AVI Global 07 May 2019

British Empire Trust (BTEM) has a very long history as a specialist “value” investment vehicle. Over the course of its history, the managers have always aimed to exploit their niche expertise in identifying listed companies which are trading at well below the manager’s estimate of intrinsic value.

Since Joe Bauernfreund took sole responsibility for the portfolio in October 2015, he has significantly concentrated the portfolio, and tried to focus more on ideas which have an identifiable catalyst for a re-rating. Increasingly, the managers look to take a “behind the scenes” activist approach which may help unlock value, or bring forward the catalyst. As we discuss in the performance section, this change has made a tangible improvement to performance.

BTEM’s portfolio of companies offers diversification on a number of levels. First, the underlying holdings of each stock are often highly diversified, meaning that the portfolio is arguably not as concentrated as it looks. Currently, the top ten investments make up 66% of the portfolio, but given these are mainly funds or holding companies with varied portfolios of their own, the top ten underlying holdings represent 20.6%, a level of concentration similar to many traditional equity funds.

In general, the idiosyncratic nature of the strategy means that its fortunes can diverge significantly from global markets, and in fact pigeon-holing the trust is sometimes difficult. Importantly, the trust has very different return drivers from many of its peers.

Following the sell-off in Q4 2018, the weighted average underlying discount of the portfolio is approaching historically wide levels. Clearly part of this is influenced by the portfolio make-up, but it also represents the availability of interesting opportunities the team are finding which have attractive discounts.

Since Joe took over sole responsibility for the trust, performance has measurably improved. After a very strong 2016, the trust has essentially kept up with its benchmark, but is currently lagging global peers over 12 months. On the other hand, it has been considerably less volatile than them, lagging in strong periods for the sector, but falling less far in more difficult periods.

The discount remains wide both in absolute terms, but also relative to other investment trusts. It has certainly narrowed since Joe took sole responsibility for the trust in October 2015, and the performance started to improve. However, the difference between the trust’s discount (9.1%) and the sector average remains wide, with global trusts now trading close to par. This could revert if the world suffers a “growth wobble”, or US interest rates start to rise once again.

BTEM has plenty of peers in the Global sector, but none that look anything quite like it. The portfolio is assembled on its value merits, but on an underlying basis, many of the holdings are high quality growth stories. In an age when many investment portfolios are assembled using a “painting by numbers” approach, it is perhaps no wonder that the discount remains stubbornly wide.

We believe the good performance numbers from 2016 onwards are a direct result of the changes that Joe Bauernfreund implemented in late 2015. We think this trust offers excellent diversification benefits, holding investments which are unlikely to be held by the average investor. The activist approach taken by Joe and the team at AVI is also reasonably unusual in a mainstream product.

If interest rates rise, or we see global growth start to falter, we could see a swift rotation in stock market leadership towards stocks exhibiting more of a “value” style. BTEM’s nuanced strategy, growth with value elements, is likely to perform well in that scenario. Over the medium term the current discount provides insulation relative to global peers, with the potential for the discount to narrow if the performance track record continues to improve, given the unique strategy.