Bargain trusts for 2023 – and Scottish Mortgage outlook

Investment trust buyer Peter Hewitt gives two trust tips for 2023, and reveals his outlook for growth investment trusts, including Scottish Mortgage (LSE:SMT) and HgCapital Trust (LSE:HGT). He also speaks about how he generates an income from investment trusts, the special relationship between growth and income shares of his portfolio, and why it is worth paying a fee for a professional to manage a basket of investment trusts for you.

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Sam Benstead, deputy collectives editor, interactive investor:Hello, our guest today is Peter Hewitt, manager of the CT Global Managed Portfolio Trust, which is an investment trust of investment trusts and comes in both income and growth versions. Peter, thank you very much for coming into our studio. We are heading into the new year, it's almost 2023. So, what are your investment tips as we move into a new calendar year? Are there any bargain trusts that are on your radar? 

Peter Hewitt manager of the CT Global Managed Portfolio Trust: Well Sam, often you can be a bit of a hostage to fortune with this. But I think that trusts invested in UK mid- and small cap, are quite well placed going forwards. Right now, they've not done that well this past year and they are probably typically towards the wider end of their discounts, but my feeling is that once we hit a peak in inflation, which probably is not far off, maybe the first or second quarter of next year, and [when] interest rates reach [their] level, whatever that may be. At that time, we are probably going to be in a recession, or the recession is beginning to deepen a bit. But the stock market looks 12 months ahead [and] it will judge that inflation is coming down a bit. I'm not saying it's going to come back to 2%, but it will be declining and so will interest rates. Both of those are good for the market and I think for mid- and small-cap investment companies, probably quite a few their holdings might be having profit warnings or missing their earnings, profits, and earnings estimates.

But that's when you should be considering them and I think firstly that trusts exposed to the FTSE 250 mid-cap index, that's where a lot of the genuine growth companies in the UK are resident. So, I would see trusts like say, Mercantile (LSE:MRC) and Henderson Smaller Companies (LSE:HSL), they’re both quite big, they’re both liquid, they’re both at discounts. Mercantile’s got a bit of a yield as well. They could move quite strongly. 

And then also, the small-cap sector could also join in, perhaps later in the year. I had a meeting with Neil Hermon, who runs Henderson Smaller Companies, [and] has done for 20 years. He’s got a great record, like Mercantile the shares are off about 40% this year, so they've been horrible. And he said to me because I asked him, he said at the beginning of this year, the p/e of his portfolio was about 18 times. Now you would expect it to be at a premium to the index, but that is quite punchy. When I met him last month, that PE was 11. That's a big de-rating, so some quite good companies now relatively inexpensively valued. Now who's to say the 11 doesn’t go to 10 or nine, it could do but it gives you an idea that probably quite a lot of the de-rating has happened. I might be completely wrong on the macro-outlook, but if we do get to a stage where the worst has peaked, that’s all it needs for the market, for the 250 index the small-cap index to start performing. And these trusts, at wider discounts could give you some interesting returns. So, that’s an area I'm certainly looking at for next year. 

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Sam Benstead: What are your favourite ways of generating income in your income portfolio? Do you look at stocks, alternatives, or perhaps even bonds? 

Peter Hewitt: Well, yes, predominantly equities, but I do have some alternatives. I've got, I think, three renewables trusts, I've got Hipgnosis Songs Ord (LSE:SONG), the royalty income fund, which has not performed, although the dividend has been fine. And I've got certain specialist property trusts in healthcare. I'm thinking of Assura (LSE:AGR), Impact Healthcare REIT (LSE:IHR), which owns care homes. I mean, they're not the most exciting, but they do generate quite a steady dividend which grows. I think that's important; you don't want a fixed dividend now and that helps bolster the revenue account. But most of the income comes from equity income trusts and they are growing quite decently now. 

Sam Benstead: And what about capital appreciation in your growth trusts? What are your favourite growth investments?

Peter Hewitt: Well, I've been saying that I've been adding to two UK trusts this past year and I've been doing that and hopefully that will come through with some strong performance over the next year or so. But I've also got what I call long-term winners, the structural growth trusts that are exposed to areas of the economy, technology, healthcare, biotechnology, and some of the higher growth names that have been out of fashion of late. I've not come out of these completely, they are smaller positions in the portfolio. But it's important to keep them because they will start performing again. And I think it's from these types of trusts that you often meet many times your original investment. So that's the way I'm looking at the portfolio just now. 

Sam Benstead: Private equity is one of those areas that you like, and Hg Capital Trust is one of your top positions. So, why do you like the sector and that investment trust? 

Peter Hewitt: It’s probably the best private equity trust. It focuses all its holdings on software companies in Europe that are business critical and so not really consumer software and they've got a fantastic growth record, some of them quite sizeable. I think Hg Capital, if its underlying companies were all taken together, is the second-biggest software company in Europe. So, it gives you an idea where it's invested. So, the NAV, the net asset value, performs very strongly and it's one I want to own long term.

I like private equity trusts, they are selling [at] quite wide discounts just now and I think you should probably expect the net asset value will come back over the next six or 12 months. But how much will it come in? Are they going to fall 40%, or maybe five or 10%? And if it's the latter, then a 40% discount is quite an opportunity. A reasonably well-run private equity trust almost always beats the All-Share index over the long run, it's worthwhile remembering that. It's a great area to invest. 

