAV

–          Owner Operated Businesses

–          Strong Track Record

–          European Equities

–          No Sell-side coverage/ Institutional Sponsorship

–          Concentrated Portfolio

The British Empire Investment Trust managers believe that their edge is maintained by keeping a very small investable universe relative to most of their “Global” investing peers. They focus on conglomerates, investment holding companies, asset backed investments or investment trusts trading at a discount to their own NAV. They think that this area of the market is particularly susceptible to inefficiencies and mispricing because their universe doesn’t possess any “natural owners” in the institutional world and often the stocks are quite hard to categorize or pigeonhole into sectors.

 

Price – 413p

NAV – 467p

Dividend Yield – 2%

 

Discount to NAV

The trust currently trades on an 11.5% discount to NAV which is as wide as it has been since inception.  Because of the nature of many of the conglomerate or investment holding companies, BTEM offers what can be considered a “double discount”. For example, Jardine Strategic is an Asian family holding company of which BTEM is a long-term owner, they believe that this stock trades at a 40% discount to its own NAV; so purchasing this via BTEM allows you to get an 11.5% discount on a portfolio containing Jardine Strategic on a 40% discount. Getting a dollar for sixty cents is good but buying it for 54 cents is better.

Asset Value Investors calculate a “look-through” NAV on their portfolio which they currently estimate at around 40% which is the highest level since their calculations began and has widened from 23% in 2010 and 39% as of the Annual Report in Nov 2011. They calculate this “look-through” NAV by using either tangible NAV, peer comparison or sum of the parts analysis, it is not exact but they have proven prescient enough in their calculation of business or asset values in the past. At the widest discount in their 26 year history, I believe that we can take comfort in the level of undervaluation. To quote Strone Macpherson in the Chairman’s Statement this year “These underlying discounts have historically proved to be an excellent source of good returns for shareholders as markets stabilise and start to improve.”

 

Strong Track Record

The track record of the BTEM managers Asset Value Investors (AVI) is a very strong one indeed as demonstrated below. AVI was founded in 1985 to manage just £6m and the majority of the increase in funds under management up to today’s £1.2bn (of which BTEM is £800m) has been the result of internally generated compound growth rather than gathering new assets. In 2003 the company was involved in a management buyout from owners Aberdeen Asset Management meaning it is now wholly owned by the small team of investors who run BTEM ensuring their skin is well and truly in the game. I found it quite hard to get data on insider ownership but what I found amounted to £16m worth of shares across the staff and the board. This seems plausible however the transaction data I found shows lead manager John Pennink buying £1.2m of shares in January 2012. This is listed as his only holdings in the trust which I just don’t believe given how long he has been managing it for and the track record. I’m sure he owns substantially more but cannot verify it.

 

I believe that BTEM will prove to be an excellent steward of my capital over the course of these lean years. I will quote from John Pennink’s 2010 Annual Report.

“What concerns us is that the challenges to economic growth are in many cases structural issues that require difficult and painful reform and are not going to be solved by QE and low interest rates. Central Bank reflationary policies may turn out to have harmful side effects that outweigh their benefits. The beneficiaries of low interest rates and QE are banks and other financial institutions but the average person is hurt by low returns on savings, a stagnant job market and higher inflation. It is hard to build sustainable prosperity on this basis.

As long as reflationary policies are seen to be working, however, the equity markets may continue to rise but we foresee periodic sharp corrections as market participants realise that developed economies remain stubbornly weak.

Overall, the equity markets may not make much progress. In this sort of environment, the equities that we find appealing are those with strong balance sheets, high dividend yields and high discounts to NAV. It will pay to find those companies that have their own catalysts in terms of restructuring potential and unrecognised value. We are trying to find a mix of assets to allow us to ride out the as yet uncertain effects of this experiment with monetary easing.”

 

Owner Operated Businesses

Investing in owner operated businesses is a favourite tactic of mine because you are more likely to find management act in a shareholder friendly manner if they are major shareholders themselves. Family controlled holding companies like Groupe Bruxelles Lambert (GBL) or Jardine Matheson have numerous advantages for long term value investors.

–   Diversification across various industries

–  Focus is truly long term, these businesses are often dynasties with a multi-generational management.

–   Exposure to assets which are unlisted/unavailable to normal investors.

–  They are often illiquid and institutional investors seem unwilling to do the analysis on them.

