Most investment trusts provide investors with a diversified portfolio invested across many different stocks and sectors which lowers the volatility or variability of returns.

They typically own small stakes in anywhere between 30 to over 100 companies which can be sold without disturbing the market price.

Castelnau (CGL) is different in that it takes big stakes in a few companies. It is a higher risk strategy, but it can potentially lead to higher returns.

Its biggest portfolio holding is funerals services company Dignity which it took private in January 2023, together with joint venture partner SPWOne, for 550p per share. SPWOne is the investment vehicle of serial entrepreneur Peter Wood who founded Direct Line (DLG).

The trust’s investment manager is Phoenix Asset Management Partners which owns 70.4% of the company. SPWOne owns 13.6% and Frasers (FRAS) has a 1.6% stake.

Castelnau’s chief investment officer is Gary Channon who briefly served as CEO of Dignity and is one of the brains behind Aurora Investment Trust (ARR).

Two portfolio holdings called Rawnet and Ocula specialise in marketing and technology and their services are used to support the other companies backed by Castelnau.

Channon and his team take winning ideas from each investee company, and they apply them to other companies in the portfolio if appropriate, effectively cross-fertilising best practice.

The trust trades at a 1% premium to net asset value. Since inception in October 2021 net asset value has fallen 29.8% compared with the FTSE All-Share’s return of 5.5%. 

It is important to consider that a lot of companies in its portfolio have problems to overcome so investors might need to stomach hard times for valuations with the hope that the eventual rewards far outweigh the near-term risks.

WHAT IS THE INVESTMENT STRATEGY?

The trust invests in companies which have a demonstrable track record of high and enduring returns on capital which it defines as an unlevered average of 15% after tax over a full economic cycle.

An economic moat to protect returns on capital is also desirable and ideally the businesses come with a management and culture who think about capital allocation in the same way as the Castelnau team.

If needed, the broad experience of the board and shareholder Peter Wood means the trust has extensive contacts to find the right people to head up portfolio companies.

WHAT IS THE TURNAROUND PLAN FOR DIGNITY?

Dignity accounted for more than two thirds (68.5%) of Castelnau’s assets as at the end of June 2023. Graham Shircore, CEO of Castelnau at Phoenix Asset Management, says that in his opinion, as a public company Dignity suffered from underinvestment and pursued a flawed strategy which exploited customers by increasing prices without a commensurate increase in service or quality.

The strategy led to a loss of competitiveness in an industry with low barriers to entry resulting in market share loss and a decline in returns on capital.

The first part of the turnaround plan is to rebuild customer trust by providing a good service at a fair price. This will take time and requires spending more money on marketing to build brand value. Ultimately, the long-term goal is to increase market share to 20% from 11% over the next decade.

The second step is to increase sales of funeral plans which Castelnau believes is an underdeveloped market in the UK compared to other countries. For example, 60% of adults in the Netherlands have a funeral plan compared with only around 8% of adults over 50 in the UK.

Not only do funeral plans lock in future business but they create an opportunity to grow surplus float which is available to shareholders.

The surplus is the amount of money in the trust above the regulatory required minimum which in itself is 110% of the expected liabilities.

Castelnau estimates that combining better management of the float with funeral prices likely trending down could generate an extra £30 million a year based on a trust value of £1 billion.

It believes Dignity could eventually have an intrinsic value of between £30 and £100 per share, implying up to an 18-fold return on the buyout price.

GETTING HORNBY BACK ON TRACK

Phoenix, the manager of Castelnau, has been invested in Hornby (HRN:AIM) for more than a decade. After buying out the second largest shareholder, Castelnau today owns 73.4% of Hornby giving it voting control and a board seat. The holding is 6% of Castelnau’s assets.

Hornby is a collection of heritage toy brands including Scalextric, Airfix and Corgi. The company is three years into a turnaround plan aimed at fixing supply chain issues (now complete) and ending discounting of products. Castelnau portfolio company Rawnet is helping Hornby realise its digital potential with customers increasingly finding its products online.

In the quarter to 31 March Hornby’s direct to consumer sales jumped 49% year-on-year. However, it is expected to make a modest loss for the year as higher overheads bite and weaker than hoped for third quarter sales impact the business.

The company is run by Oliver Raeburn who joined in January 2023 and who is already having a positive impact on the business.

Earlier this month Hornby purchased a 25% stake in Nottingham-based international models and collectibles company Warlord Games for £1.25 million with an option to acquire a majority stake on the second anniversary of the transaction and more shares on future anniversaries.

Warlord was founded in 2007 by two former Games Workshop (GAW) employees and is now one of the world’s leading producers of tabletop wargames, miniatures and accessories. The business is run by one of the founders and will continue to be managed by the existing team.

Castelnau believes that creating closer ties between Hornby and Warlord Games, which have known each other for a long time, will offer mutual benefits.

Warlord will benefit from access to a greater pool of resources which may give it the opportunity to accelerate growth of the business while the expertise and experiences of the Warlord team have the potential to aid Hornby.

Dealing restrictions 

Castelnau is listed on the specialist fund segment of the London Stock Exchange which has restrictions on who is permitted to trade  the shares.

This part of the market is aimed at more sophisticated investors and anyone seeking to buy the stock may have to fill out a questionnaire with their investment platform provider before being allowed to trade.

They must prove their suitability and understand there may be limited liquidity in the underlying investments in the trust’s portfolio. 

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