Investors looking for direction and inspiration should look no further than John Baron’s Portfolios


#1

Originally published at: http://whichinvestmenttrust.com/investors-looking-direction-inspiration-look-no-john-barons-portfolios/
John Baron crams a lot in to his day, he’s an MP and member of the influential Foreign Affairs Select Committee, he is married with teenage daughters, he’s campaigned to improve cancer services, he writes a regular column in Investors Chronicle, oh and he manages and regularly reports on a range of model portfolios as…


#2

The performance of his portfolios is impressive. Especially the Summer portfolio, I’ve nicked a few god ideas from him.


#3

I agree and I find it interesting to compare myself to the description of them. I imaging a person for all of them, and one of them is me.

Did you know he is a Conservative MP as well? That’s a surprise. Not too keen on the Conservatives overall but I like John Barron.


#4

I do have issues with a couple of aspects of these portfolios, and mainly with the Winter Portfolio.

The first is to do with bonds. One of the attributes given to this allocation is that it usually brings diversification to movements in the prices of capital, i.e. when equities fall, bond proces rise and vice versa - QE notwithstanding. However, a fair proportion of the bond allocation is to the high yield variety, also called sub-investment grade, and this type of bond has a higher correlation with equities than either gilts or investment-grade bonds. So the actual level of diversification is lower than might appear at first glance.

The second is the inclusion of Invesco Perpetual Enhanced Income and M&G High Income income shares. IPE’s method of gearing carries additional risks compared to other forms: a counterparty might go bust, or one oe more of the counterparties might close the position which could force IPE to sell assets in order to pay back the debt, and those assets could be difficult to sell in a market downturn and having a negative impact on the NAV. Plus, IPE maximum gearing level is 50% which it quite a bit higher than usual for investment trusts, although it is not near this level right now.

Further, IPE has the same management team as City Merchants High Yield Trust which is also in the Winter Portfolio, so there is no benefit from manager diversification with holding both. From an income persective, consider what holding both gives instead of consolidating into just the comparatively lower-yielding CMHY. Using the yields provided by the AIC, a potfolio allocation of 6.5% to IPE yielding 6.9% plus 9.5% to CMHY yielding 5.5% versus a single allocation of 16% to CMHY gives an increase to the portfolio’s overall yield of… 0.091% - on a portfolio valued at £100,000 that amounts to an extra ninety-one quid a year. Is the additional risk worth the risks? Whilst there have been some changes to IPE over the years, a look at its performance in the downturns of 2000-2003 and 2008-2009 shows the potential risk to capital that this fund has, and over relatively short periods.

MGHI has a fixed life and is due to be redeemed in March 2017. Although the yield is currently hefty, there is a risk to capital because the IT’s assets do need to grow in order to be able to pay back the current share price, never mind paying back the full redemption entitlement. Although they are reported as currently being at a discount to NAV this is based upon the current entitlement of the ZDPs rather than their final redemption price: assuming zero growth in current assets would mean that there would be enough left over after repayment of the ZDPs to pay around 51.4p per income share - something that has a current ask price of around 56.5p. If that loss did transpire then that would eat substantially into that income yield. Whilst the gearing provided by the ZDPs does mean that the growth in assets required to repay the current ask price is not too great, it also means that a fall in assets of a similar magnitude would accelerate losses. In all, too much potential risk to capital which is not in keeping with one of the stated aims of seeking to protect capital.

The further problem with MGHI is how to replace that yield after redemption, regardless of the eventual redemption price. Anything yielding similar must be seen as carrying a higher risk to capital. If the answer is that the reduction is something that can be lived with, then my next question would be to ask why to take the risk with the capital if that level of income is not a necessity right now.


#5

Certainly quite a lot of overlap with my own holdings across these portfolios. Main oversight I can see, is no private equity exposure - especially given some of the yields available in that sector and trusts still on reasonable discounts.

I can appreciate @arkwelder view on MGHI with reference to the portfolio aims, but as an investment its done me very well over the last few years (I wouldn’t re-invest the dividends though). The share is on a large spread so I wouldn’t necessarily buy (or sell) this close to the wind-up. Overall the package unit has performed ok, and if you understand the split capital gearing impacts (both on the upside and downside) then these shares can be worth a look.
For the Autumn portfolio - I’m sure MGHI has been a lower risk investment than City Natural Resources (CYN).

Good to see Aberforth Geared Income (AGIT) in the Summer portfolio - its a split capital trust I’m very keen on, but can see a lot of overlap with Acorn Income (AIF).


