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Merchants Trust: May 2022 update

Senior Investment Analyst Joseph Hill shares our analysis on the manager, process, culture, ESG integration, cost and performance of Merchants Investment Trust.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

  • Simon Gergel is an experienced income investor and has managed Merchants Trust since 2006
  • The trust increased its dividend by 0.4% to 27.3p per share in the year to the end of January 2022, the 40th consecutive annual increase
  • The trust aims to provide a high level of income, and to grow the income and capital over the long term

How it fits in a portfolio

Merchants Trust invests mainly in larger companies listed in the UK with an aim to provide a high level of income, and to grow the income and capital over the long term. It could therefore fit as part of an income-focused investment portfolio or add larger UK companies exposure to a broader, diversified portfolio.

Manager

Merchants Trust has been managed by Simon Gergel since 2006. He works closely with Matthew Tillett and Richard Knight and with the wider investment resource at Allianz Global Investors (AGI). They carry out individual company analysis in addition to looking after the management of the trust.

Gergel is Chief Investment Officer for UK equities and head of the UK Equity Income & Value Team. He joined AGI in 2006 from HSBC and previously began his career managing UK equities at Phillips & Drew. He also co-manages the open-ended Allianz UK Equity Income fund. Tillett joined AGI in 2006 and manages the Allianz UK Opportunities fund and Brunner Investment Trust, which also invests overseas. Knight joined AGI in 2014 and is co-manager of the Allianz UK Equity Income fund with Gergel and deputy manager of the UK Opportunities fund with Tillett.

The team can also draw upon the wider group’s research and analysis in the credit, Environmental, Social and Governance (ESG) and macroeconomic areas. They can also use “grassroots”, which is an established, on-the-ground research and information gathering program to help provide real world insight.

Process

Merchants Trust mainly invests in larger UK companies with a small allocation to some overseas companies. As of the end of April, this stood at 10.9%. Gergel looks for quality companies, which can be bought at a reasonable share price and pay a high dividend. If they don’t pay a high dividend now, they are bought on the basis they will yield in line with the market within 18 months unless there is an exceptional circumstance.

Gergel’s investment process focuses on three key areas. Firstly, he aims to understand the fundamentals of a company, including its competitive position and financial strength. Valuation is a key element, and the manager aims to buy shares at a price he believes is much lower than what the company will be worth in future. He looks at valuations compared with both the company’s own history and its peers. Finally, he considers industrial and consumer themes together with the economic outlook. Themes describe the environment in which a business operates and help Gergel to understand the likelihood of various scenarios happening in the future.

Investments are sold if the share price no longer offers enough value, if there’s a change in the investment case or if there are better opportunities elsewhere with greater return potential.

In the trust’s last financial year to the end of January 2022, the manager made some changes to the trust. In total during the year Gergel added 12 new companies to the portfolio whilst nine were sold completely. Gergel added the emerging market fund manager Ashmore to the trust on the basis of its strong balance sheet and exposure to an attractive asset class. Other new investments were made in the shares of supermarket, Tesco and analytics company RELX after periods of underperformance. Gergel also made use of his flexibility to invest up to 10% of the trust’s assets in listed overseas shares by adding four European businesses.

In terms of businesses sold, real estate operator, Hammerson exited the portfolio after Gergel’s conviction in the business fell given the structural pressures on shopping centres. Another of the businesses sold was car distributor, Inchcape which Gergel felt had reached fair value and so favoured alternative opportunities.

Investors should be aware the trust can borrow money to invest with the intention of increasing returns (known as gearing), but this could magnify losses in a falling market and increases risk. The average level of gearing in the year to the end of January 2022 was 12.7% of the trust’s assets. The manager can also uses derivatives, which adds risk.

Culture

Allianz Global Investors (AGI) is the asset-management arm of Allianz SE, the German-based financial services and insurance company. As with any large asset manager, the investment resources are substantial and spread globally across asset classes. AGI’s research platform combines a large global team of investment professionals, including credit research analysts and environmental, social and governance (ESG) specialists.

