Job Curtis, fund manager for City of London Investment Trust (CTY), has engineered a remarkable turnaround in performance over the past year. This has negated concerns Shares highlighted last October regarding a period of underperformance versus the UK equity income investment trust sector average on a three and
five-year basis.

On 19 September when the eyes of the nation were focused on the funeral of Queen Elizabeth II, City of London Investment Trust reported results for the year to 30 June 2022. These revealed an improvement in performance with the trust recording a one-year increase in net asset value of 7.5%. This compared with a 1.6% increase in the FTSE All-Share index and a 1.4% decline in the AIC UK Equity Income sector.

This return to form for Curtis means the trust has outperformed the FTSE All-Share index, the AIC UK Equity Income sector and the UK Equity Income OEIC Sector on a one, three, five and 10-year basis.

The trust’s earnings per share increased by an impressive 21% from 17.09p to 20.72p, helped by good dividend growth from its portfolio companies. City of London increased its own dividend by 2.6%, marking 56 years of annual dividend increases, the longest record of any investment trust.

It must also be noted the trust’s ongoing charge ratio of 0.37% is the lowest in the AIC UK Equity Income sector.

VALUE STOCKS BACK IN FASHION

A key driver behind the resurgence in City of London’s performance has been the rerating of value-oriented stocks. This has been driven by a rise in interest rates as central banks have attempted to tame inflation.

In an inflationary and rising interest rate environment, the present-day valuation of future cash flows is negatively impacted. This is bad for funds and trusts that invest in growth style stocks where earnings are expected to be much higher in the future than today. However, it favours those with value style investments – which is City of London’s approach – as these stocks already offer good cash flow today.

New additions to the trust

One of the newest additions to City of London’s portfolio is FTSE 100 private equity investor 3i Group (III).

3i’s biggest investment is in Dutch retailer Action and accounts for approximately half of its assets.

Action is the fastest non-food discounter in Europe, offering an ever-changing variety of approximately 6,000 products in 2,000 stores to more than 11 million customers every week. An additional 8 million customers visit Action’s website on a weekly basis.

The low-cost retailer is ideally positioned to benefit from the squeeze in consumer discretionary expenditure as soaring food and fuel costs force individuals to trade down from more expensive retailers.

3i Group also owns 30% of 3i Infrastructure (3IN) which has stakes in various infrastructure projects including ones focused on energy generation and data communications.

STOCKS DRIVING OUTPERFORMANCE

Defence contractor BAE Systems (BA.) was the top contributor to City of London’s full-year results. The world is on the cusp of a significant increase in defence spending, a direct response to Russia’s invasion of Ukraine, and investors have bid up shares in the sector including BAE in the belief that near and mid-term earnings will greatly improve.

The trust has a 3.3% weighting in BAE Systems whose share price has risen by 43.5% so far in 2022.

The tobacco sector has been another key driver of performance. Curtis holds both British American Tobacco (BATS) which is the portfolio’s largest holding at 4.8% and Imperial Brands (IMB) at 2.5%.

Curtis highlighted British American Tobacco’s 6% dividend yield and free cash flow yield of over 10%. He said the US is the company’s biggest market where it is experiencing considerable success in both the cigarette market and next generation products. British American Tobacco recently became the US leader in vaping after its Vuse product outsold rival Juul.

Year-to-date shares in British American Tobacco and Imperial Brands have risen by 21.6% and 13.9% respectively.

PRICING POWER

The ability to raise prices without damaging demand is a key competitive advantage during periods of high inflation. Both British American Tobacco and Imperial Brands excel on this front. Tobacco is addictive which makes it difficult for people to quit. The industry is also highly consolidated with the four largest companies controlling more than 80% of the market value.

Within the consumer staples sector that accounts for 20.4% of City of London’s portfolio, Curtis has mastered the art of selecting companies that have pricing power. Diageo (DGE), Unilever (ULVR) and Reckitt (RB.) have all demonstrated the ability to pass on increasing input costs to the consumer.

In its results for the year ended 30 June 2022, Johnnie Walker whisky seller Diageo said price increases and supply productivity savings had ‘more than offset the absolute impact of cost inflation’. Unilever increased prices by 9.8% in the first half of 2022 to mitigate cost inflation.

Reckitt also demonstrated the strength of its brand portfolio in its recent first-half results (published on 27 July). The group posted an 8.6% increase in like-for-like sales despite lifting prices by 7.4%.

TAKEOVER BOOST

Asset manager Brewin Dolphin (BRW) is another stock that has been key in driving performance. On 31 March Royal Bank of Canada made a surprise bid for the 260-year-old UK wealth management firm. The cash offer of 515p per share values the business at £1.6 billion, a 62% uplift on the share price the day before the bid.

Fund manager Job Curtis didn’t wait for the takeover to complete before offloading some of the trust’s investment in Brewin Dolphin, selling half of his position at a small discount to the offer price.

He then bought shares in another wealth manager, Rathbones (RAT), whose shares were trading at a significant discount to the valuation at which Brewin Dolphin is being acquired.

Rathbones operates across the full spectrum of wealth management services from discretionary where a professional manages a tailored portfolio of assets on an investor’s behalf to multi-asset solutions, investing in everything from stocks to bonds to property and single-strategy funds.

On a pre-synergy basis Royal Bank of Canada is paying 21 times current year earnings for Brewin Dolphin. Putting Rathbones at a similar multiple would imply a share price of more than £30 a share versus the current £18.68 market price.

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