1 February 2006

Talking about a revolution

John Kennedy's appointment as lead manager on the Scottish Investment Trust has seen it undergo a major overhaul. Alison Swersky takes a look at how the trust is continuing to reinvent itself to woo investors.

John Kennedy's appointment as lead manager on the Scottish Investment Trust has seen it undergo a major overhaul. Alison Swersky takes a look at how the trust is continuing to reinvent itself to woo investors

After a difficult and at times downright grim few years, the revamped Scottish Investment Trust is clearly ready to be noticed by private investors. Since John Kennedy took the reins as lead manager in January 2004 from Ian McLeish, who retired after 30 years at the trust, the £1.1bn sleeping giant, one of the world's oldest and largest independent, self-managed investment trusts, has been quietly but vigorously shaken up.

In the past two years, Kennedy, who joined the trust in 1992 and was promoted to chief investment offi cer in 2002, has signifi cantly reduced borrowings – sliced the number of holdings, from almost 250 in mid-2002 to around 115 – and overhauled the stock selection process, getting rid of quasi-tracker investments.

This more focused approach to stock selection is refl ected in the absence from the portfolio of major stocks such as Shell, Unilever, Nestle and HBOS. Kennedy has also reorganised his team around a coherent global strategy, rather than having separate portfolios in each of the major geographic regions, freeing the trust from its old institutional-style shackles.

The revolution is set to continue, with the board recently suggesting the company's 50% FTSE All-Share, 50% World excluding UK benchmark be removed to allow greater fl exibility away from the market capitalisation- weighted indices, although no major changes are expected in the near future.

The board is also proposing a tender offer for up to 40% of the trust's share capital at a discount of 9% with debt at par (around 7% with debt at fair value), to clean up its shareholder base and take out arbitrageurs, who have built up signifi cant positions in the trust. Hedge fund Carousel Capital, which has a stake of 10.6%, has already pledged to tender its entire holding.

The tender offer will be supported by a new share buyback policy aiming to maintain a discount of 11% or less, with debt at par value, or 9% at fair value in "normal market conditions" – if such a thing exists. If the scheme is approved at an extraordinary general meeting on 27 January, the board will use the equity repurchased through the tender to repay part of its longterm debt of £150m. In anticipation, it has already hedged interest rate movements on 20% of its debt through a swap agreement.

Like most Global Growth funds, Scottish Investment Trust has been under threat from lack of interest over the past few years as dull performance turned investors off. According to Charles Cade, head of investment trusts at Close Wins, the trust had little option but to provide an exit for dissenting shareholders, although he admits to being disarmed by the level of the tender discount.

"This is positive for ongoing shareholders, who will benefi t from an uplift in the net asset value of around 2.5% if the tender is fully subscribed, allowing for the cost of repurchasing 40% of the outstanding debt," he says. "The company's expense ratio is likely to rise to around 0.75% but this is still low in relation to most savings vehicles."

Cade is upbeat about the terms of the tender, suggesting that, even if it is slightly oversubscribed, the buyback powers could be used to mop up the excess. However, the question of whether or not to tender appears less clear-cut.

"Historically, this would have been a pretty easy decision because Scottish Investment Trust was a consistent underperformer," he notes. "However, our views on the stock have changed since Kennedy took over. He adopted a single global portfolio approach and introduced greater rigour and consistency in the investment process.

"This has delivered much stronger performance and the net asset value is up by 37% on a total return basis since Kennedy took charge, compared with 33% for the benchmark index, despite a cost of 3.1% – with debt valued at par – for early repayment of part of the company's debt."

In July 2004, the trust repaid a total of £75m of debenture stock, reducing potential borrowings from 32% to 22% of net assets. Effective gearing is currently around 6% and thus well within the board's stated range of 0% to 20%.

The portfolio is currently underweight telecom services, partly as a result of having reduced its position in Vodafone. The manager is also wary of UK and US consumers and has been underweight in retailers and autos in these regions for some time. By contrast, he likes Asian and Japanese retailers and has been adding to banks.

Geographically, the fund is overweight in Asia Pacifi c excluding Japan and Continental Europe, which has paid off handsomely for the fund over the past two years. By contrast, the Japanese weighting of 4.5% is low, particularly in relation to its peers.

"Scottish Investment Trust's performance record still does not stand out among its peers, but we believe it is an attractive medium-term investment for private clients seeking diversifi ed global equity exposure," Cade concludes. "As a result, therefore, we feel there is no compelling reason for investors to tender."