Mercantile Investment Trust: May 2021 Update

• Guy Anderson and his team hunt outside the FTSE 100 for the next generation of UK market leaders
• The trust mainly invests in small and medium-sized companies, which make more of their money in the UK than overseas
• Long-term performance under Anderson has been strong although this is no guide to future returns

How it fits in a portfolio

Mercantile Investment Trust aims to grow capital over the longer term by investing in small and medium-sized UK companies. It also aims to grow the dividend at least in line with the rate of inflation. The managers look for tomorrow’s market leaders, providing exposure to fast-growing industries which have the potential to benefit from innovation and disruption. Smaller companies are higher risk so this trust could form part of an adventurous portfolio focused on growth. It could also complement others investing in the FTSE 100 or larger international companies.

Manager

Guy Anderson has been co-manager of the trust for nine years and spent just under two decades working in the industry. A graduate of Oxford University, Anderson started his career at management consultant firm Oliver Wyman before moving into investment analysis. He is also Head of UK Mid and Small Caps at J.P. Morgan, a role we believe to be complementary to his management duties.

Anderson works alongside Anthony Lynch who has been co-manager since 2012. He joined as an analyst 12 years ago and has spent his entire career at J.P. Morgan with a particular focus on UK small and medium-sized companies.

Together they form part of a team of six, which includes other fund managers investing in similar parts of the market. They are also supported by an extensive bank of research analysts from across the business.

Process

The managers believe that investing in small and medium-sized companies offers the potential to outperform larger businesses over the longer term. Being small offers flexibility and agility in changing market conditions. Many of these companies often receive less coverage from analysts who typically spend more time researching larger companies, creating an opportunity for the managers to uncover hidden gems.

The process centres around rigorous individual company analysis in order to assess three key areas; quality, valuation and outlook.

Business quality is analysed by looking at quantitative metrics such as profitability and earnings sustainability alongside more subjective areas like the skill of the management team. Annually, they conduct over 350 management meetings which helps them gain a deeper understanding of how management plan to allocate company resources to drive future growth. Ultimately, they are looking for management teams that can successfully execute their strategy and consistently exceed expectations.

Although long-term growth is important, it’s vital to pay the right share price for it. So the team are mindful of valuation and assess whether a company is appropriately priced given its quality and future growth forecasts.

The outlook is also one of the most significant factors they consider. Whilst focus is primarily on businesses fundamentals, it’s hard to ignore the wider economic situation as this can be either a positive or negative. Over the next three to five years they establish if they think the business can deliver better returns than competitors.

This whittles a universe of over 500 companies down to a portfolio of between 70-100. Currently they own around 75. When Anderson first joined in 2012 this figure was over 130 but he’s streamlined the portfolio, now expressing views with greater conviction.

The trust is exposed to the domestic economy with just under 60% of the trust’s revenues generated in the UK. The managers see plenty of opportunity in the retail sector which could benefit from easing lockdown restrictions. Technology orientated sectors like software and computer services are another overweight in the portfolio which have continued to benefit from innovation and disruption.

Most of the trust invests in medium-sized companies in the FTSE 250 and around 6% in smaller companies. Over time, many of these companies have grown and graduated into the larger FTSE 100 index which is home to roughly 13% of the trust’s assets. Once a company enters the FTSE 100, they are not forced to sell it but it’s often used as a source of funding for new ideas. The managers also invest in higher-risk unquoted companies, which aren’t listed on a stock market, but these only account for a very small part of the trust.

Initial public offerings (IPO’s) also provide opportunities for the team to identify potential winners of tomorrow. Companies such as digital automotive marketplace Autotrader, IT infrastructure firm Softcat and value retailer B&M have all been held since they first floated on the stock exchange. IPO activity has been at elevated levels so far this year and the team has invested in the online card retailer Moonpig and clothing brand Dr. Martens. They have already sold their holding in Dr. Martens to take profits after it quickly reached their valuation target.

Aside from supporting new entrants to the market, they also purchased already public stocks such as fashion brand Boohoo and Hollywood Bowl, a company they hope will benefit from plenty of pent-up demand in the economy. They also purchased pet care business, Pets at Home, which offers exposure to rising levels of pet ownership and the products and services required to support this. Holdings such as mining company Polymetal and travel platform Trainline were sold.

The trust has the flexibility to use gearing which can magnify any gains or losses and increases risk. Currently this figure is around 12% but has the potential to be as high as 20%. The manager can also use derivatives, which if used adds risk.

Investors in closed-ended funds should be aware the trust can trade at a discount or premium to NAV.

Culture

Mercantile Investment Trust was founded over 130 years ago, growing to be one of the largest in the UK and is currently a constituent of the FTSE 250 Index. J.P. Morgan is one of the world's biggest asset managers and has investment professionals based all over the world. The team are able to tap into this experience to help guide their decisions.

The managers consider sustainability issues. They favour companies with strong governance, which could enhance a firm's reputation, and actively engage with businesses to help reinforce positive behaviour. ESG (Environmental, Social and Governance) issues also form a core part of the analysts' research process.

Cost

The ongoing annual charge over the trust’s financial year to 31 January 2021 was 0.48%, compared to 0.44% the previous year. Investors should refer to the latest annual reports and accounts, and Key Investor Information for details of the risks and charging structure.

If held in a SIPP or ISA, the HL platform charge of 0.45% (capped at £200 for a SIPP and £45 for an ISA) per annum also applies. Our platform charge doesn’t apply if held in a Fund and Share Account.

Performance

Performance has been strong since Anderson took over in August 2012. Over that period, the trust returned 252.6%* compared with 148.1% for the benchmark**. Remember past performance is not a guide to the future.

Since the start of 2020 it’s been quite a rollercoaster for investors, particularly those investing in small and medium-sized companies. Fears surrounding the impact of the pandemic caused quite a stir in equity markets with many companies seeing sharp declines in their share price. Initially, the trust fell slightly more than the benchmark but has since recovered lost ground.

Over the past 12 months the trust’s net asset value (NAV) grew by 52.8% vs 44.3% for the benchmark. The share price also grew by 47.1%. One of the best performers was long-term holding Games Workshop which navigated the pressures of the pandemic, benefitting from increased online demand and expectation-beating product launches. Performance was also strong in some of the technology focused companies such as Computacenter and Softcat, which recorded its 15th year of consecutive growth.

Not all holdings performed well though. Housebuilder Bellway was one of the largest detractors as the pandemic clouded both future demand and house prices. Other notable detractors included bus operator National Express and travel retailer WH Smith. Whilst they have hindered short-term returns, the managers remain positive towards these business models and their long-term prospects.

A 6.7p per share dividend was paid for the year to 31 January 2021 – a 1.5% increase on the previous 12 months, although the managers did use some of the trust’s reserves built up over previous years. Remember all yields are variable, not guaranteed and are not a reliable indicator of future income. At the time of writing the trust trades at a discount to NAV of -4.39%.

Past performance is not a guide to the future. Source: *Lipper IM to 30/04/2021.

**FTSE All-Share ex FTSE 100 ex Investment Trusts.

Find out more about Mercantile Investment Trust including charges

Mercantile Investment Trust Key Investor Information