Sam Benstead: And why do you think the net asset value of these private equity trusts hasn't fallen yet? We're still getting reports from the companies about the value of the companies they own. But they haven't fallen in the same way that public markets have. 

Peter Hewitt: Yes, I think how the private companies are valued is important. There is an element of comparison to listed alternatives, and that will have come back a bit. There's quite a lot of merger, acquisition, takeover activity, often at premium. And if some of these businesses are growing quite fast and in the case of Hg, something like, I think, 25% a year is what they're EBITDA, their operating profit growth, which is pretty strong. I mean you’re not going to get down rating those types of businesses and sometimes they have an additional funding round where new investors are brought in and that’s often at a higher level. So, we’ve not really seen much in the way of a downgrade of the asset value, but I do think it is likely you will see some reductions in the next six to 12 months. 

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Sam Benstead: Another trust you own in the growth bucket is Scottish Mortgage. It’s a favourite among our customers, but shares have had a tough year, so why are you still holding on and what could be the catalyst for a turnaround in performance? 

Peter Hewitt: Well, Scottish Mortgage has been a fantastic winner over the long term and the shares got to about £15 a year ago and then within six months they were £7. I still hold them, but I halved my holding at about £13 in January. And it was a difficult decision that, but now you could rightly say, why didn't you sell the entire holding? And I think the answer to that is, they have got great prospects. Longer term, some of the investments they've made, they've got quite a lot of private companies and some of the technology and healthcare names in that portfolio. Illumina Inc (NASDAQ:ILMN), Moderna (NASDAQ:MRNA), have got great upside. I think you'll not see that starting to perform until we see interest rates beginning to come down. And that may not be till later next year. So, do I think Scottish Mortgage is going to perform in the next week, month, quarter? Probably not. But if you didn't own it, it wouldn't be a bad time to start building a position because genuinely it's one you should be holding on a five to 10-year view.

Sam Benstead: They lost their lead manager James Anderson quite recently. What is your reading of that? Do you think with the two managers in charge now, which is Laurence Burns and Tom Slater, do you trust them to deliver what James did under his tenure?

Peter Hewitt: Well, the answer's yes. I mean Tom Slater was working with James for a long time, I'm going to say a decade. I’m not sure of the exact period, but many years. And so, he is now the lead manager. And it's not just Laurence, they've got quite a big team with them as well. And Baillie Gifford, that's what they do is find some of these high growth opportunities in new areas and they take investments in them. Some can fail, but when they get a winner, I'm going to [say] they made something like 160 times their money in Tesla Inc (NASDAQ:TSLA) and Amazon.com Inc (NASDAQ:AMZN), which are two of the better-known ones. Now, they're not going to do that again because they're already humongous companies. But there could be ones coming behind, which will give you some interesting returns. So, I'm still relatively confident about that. It doesn't upset me too much that James is no longer there. 

Sam Benstead: When investors buy shares in your trusts, they pay a fee to Columbia Threadneedle, but also they're paying the fee of the underlying investment trusts. So why should investors pay up? Why should they pay these double fees? 

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Peter Hewitt: Well, yes, that's a good question, Sam. Our management fee is 0.65%. And what I would say firstly on fees on our trust and fees in certain areas such as, say, private equity, where there's quite high fees, of course we want lower fees. In the case of private equity trusts, I do often ask them about that. But it's about not losing the wood from the trees because a lot of these trusts, despite the supposedly higher fees, still outperform the All-Share index quite significantly.

In the case of our trust, the growth portfolio had nine consecutive years of beating the FTSE All-Share. It didn't in the last year, it performed poorly. So yes, it was fees, but hopefully a professional manager will help to get some outperformance. The other thing about owning our trust is it has a unique feature and I think it's unique anywhere in the London market. And it's this, the two portfolios have really nothing to do with each other except in terms of income and capital transfer.

So let me explain very briefly. The income portfolio from the day we launched, to today has an underlying yield of somewhere about 4% and 4.5%. And the growth portfolio, and remember it's capital only, but some of the holdings do pay some dividends. Its yield is often 1%, give or take. So, what we do is when a dividend goes into the growth portfolio, say Scottish Mortgage, a very small dividend, it gets transferred across to the income portfolio and at the same time, the same amount gets transferred back to the growth portfolio in the form of capital. So, the growth portfolio gets a bit of an uplift, about 1% a year to its NAV. The income portfolio, and remember I said it yields about 5.5%, well, it gets about 1% extra dividend yield, it’s NAV is about 1% lower. But it is a partly an income trust, so it's total return. And that income transfer, I'm not sure if anybody else does it. What I can tell you is it's been massively beneficial, particularly to the income portfolio. I've never had to take big risks with high-yielding trusts that might cut their dividend and it helps the growth portfolio a bit in terms of its capital performance, too. 

Sam Benstead: Finally, the question we ask all our guests. Do you personally invest in your portfolios? 

Peter Hewitt: I do. In fact, I only have two shares that I own, which is the growth and income shares of the managed portfolio trust, it's the same for the whole of the Hewitt family. So, yes. I mean, I'm signed on, [and] if we have a horrible year, it affects me, too. 

Sam Benstead: Peter, thank you very much for coming in. 

Peter Hewitt: Thank you. 

Sam Benstead: And that's all we have time for. You can check out more Insider Interviews on our YouTube channel where you can like, comment, and subscribe. See you next time.