#6

Hurray for Splits! :heart_eyes: I also love AGIT.
I think M&G should make the Redemption price of 70p in time (March 17) - all things considered, but any bump in the road will bring it back significantly. However, this trust is an exception to splits in that it has three classes. Two of which don’t pay an income, hence the massive current yield of 12.6% :open_mouth: . If you really want a punt look further down the tree and go for the capital shares! Big risk of losing the lot but if there is a steady positive run… If the trust was to wind up now the caps would be worthless, underwater by about 20p but the recent comeback has been impressive. Track the numbers, however I would be wary of Morningstar data. Currently having a little spat with them! :angry:


#7

Sorry, the -20p for the caps was if you deducted the full redemption for both the ZDPs and Income shares from month end NAV, not a pro-rata windup.


#8

Three share classes might be unusual for a Split IT these days, @james_pigott, but it was quite common a decade or more ago, and some trusts had more than just three: annuity income shares being one that I recall, which if I do remember rightly would pay out a fixed dividend over its lifetime and have a negligible redeption price. But there seemed to be quite a few variations on this along the way.

In the past I have held income (including MGHI), capital, ordinary income and ZDPs, but I hold only zeroes at the moment. MGHI might be a hold for anyone that needs an immediate boost to their income, but the scope for a total wipeout isn’t that onerous in the context of the ability for markets to fall over a fifteen month period. From this perspective, I consider then to carry far more risk over their remaining life than the likes of CMHY @scjim!

As for the capital shares, I see them as more like investing in derivatives given the level of gearing that they have from both the zeroes and the income shares. Perhaps their only saving grace is that they do have the benefit of limiting maximum possible losses to 100% without the need for a stop-loss strategy.


#9

Yes, I agree @arkwelder. The market certainly needs to move up for anything other than a ZDP to benefit. Some investors just love a wild punt though and I don’t think it comes wilder than MGHC! A sideways market, like the last two years, is not that helpful. Although some trusts still manage to do well, and it tends to be the same investment houses that have the ability.


#10

Re: the M&G High Income Trust
Don’t assume that come 17th March 2017 the trust will cease to exist. It could well be, what is known as and with shareholder approval, rolled-over into a further split trust creation for those investors not wanting to seek a cash exit. Indeed, the M&G High Income Trust was itself created in 1998 as such a tax-efficient roll-over vehicle when the M&G Second Dual split trust came to the end of its 20-year duration. Whether or not the Board recommends such a roll-over course of action will depend on the final NAV of the trust. Being that for the trust’s three classes of share (zero, income and capital) to be ‘in-the-money’ the final NAV will need to be in excess of 193p. This not being the case, then it will be a hard sell for the Board to justify a continuation in some form of investment trust shape or other.
It’s also worth remembering that the vast majority of the trust’s shareholders are in-house retail clients of M&G and its parent company Prudential. Therefore, as the M&G High Income Trust is now the only closed-end fund still being run by M&G, it is still unclear if M&G want to completely get out of investment trusts. I have the feeling that M&G are being pushed in that exit door direction by its parent company – though, things could change. The jury has yet to reach a final verdict on M&G’s long association with split investment trusts – but, I’m not particularly hopeful on that score.


#11

What is a ‘zero’ in the split cap structure @forrado ? I am familiar with the income and capital shares but I am not familiar with the zeros?


#12

Hi there harjinder
A “Zero” – or to give its full title “Zero Dividend Preference” - is a class of share that:
1: Is zero dividend – meaning that if pays no dividend during its life.
2: Takes preference over other subordinate classes of share – in this particular case; the income and the capital – come a scheduled wind-up date.
3: Is entitled to be redeemed at a predetermined value to be paid out of capital come a scheduled wind-up date – in this particular case; 122.83p per share – ahead of such payments made to subordinate classes of share.

Zero Dividend Preference shares are effectively a form of borrowing. But rather than being charged against the portfolio assets of a trust, the ‘debt’ - and accumulating interest - is charged to the subordinate classes of share to be repaid out of capital on wind up. Zeros are a way of gearing Income shares to provide greater income producing potential. The danger is that gearing is a sword that cuts both ways. The M&G High Income Trust has attempted to mitigate such gearing dangers to some degree by always declining to gear up the balance sheet.

I know that if one applied for the three classes of share of this M&G IT prior to floatation then:
• 20p would have bought 1 x Zero share that would compound monthly at a rate of 0.75915% over the course of the proposed 20-year life of the trust to give a capital entitlement of 122.833224p on 17 March 2017.
• 70p would have bought 1 x Income share that would be entitled to receive all income generated during the same 20-year life of the trust – and, was redeemable at 70p on wind up after the Zero had been paid its 122.83p.
• 10p would have bought 1 x Capital share that would be entitled come wind up to any excess capital following firstly, the Zero’s payout entitlement of 122.83p then the Income share’s 70p redemption value.

