The main attractions of the generalist investment trust for the private investor have always been cost effectiveness and simplicity. By buying a few shares in a generalist investment trust, you can have access to a professionally managed portfolio that can literally invest anywhere in the world that the manager feels offers an attractive opportunity.

Mark Dampier, head of research at Hargreaves Lansdown, outlines the traditional attractions of the generalist investment trust: ‘For the vast majority of people, global funds are really great. They can be used as the core of a portfolio and investors can then put two or three funds around it as satellites. Global growth funds are sufficient and will serve you pretty well.’

He adds, ‘If you choose your own funds by sector and if you are lucky enough to pick the right market you could do better than a global fund, but I would advise letting the global investment managers get on with it. Global investment trusts can be used by anyone from beginners to experienced investors, as well as by those that just don’t have the time.’

A homogenous group?

However, there was a tendency for most of the last century for the majority of the established generalists to limit themselves primarily to equity investments, with a significant proportion of their holdings in the UK. As a result, it became difficult for investors to tell them apart.

As Robert O’Riordan, investment trust development manager at Baillie Gifford, admits, ‘Ten years ago, all generalists had the same top ten holdings. Now there is a lot more variety, although most global generalists are still heavily orientated towards the UK.’

He adds, ‘If you take a general look at the sector, there is a lot of diversity. In fact, I would say that the differences between the specialist sectors and the generalist sector are beginning to break down. Most of these trusts are now specialist in their own way.’

A key contributing factor as to why these trusts are asserting their individuality is shareholder pressure. Richard Scott, a fund manager at iimia, suggests that ‘The obvious point to make is that with the amount of arbitrage activity that is taking place at the moment in the investment trust sector, no trust, whatever its size, can sleep easily if it is on a large discount. All of the generalist trusts are being held to account for the size of their discounts.’

He adds, ‘This also ties in with developments in regulation. Boards have to justify retaining their fund managers, and every year the trusts’ boards are having to ensure that their mandates are still acceptable.’

Asserting their individuality

Simon Elliott, investment trust analyst at WINS, argues that ‘It is all about the generalist trusts differentiating themselves, and it depends on which route they choose to go down. All of them have stepped up their game and made themselves more attractive propositions as a result. For example, Scottish Mortgage has changed its benchmark from being a 50/50 UK and overseas trust to a genuine global equity portfolio, and has become much more concentrated with 60 holdings.’

He adds, ‘Alliance has become a general wealth management-style product. It has been looking at property investments, hiring a venture capital team, setting up an office in Asia and so on. That is more of an evolutionary story. Foreign & Colonial has also had exposure to private equity for a few years, but to a limited degree. Witan is a fund of funds that is hoping to add value through that approach. It is not really a mixed-asset vehicle, although they are trying to add value through a currency overlay.’iimia’s Scott feels that ‘The move to greater specialisation has led many people to question the role of the generalists. After all, is any investment house now able to offer both good-quality global asset allocation and strong performance across all markets and sectors?’

Long-term focus

The development of the “fund of funds” approach by trusts such as Witan and, to a lesser extent, Foreign & Colonial – whereby specific areas of the generalist trusts’ portfolios are parcelled out to third-party managers – is one solution to the problem of maintaining a consistency of performance across different markets.

James Budden, marketing director at Witan, explains the way his trust approaches asset allocation: ‘The board makes a strategic asset allocation, but the tactical asset allocation is carried out by our two global managers, and they decide where the portfolio will be tilted. At the moment, we are in the middle of a strategic review of managers, mandates and strategies. The board is asking what the best mix will be to achieve the long- and mid-term objective of total return.’

But he stresses that ‘The one thing the board does not do is take short-term bets on the movement of markets, because history has shown that that sort of short-term tactical asset allocation does not work. If it comes off, it is more to do with luck than anything else.’

Budden argues that ‘It is a very measured and logical process that doesn’t rely on in-house economists taking a view on markets. We believe that, in the long term, taking a measured view of what will be happening with markets will provide for better returns that just taking punts.’

Responding to globalisation

Another important factor is the increasing globalisation of markets, which means that asset allocation by market is less important than it used to be. John Kennedy, investment manager at Scottish Investment Trust, insists that ‘What we don’t do is “top down”. We don’t say “This is the year for Latin America and not the year for Japan, so we will overweight Latin America by ten per cent and underweight Japan by the same amount”. For us, asset allocation is really a function of stock selection. We are asking where the best ideas are, and we have geographical teams who compete for the capital of the trust on the strength of their ideas.’

