Mercantile 19 November 2020

The Mercantile Investment Trust (MRC) looks to deliver long-term capital growth from a portfolio of UK medium-sized and smaller companies. Managed by Guy Anderson and Anthony Lynch, the trust typically consists of around 80 positions in various UK companies where the managers believe the wider market fails to sufficiently appreciate the long-term potential of the business.

As we discuss under Portfolio, MRC is very much focused on the UK mid-cap market, with Guy and Anthony believing lower levels of broker coverage offer structural advantages to active investors. The managers operate a disciplined investment process focusing on the characteristics and advantages of a business, how these are presently valued, and what the operational momentum of the business is. At present the managers believe that, amidst the ongoing economic challenges, there remain significant opportunities for a number of companies that are not being accurately reflected by their valuations.

Long-term returns have been strong, with a significant contribution over the previous ten financial years from stock-picking, as we discuss under Performance. The Discount has narrowed in recent weeks to c. 2.3% (as at 06/11/2020), as share prices caught up to NAV gains in recent months. More recent returns have remained strong, but the perceived sensitivity to political developments of UK mid caps has, in recent years, seen a degree of mean reversion in relative returns.

MRC shareholders benefit from economies of scale, with an OCF of only 0.44%. Despite MRC’s large size, the closed-ended structure helps Guy and Anthony to manage portfolio liquidity whilst continuing to look for the most attractive growth opportunities and to invest further down the market capitalisation spectrum.

The relative fortunes of the UK market, both in intra-market dynamics and relative to global peers, seem likely to hinge on the shape, velocity and rapidity of any ongoing global economic recovery (and market perceptions thereof). Recent fluctuations in the relative performance of UK financial assets seem suggestive to us that the market continues to regard the UK economy as relatively cyclically exposed to variations in global growth and trade data. The ongoing situation with Brexit negotiations is likely to add to this dynamic. More positive data or positive shifts in global market assumptions on the relative strengths of the UK economy could potentially drive a normalisation in global investor allocations to UK equities.

By further extension, the relative and absolute fortunes of MRC in the short term seem likely to remain tied to these variables. Positive sentiment increases would, we would expect, be likely to see additional upside capture. However, assumptions that the constituent companies are inherently more economically vulnerable than the broader market because of the mid-cap tilt could, in conjunction with gearing, cause downside beta too. Yet MRC appears to be tilted towards companies enjoying more structural drivers of operational growth. Irrespective of near-term dynamics, we think this offers long-term potential in a market offering compelling valuations, but investors should be prepared to accept near-term volatility.