Mercantile 30 November 2022
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.
The Mercantile Investment Trust (MRC) looks to identify the best mid and small-cap opportunities within the UK market to generate long-term capital growth. Lead manager, Guy Anderson, looks for companies with quality characteristics that will allow them to grow faster than peers and become the future leaders of their industries.
MRC has a strong long-term track record but, as we discuss in Performance, Guy’s quality-approach has been out of favour in 2022, leading to a rare period of underperformance. Guy has tightened up the trust to help deal with challenging times by focussing on companies with resilient businesses and on structural growth opportunities. This has resulted in the number of holdings being reduced to the lowest since Guy took over (see Portfolio). Guy believes the quality characteristics in the portfolio will provide resilience in the short term, potentially setting the trust up well when the headwinds eventually subside. The sell-off has led to a fall in not only the value of the underlying portfolio, but also the trust itself. As a result, the trust has moved to a Discount that is wide versus recent history.
Notably, the trust arranged long-term debt in late 2021 before interest rate rises which means it is in a very strong position to gear up and take advantage when the recovery comes (see Gearing).
As markets have sold off, MRC has moved to a discount of 10.8%, as at the time of writing. The dividend yield is 3.3%, with the board aiming to pay a progressive dividend, growing at least in line with inflation over the long term.
The FTSE 250 Index, in which MRC’s portfolio is concentrated, is historically a source of exciting returns for investors, housing fast-growing companies which often grow into the giants of tomorrow. While it has fallen out of favour over the past year, as the outperformance of the energy sector has supported the FTSE 100 Index, we think over the long run it is likely to be a more fruitful place to invest for growth investors. MRC has a strong track record of adding value under Guy’s management.
We think the sell-off seen this year has led to a ‘triple discount’ emerging. As we discuss in Performance, not only have broad market valuations come down in 2022, but the quality growth companies in which Guy invests have been particularly hard-hit. Meanwhile, sentiment has pushed the trust’s shares to a potentially attractive Discount. For long-term investors, we think this could prove a compelling entry point to this part of the market, although we acknowledge there could be more volatility in the short term.
Additionally, we think the regearing completed in late 2021 provides MRC with substantial, cheap firepower for when the recovery does come. Somewhat fortuitously, the trust has managed to lock in rates of c. 1.9% on ultra-long-term debt. Guy has focussed on resilience for now, but we believe this Gearing should benefit the trust for years to come.
- Trust has fallen to a wide discount
- Cheap long-term gearing position locked in before rate hikes
- Portfolio focussed on resilient, quality companies
- Small and mid-caps can be more volatile and economically sensitive
- Increased gearing could exacerbate downside, (as well as amplify upside)
- A rising interest rate environment would be a headwind for the trust’s style