ESG Integration

Simon Gergel aims to identify and analyse environmental, social and governance (ESG) factors that could impact a company’s prospects. This helps him understand the extent to which a business is exposed to reputational issues and if they are reflected in the share price. Companies with a low score on any ESG factor are sold, or if they are to be included in the trust, need to be justified. The manager actively engages with companies included in the trust to promote best practice. Over the course of the Trust’s financial year, Allianz Global Investors has conducted 30 meetings with portfolio companies to further their understanding of ESG issues and engage with company management.

ESG factors have become increasingly prominent within the investment community over recent years. Allianz Global Investors has incorporated ESG into company analysis since 2000, which makes them somewhat of a pioneer in this area. As long-term stewards of investor capital it makes sense for them to closely consider these factors in their investment analysis.

Cost

The annual ongoing charge to January 2022 was 0.55%. Investors should refer to the latest annual reports and accounts, and Key Information Document for details of the risks and charging structure. If held in a SIPP or ISA the HL platform fee of 0.45% per annum (capped at £200 per annum for a SIPP and £45 for an ISA) also applies. Our platform fee doesn’t apply if held in a Fund and Share Account.

Part or all of the annual charge is taken from capital rather than income generated, increasing the potential for your investment’s capital value to be eroded.

Performance

The trust has performed well over Simon Gergel’s tenure as manager, delivering a return of 187.38%* to investors, ahead of the FTSE All Share’s 143.50%* return. The board’s also increased the annual dividend every year for the last 40 years, which is one of the longest records of dividend growth in the UK Equity Income sector, an impressive feat. Although this shouldn’t be taken as an indication for future payments and past performance is not a guide to the future.

Income funds had a tough 2020 as the COVID pandemic severely impacted many companies’ ability or willingness to pay dividends. In the financial year to the end of January 2021 the trust paid dividends totalling 27.2p per share, using revenue reserves to do so. This method of boosting income is used by investment trusts to help boost the income paid to investors during tough times for the market, using reserves accumulated during the good times. In the trust’s most recent financial year to the end of January 2022, the dividend increased by 0.4% to 27.3p per share.

2021 was closer to normality than the previous year with many businesses able to operate with more freedom. That said, the year was still marred by a combination of travel restrictions and disruptions to the labour market with waves of Covid-induced isolation contributing to imbalances and shortages of workers in different sectors. We also saw high and rising inflation with wages, commodities and energy prices rising and unemployment falling. This saw the annual rate of Consumer Price Inflation (CPI) hit 5.4% in December, well above the Bank of England’s 2% target. Despite the challenging environment, the UK market had a good year as confidence in the economic recovery from the pandemic gradually improved.

Over the trust’s last financial year to the end of January 2022, several of its cyclical or market sensitive stocks were among its strongest performers. The engineering group, Meggitt, energy generator Drax Group and media agency WPP were all meaningful positive contributors to the trust’s performance. In contrast, new investments during the year in home repairs and improvements business, HomeServe and reinsurer, Conduit were among the trust’s weakest performers.

Gergel believes that on the whole, corporate profitability is good and the UK stock market is reasonably valued with many sound companies priced attractively. He remains confident that the trust is well positioned to deliver a rising income stream and capital growth over the long term to patient investors. Over the 12 months to the end of April 2022, Merchants Trust returned 18.16% vs the FTSE All Share return of 8.72%. Past performance isn’t a guide to future returns.

Annual percentage growth

Apr 17 – Apr 18 Apr 18 – Apr 19 Apr 19 – Apr 20 Apr 20 – Apr 21 Apr 21 – Apr 22
Merchants Trust 14.46% 1.03% -16.84% 39.46% 18.16%
FTSE All Share 8.16% 2.62% -16.68% 25.95% 8.72%

Past performance is not a guide to the future. Source: *Lipper IM to 30/04/2022.

FIND OUT MORE ABOUT MERCHANTS TRUST INCLUDING CHARGES

VIEW MERCHANTS TRUST KEY INFORMATION DOCUMENT

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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