Stock picking secrets of the world’s oldest investment trust

Manager of F&C Investment Trust (LSE:FCIT) Paul Niven breaks down the investment strategy of FTSE 100 investment company, which was founded 1868. Niven talks about where and how the trust invests, why he has been moving money out of expensive shares and into cheaper ones, and what FTSE 100 inclusion means for the strategy. Niven also gives his views on recession and interest rates, and which types of stocks could perform best.

Sam Benstead, deputy collectives editor at interactive investor: Hello and welcome to the latest Insider Interview. Our guest today is Paul Niven, manager of the Super 60 rated F&C Investment Trust. Paul, it's great to have you here.

Paul Niven, manager of F&C Investment Trust: Thank you.

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Sam Benstead: The trust has been around for about 150 years. It's the oldest investment trust and it's just entered the FTSE 100. So, can you tell me a little bit about how it's managed and why it's been so successful?

Paul Niven: F&C Investment Trust aims to be a one-stop shop for investors looking for exposure to growth assets, and growth assets are equities and private equity. So, we take full advantage of the closed-ended nature of the investment trust structure. We have some illiquid exposure in there in terms of private markets, around about 10% or so at the present time. And the remainder is invested into large-cap liquid equities, and we invest in a diversified manner. That means that we have a range of underlying investment strategies that we have exposure to geographically by sector and by style. For example, within the US, which is the single largest part of our portfolio, we have exposure to both large-cap growth stocks like Apple Inc (NASDAQ:AAPL), Microsoft Corp (NASDAQ:MSFT), Amazon.com Inc (NASDAQ:AMZN), and so on, and large-cap value stocks. We blend and manage those exposures through time in a manner that's consistent with delivery of strong investment outcomes for our shareholders.

Sam Benstead: And you have about 400 stocks, does that look very different to the benchmark?

Paul Niven: So, we operate, as I said, an approach which blends focused strategies. We have eight to 10 individual listed strategies, each of those holding a relatively limited number of stocks. In the case of Europe, for example, we've got around 40 stocks in our European strategy, around 40 stocks in our large-cap value strategy. When you add them together, then you end up, as you said, with a little under 400 stocks. The principle is essentially that returns are additive, and risk is not. So, blending those individual strategies in a diversified portfolio should be accretive to returns, while reducing risk, meaning that the overall performance journey for shareholders should be smoother than taking a stance on one segment or area of the market, either geographically by sector or by style.

Sam Benstead: Does FTSE 100 status change anything for you? Do you get better access to companies? More internal resources? And what about the press attention? Is anything going to change with the way you now manage the portfolio?

Paul Niven: It's very much business as usual in terms of how we invest, where we invest. We've got substantial scale in terms of the investment trust and the organisation which I work for Columbia Threadneedle, with $650 billion of assets under management. That gives us great access to corporates, so they'll be no change in terms of where and how we invest.

We've got tremendous scale in terms of resources that we apply to the trust. I manage a team of more than 20 individuals who manage multi-asset portfolios, of which if an investment trust is one and throughout the organisation as well as externally, we've got a lot of access to individuals who at the underlying level are picking either securities for us or helping us select managers and individual private equity investments.

In terms of the attention, the attention is welcome in the sense that we clearly want exposure of the trust as widely as possible, would lure very strong returns for shareholders. I think the addition of the trust, the FTSE 100 will hopefully increase attention.

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Sam Benstead: This year the trust has fallen less than your peers. Why is that? Is it because it's more defensive naturally? Or have you pivoted to taking less risk as the macroeconomic backdrop has deteriorated?

Paul Niven: Year-to-date, it's been a tough period for investors in equities. As you know, we have lost some value in shareholder total return terms and net asset value terms. But against peers, as you said, we've delivered good returns. In fact, we're top quartile year to date, one year, three-year, five-year and 10 years, over all those time periods against closed-ended competitors, so it's been a good period of relative performance.