These stocks are currently despised by the market, hence the massive discount to NAV but this has not always been the case. In 2006/7 these stocks were very much “in play” with hedge fund arbitrage and the discounts narrowed dramatically. There is no sector wide catalyst but eventually the discounts tend to narrow as a result of investor attention or corporate actions unlocking value. As you would expect, valuations dictate the level of exposure the portfolio has to these stocks, in 2006 after the discounts had narrowed substantially only 25% of the portfolio was in these companies as opposed to 55% today. The allocation reflects the opportunity set.

 

European Equities

I laid out the case for turning relatively bullish on European Equities in a previous post here…

http://kelpie-capital.com/2011/12/12/europe-be-greedy-when-others-are-fearful/

Ultimately, much of Europe is now at a level of CAPE valuation where returns are very good almost regardless of what is going on in the macro environment. The holding companies that BTEM owns are often European (Vivendi, Investor AB, Orkla, Aker, Deutsche Wohnen) and some contain relatively cheap European equities with the additional conglomerate discount layered on top.

About 41% of the portfolio is in Continental Europe and 4 of the Top 5 holdings are European (totalling 27%).

 

No Sell-side coverage/Institutional Sponsorship

A cynic would say that research analysts from sell side firms are only assigned to cover stocks and sectors where the investment bank or brokerage divisions can leverage their work to make good commissions or fees.

Investment Bankers must be sick of these conglomerates and family owned holding companies, they aren’t particularly acquisitive, they don’t take on much leverage because they don’t want to jeopardise their reputation or their hard-earned wealth.

Brokers can’t make much money from them either, the volume in these stocks is quite thin and the average holding period is a lot longer than your average stock so they don’t get the turn or churn in clients portfolios either. It’s difficult to justify a quick buy and sell of a stock like Jardine Matheson or Jardine Strategic, the owners of which can trace their involvement in the company back to 1832. Furthermore, the controlling Keswick family have had five generations of the family in the business – these companies are about much more than a stock price, they are a family tree, an inheritance and they are legacy.

Because of this awkward reality, a browse through most sell side research databases would have you believe that these companies do not exist or an in some way inferior, the lazy “conglomerate discount” tag being used to keep price targets unnecessarily low. This is the reason why the investment holdings companies and conglomerates are mispriced.

A second angle to this institutional disinterest lies on the “buy-side” and explains why I think Investment Trusts are attractive going forward. The Wealth Management and Asset Management industries are undergoing great change. Wealth Managers and private client stockbrokers have traditionally been the holders of investment trusts but “fashion”, size/liquidity constraints and desire to minimize benchmark risk have meant that there is a wholesale move across the industry out of “old fashioned” investment trusts and into the newer style of unit trusts or OEICs which are open ended and do not have premium/discount issues. They are also attracted to the hidden fees/remittances available through OEICs rather than investment trusts.

So I think that means we have a structural, but not particularly time pressured, non-economic seller slowly liquidating their shares in Investment Trusts. Personally, I think BTEM is particularly likely to be sold by these large firms because it is particularly hard to put in a “style box” – what is it? Global Growth? Property? Equity Income? Alternatives?  It’s nothing in particular and for some reason, these institutions seem to hate that!

 

Concentrated Portfolio

 

Description of the Top 5 Holdings

Vivendi – A French telecommunications and media conglomerate that trades on a discount of over 40% to the sum of its parts. Vivendi owns stakes in companies operating in the music, games, television, films and telecoms industries.

Orkla – A Norwegian conglomerate operating in the branded consumer goods, aluminium and energy sectors. A streamlining of the business may narrow the discount to NAV which currently stands at 35%. Orkla could be the Norwegian Unilever.

Jardine Strategic – Controlled by Jardine Matheson, an investment vehicle for the Keswick family, trades on a 38% discount to an attractive collection of Asian listed companies including Hong Kong Land, Dairy Farm and Mandarin Oriental.

Investor AB – A Swedish industrial holding company that owns significant shareholdings in major public multinational companies as well as private companies in the healthcare sector. Investor AB takes an active owners ship role in many of the companies and currently trades on a 37% discount to estimated NAV.

Aker ASA – A Norwegian conglomerate whose interests range from oil and gas exploration to seafood processing. The company currently trades on a 32% discount to estimated NAV.

 

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