Mercantile 05 May 2021
Disclosure – Non-Independent Marketing Communication
This is a non-independent marketing communication commissioned by Mercantile. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.
To achieve long-term capital growth from a UK portfolio of medium and smaller companies with dividend growth at least in line with UK inflation.
JP Morgan Asset Management
Anthony Lynch & Guy Anderson;
Association of Investment Companies (AIC) Sector
UK All Companies
12 Month Yield
Dividend Distribution Frequency
Latest Market Capitalisation
Latest Net Gearing (Cum Fair)
Latest Ongoing Charge Ex Perf Fee
(Discount)/ Premium (Cum Fair)
Daily Closing Price
The Mercantile Investment Trust (MRC) is currently the largest investment trust in the AIC UK All Companies sector, with concurrent benefits from economies of scale. Managed by Guy Anderson and Anthony Lynch, the trust typically consists of over 80 positions in various UK companies where the managers believe the market fails to sufficiently appreciate the long-term potential of the business.
As discussed under Portfolio, MRC has historically had a strong mid-250 bias. The managers believe this offers something of a ‘sweet spot’ between operational scalability, stock liquidity and stock pricing inefficiency, amongst other factors. At a stock level, the investment process balances quality, momentum and value considerations. The managers further consider top-down factors (in many cases informed by bottom-up, stock-specific observations), in portfolio construction, and presently this is seeing them lean towards ‘recovery’ plays at the margin.
Stock selection has been a notable contributor to longer-term returns, as we discuss under Performance, with MRC providing significant long-term outperformance relative to peers and indices. On an NAV basis, MRC has consistently generated a positive information ratio. Flexible use of gearing boosted returns over the previous financial year (ending 31/01/2021). In recognition that significant NAV gains were reducing the effective ratio of gearing the managers could deploy, MRC’s board recently negotiated an expansion of gearing facilities, of which the managers have subsequently availed themselves.
Though the managers focus on total returns, MRC has a strong record of dividend growth. With sizeable revenue reserves in place and a board which has demonstrated its willingness to deploy these to support the dividend, MRC’s managers tell us they have not had to compromise their investment approach in order to chase yield.
Long-term returns have been strong, and we think the evidence strongly suggests that the stock-picking process has been consistently additive to returns (with particular reference to the consistently positive information ratio displayed, as discussed under Performance). Marrying different stylistic inputs, we think the portfolio looks to be reasonably balanced across probable top-down macroeconomic outcomes, but ongoing and potentially accelerating recovery in domestic UK economic activity looks likely to be a positive. Given significant levels of gearing are being deployed, the fact that MRC’s NAV relative to the UK market tends to correlate with the fortunes of mid caps – and that mid caps tend to outperform if the UK is outperforming – we think MRC could be attractive to those positive on the UK market at this time. We think that recent measures to expand the level of gearing available, in recognition of the growth seen in NAV, should be welcomed for ensuring the managers should retain similar flexibility to that they have enjoyed in the past.
Whilst a historic yield of c. 2.5% is not by itself likely to be the central interest to income investors, the strong track record of dividend growth may be. Although it has been necessary to draw down revenue reserves to maintain this in the most recent financial year (and possibly going forward), MRC retains substantial revenue reserve cover – money held back which can be used to support dividends during years when underlying portfolio income is leaner. A mid-single-digit discount level, as presently seen, does not leap out at us as screamingly cheap relative to recent history, but nor is it unattractive.
|Strong long-term returns boosted by stock-picking (with a consistently positive information ratio)
||Overweight to UK revenue generation could weigh on returns if UK economy underperforms
|Large and liquid trust, with attendant low management fees
||Gearing can exacerbate downside (as well as amplify upside)
|Experienced team with significant depth of analytical resources
||Discount is narrower than has been the historic norm
|Strong revenue reserves to support the dividend