We made some quite substantial changes to the portfolio over the last couple of years that's carried on into this year, but essentially pivoting away from expensive large-cap growth stocks predominantly in the US. We've sold around $800,000,000 of large-cap growth stocks starting in the second half of 2020, and we carried on that process earlier this year.

We also reduced our position on emerging markets last year and into this year, and we sold out completely of global smaller companies this year, which had been around 6% or so of the portfolio. Proceeds predominantly into cash we raised cash levels up to about £300 million at the end of the first half. Quite a substantial rise that reduced our gearing position. We're expecting more difficult markets and unfortunately that has been the case. And we also reduced a long position that we had on sterling. Sterling has been notably weak at the beginning of 2021, we'd a £300 million long position on sterling, that was reduced to £200 million, at the start of this year. And at the end of the first half, about £30 million. So quite substantial changes, predominantly raising cash, reducing gearing, shifting out of growth stocks with proceeds predominantly going into cheaper value stocks and those stocks with higher yields.

Sam Benstead: Can we have some examples of companies you've sold then over the past year or so to reduce that element of growth in the portfolio?

Paul Niven: We, as I said, invest into individual strategies where we hold stocks in segregated mandates. For example, we have divested materially from US large-cap growth. And as a function of that, we've gone underweight, some of those big names in the portfolio, sold out of names like Microsoft, Amazon, Apple, the big names that obviously had been driving markets up until relatively recently.

Sam Benstead: You said you increased the cash position. So what percentage is now invested in cash and where might you deploy some of this capital?

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Paul Niven: Cash position right now is between 5% and 6% of the overall portfolio. We had raised quite substantial cash levels through borrowings over the course of the past 18 months or so, securing very low rates of borrowing for an extended period. Most of that recent cash freeze has been left in cash. And as I said, some of those sales we've made from large-cap growth has also been left in cash.

What are we looking for to reinvest? The first half of this year has predominantly been about a de-rating of markets. Markets getting cheaper, essentially, as there's been a reset in terms of rising inflation and interest rate expectations. Unfortunately, I think that there is still some downside risk to markets, equity markets from here. The reason I believe that is the case is because we are likely to be entering recession in many of the developed economies. In fact, China looks somewhat problematic as well. And that means there's going to be some pressure on earnings. In terms of the corporate earnings, outturns from here. That I think is likely to place some downside pressure on equity markets in the near term. And therefore, what we're looking for to reinvest [is] better live evaluations, a more realistic assessment by the market in terms of the growth and inflation outlook, pricing levels more generally. And I think that that will take some time. But we're in a good position as and when that unfolds to put that cash to work.

Sam Benstead: You mentioned recession as one of the main risks. Which types of sectors do you think will be most resilient in terms of profits when there is slower economic growth?

Paul Niven: It's an interesting question because classically one would look to growth sectors in the market, your tech stocks, for example, typically in a downturn, they will prove more resilient in terms of the corporate earnings that they deliver. Value stocks, which tend to be more cyclical in nature, albeit cheaper, will tend to underperform. And the quality stocks which have got persistent earnings or free cash flow delivery, will similarly provide typically a good outcome.

I think the challenge this time is that quality and growth, the areas that one would typically expect to outperform in a recession, are still trading at quite a high premium relative to the rest of the market. Some good examples of that, if you take Apple trading at something like a 30% premium to the market, that's pretty much as high a premium as one has ever seen. Great company. But like many other growth companies or high-quality companies, they're turning quite high levels of valuation.

I think it's difficult to be categorical in terms of which areas will provide the best downside protection. I would fall back on the approach of being diversified in our approach. We do have a bit of a tilt to value. I do think investors will remain value sensitive. We have more by way of capital and higher-yielding stocks, which we think will perform relatively well. So, we're avoiding those more expensive areas of the market, which remains the growth tech where we have exposure but are below benchmark at the present time.

Sam Benstead: Paul, thanks very much for coming into the studio.

Paul Niven: 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.