Therefore, at flotation, the Income share had in effect ‘borrowed’ 20p (28.6%) of its 70p redemption value from the Zero share in order to provide itself with more income generating power over the course of 20 years. With the ‘promise’ to repay the Zero share 122.83p out of capital come wind up. In addition, the Income share ‘borrowed’ a further 10p (14.3%) of its 70p redemption value from the Capital share to likewise increase its income producing capacity. With the ‘promise’ to pay the ‘debt’ back by allowing the Capital share to claim all excess capital remaining after the needs of first, the Zero share and second, the Income share had been honoured - no matter if there were any excess funds to claim or not.

I know the purpose and impact of Zeros are difficult to understand for some who haven’t seen them at work before. Think of it as money borrowed to gear income but repaid out of capital in a lump sum at some later date. In all honesty, I wish Zeros had never been introduced from the States in the 1980s. They over complicate matters. I much prefer split investment trusts to have just two classes of tradable share. An Income share that is entitled to all the income and comes with a preset redemption value on wind up and a Capital share, that once the redeemable value of the Income share is covered by the NAV, gets everything else – that’s gearing enough for me.


#13

@forrado, I’ll be very surprised if M&G offer the option to roll over into a new Split IT, more likely that investors will be given the option to roll into one or more of their open-ended funds. There might also be the option of rolling into an existing conventional trust, possibly managed by a different fund company - would Mr Woodford fancy increasing the size of his income IT, for examle?

Throughout the ninenties and noughties, I think it was three ITs that where run by M&G, of which two were lauched as rollover options for their older split trusts. At the end of their lives, one, if not both of those trusts had the option of rolling into M&G High Income as well as OEICs, but the IT was already in existence at the time.

It might be more difficult, or at least the potential outcome too uncertain, for M&G to launch a new IT in the hope of retaining sufficient capital to make it viable. This issue is compunded by the current split of total assets between each share class, being approximately 2:1:0 for zeroes, income and capital shares (data sourced from the AIC). However MGH started life, the current split represents quite a massive level of gearing on the income shares: around two hundred percent - compare that with the more usual 20%-30% maximum for conventional trusts.

For a new IT to be launched and to be viable, a large proportion of the current ZDP holders are likely to have to convert into either ordinary or income share classes. This would reduce the level of gearing provided by the zeroes to those other classes, but it would also reduce the yield on those other classes too. Possible, I suppose, if a new Split IT were to have zeroes and their redemption entitlement set at such a low rate as to make other the options more attractive - and quite possible given the low rates available elsewhere (and an example being the 2016 ZDP rollover for JZ Capital). But if the ZDP holders were allowed to fully roll over into a new ZDP then those other new share classes are likely start life with a similar level of gearing to the current level - how may investors would - or should - want to buy into a new income-generating investment with that level of gearing? But what do I know - I wouldn’t have forecast that Leicester City would be vying for the Premiership title this season, never mind for a place in Europe next season…! :wolf: (not that I’m a Foxes fan, I might add - and yes, I do realise that the smiley would be more appropriate for Wolverhampton Wanderers…).

If M&G did decide to offer a closed-end rollover - and one which they managed - then I’d expect the Capital share class to be ditched, so either a conventional trust or an ordinary income share class geared with zeroes. If you consider that many investors these days seem to want to eliminate discount/premium issues with discount controls, they’re unlikely to have much interest in a share class where there is the chance of a 100% loss of capital over the long term. But whatever the eventual options provided, I strongly suspect that the replacement yield will be substantially below the one available on MGHI.

+++

Trusts that are geared by ZDPs can be of great benefit to income investors. Because the ZDP’s entitlements are rolled up and paid out of capital upon their redemption, this lack of charge againt the revenues of the trust allows more of those revenues to be paid out in the form of dividends, i.e. you get a higher dividend yield than might be achieved by a similar level of gearing provided by interest-based debt, such as debentures and bank loans where the ongoing interest is serviced out of the trust’s revenues. So a trade-off for the income investor: higher payments now at the cost of a lower capital return sometime in the future. But so is allocating a proportion of management fees to the capital account for that matter!

If I had gripes about any particular form of gearing then it is likely to be that provided by convertibles: not only are the interest payments paid out of revenues, therefore reducing the yield on the trust, if the bonds are converted into equity then that can still dilute the returns to existing investors because the new shares will be entitled to future dividends out of those same revenues.