City of London underperformance is a worry
City of London Investment Trust (CTY) has been a popular choice for investors over the years, but a period of underperformance versus the UK Equity Income investment trust sector average on a three and five-year basis is a worry.
Typically investing in FTSE 100 companies, City of London has been a hit with certain types of investors, particularly those approaching retirement or already in it. The trust has a conservative investment approach and has raised dividends every year for the past 55 years. Its charges are also very low at 0.38%.
According to FE Fundinfo data, City of London has generated a near-20% total return over the past five years, which factors in share price gains and dividends.
In comparison, the FTSE All-Share index has returned nearly 30% over the same period. The UK Equity Income investment trust sector has returned 37% in this timeframe, suggesting that income investors might have better options elsewhere.
To illustrate this point, Shares has published the list of top performing investment trusts in this category. The top position on a five-year basis is held by Law Debenture (LWDB) with an 82% return, followed by Dunedin Income Growth (DIG) in second place with a return of 68%.
City of London attributes its lagging performance over periods up to five years as a reflection of how higher yield value shares have underperformed. It has various holdings that fit the high yield value description including stocks in the tobacco sector.
Over 10 years the investment trust has outperformed the broader UK market; data from FE Fundinfo shows the trust returning 128% versus 119% from the FTSE All-Share. However, that is still less than the 146% from the UK Equity Income investment trust sector over the same timeframe.
City of London aims to buy into companies with prospects of long-term growth in profits and dividends at a reasonable valuation. It then sells when the shares become overvalued.
Fund manager Job Curtis prefers companies with good cash generation. This serves two functions. First, it provides money to spend on the business that is critical to facilitating growth. Second, it supports dividend payments. Curtis also favours companies with strong balance sheets.
Curtis has added to his position in utility company SSE (SSE), which he believes is the leading renewable company in the UK. He is confident the group will benefit from increasing opportunities from ESG, which covers environmental, social and governance matters.
The financial sector is another area where Curtis has been adding to positions. ‘UK financials look very poorly rated compared to some of the overseas areas. This was highlighted by the bid for RSA,’ he comments. He has added to his positions in M&G (MNG), Direct Line (DLG), Legal & General (LGEN) and IG Group (IGG).
Curtis has warmed to the tobacco sector, with British American Tobacco (BATS) the largest holding in his portfolio. His enthusiasm for the sector is predicated on their renewed focus on next generation products and their ability to generate prodigious amounts of cash.
‘Tobacco stocks have gone back to having the pariah status that I witnessed at the beginning of my career,’ he says.
The market’s scepticism towards British American Tobacco has left the shares trading at an attractive valuation, in the fund manager’s eyes. ‘It is yielding 8%, has a free cash flow yield of 14%, it is rapidly deleveraging and will be down to three times net debt to EBITDA (earnings before interest, tax, depreciation and amortisation) this year.’
Getting debt under control may prompt British American Tobacco to undertake a share buyback, which according to Curtis may provide a catalyst for a re-rating of the shares.
Curtis favours the consumer staples sector which is a core part of his portfolio. ‘The sector is global and provides exposure to emerging market growth,’ he comments.
The fund manager has been particularly impressed by Diageo’s (DGE) success in America where its Casamigos tequila brand acquired in 2017 has experienced phenomenal growth by leveraging the group’s extensive distribution network.
IN AND OUT
Curtis added three new holdings to the portfolio in the past financial year. These were American network provider Cisco Systems, UK specialist Lloyd’s of London insurer Beazley (BEZ) and Synthomer (SYNT), the specialist chemical maker of nitrile used in the manufacture of rubber gloves.
Recent disposals on valuation grounds include Halma (HLMA), Renishaw (RSW) and Spirax-Sarco (SPX), all positions that Curtis established over 10 years ago and which have made the trust 10 times the money invested.
Positions in Greggs (GRG), National Express (NEX), Ten Entertainment Group (TEG), ITV (ITV) and Carnival (CCL) were all sold on the basis that their strong share price recovery at the time of disposal was ahead of dividend prospects.
Curtis is 60 years old and succession planning appears to be in motion. David Smith has been appointed as deputy fund manager on City of London, having worked alongside Curtis at asset manager Janus Henderson for the past nine years as part of the global equity income team.
City of London needs to find its mojo again if investors are to stick with it. JPMorgan is concerned that underperformance relative to the market and its peers could lead a de-rating of the trust’s shares, which currently trade on 1% premium to net asset value.
However, it notes that the trust has a desire for its shares to stay close to net asset value, implying that it could buy back shares if the stock did move to a discount.
One thing that’s clear is plenty of options exist in the equity income space and City of London shareholders might look elsewhere if they aren’t getting the added value that comes with paying an active manager. The trust does have a good longer-term track record and it would be nice to see it return to form.
Your chance to hear more from Job Curtis
Register now for the free Shares webinar on 12 October 2021 featuring a presentation from City of London Investment Trust.