He adds, ‘The one qualifying element is that you have to maintain a balance, but we are more interested in looking at what the earnings cycle is doing and what investment style will be most rewarded. We have noticed that these days, with an increasingly globalised economy, individual markets are much more correlated than they used to be.’

Kennedy argues that ‘Looking at the geographical location of a company is only one of a cross-section of factors that we take into consideration. We are also looking at the mix of style and size in the portfolio.’

Robert O’Riordan agrees: ‘We have found with, for example, Scottish Mortgage that, increasingly, where a company is listed is becoming less relevant. For example, we hold Swedish resources companies like Azko, whose business has little to do with the Swedish economy. So if you concentrate on top-down asset allocation, it doesn’t necessarily mean you will end up with a portfolio that is broadly spread.’

‘James Anderson at Scottish Mortgage adopts a bottom-up approach. For example, some years ago he sold the trust’s holdings in Shell and BP and bought a lot of emerging market oil and resources stocks which were exposed to global growth that was primarily being driven by demand from China.’

Witan’s James Budden says, ‘We probably do it differently to most other generalists because of the nature of our structure. We are a manager of managers. We had to decide how to divide up the assets of the trust, so, at that point, the board decided on an overall strategic asset allocation. This was 40 per cent mainstream UK, five per cent UK smaller companies, ten per cent Europe, ten per cent US, five per cent Japan, five per cent Pacific excluding Japan and 25 per cent global markets.’

Budden points out that ‘The crucial thing in determining our overall weightings is the global portfolio. That is split between two managers, and their decisions will determine the overall split of the portfolio at any given point. So, for example, the current split is 47.6 per cent UK, 21 per cent US, 15.4 per cent Europe and 15.1 per cent Asia including Japan.’

A developing trend

Richard Scott predicts that ‘The trend towards specialisation and differentiation of mandates will intensify. To a great extent, Alliance typifies what is going on. Its 15 per cent discount is as wide as it is because it reflects the criticism from some investors of the generalist approach. But the management is doing the right things and there is a lot happening on the investment side. It is also trying to add value with Alliance Trust & Savings, and that business is growing like Topsy.’

He adds, ‘But it is still seen in the market as encapsulating everything that is wrong with the generalists. Yet under the management of Alan Harden, Alliance has been addressing that. In time, this will probably be recognised by the market and that will lead to a re-rating.’

Scott points out that ‘The other way of doing it is to tweak the mandates, for example trusts like Edinburgh Worldwide adopting a more focused portfolio. I feel that the case for the multi-manager route, as exemplified by Witan and, to a lesser extent, Foreign & Colonial, has yet to be proved.’

Edinburgh Worldwide is another of the stable of generalist trusts managed by Baillie Gifford. Robert O’Riordan illustrates how trusts can differentiate themselves by contrasting the approaches of two more trusts under its management. ‘With Scottish Mortgage, the exposure to UK quoted stocks has come down a lot. It is down to 19 holdings from 33, representing 22 per cent of the portfolio, and many of those companies receive a large part of their earnings from overseas.’

He adds, ‘But you can contrast that with Monks. This trust takes a pretty top-down view, which makes it a very international fund. Currently it has a heavy weighting in oils. The centre of gravity is shifting away from the developed markets and towards the emerging markets, and the relative importance of some sectors has changed enormously.’

Focusing on stock selection

Scottish Investment Trust’s John Kennedy also stresses the importance of focusing on individual stocks: ‘Our principle is always to work from the bottom up because we have to be sure that what we are investing in is interesting, rather than forcing investments into a template. It has been an interesting approach as, for example, it has kept us out of Japan, with one or two exceptions. Nintendo has done well and we have just sold out of Suzuki, but considering the size and depth of the Japanese market, we have next to nothing there. That is because every time we go to our Japanese team, they have advised us not to invest there.’

Alternative assets?

And the emphasis of the global generalists remains squarely on investment in equities, despite trusts like Alliance establishing specialist property and private equity teams. WINS’ Simon Elliott feels that ‘Most generalists would be wary of moving to a mixed-asset type of approach, given their shareholder base. They would not want to go headlong into alternative asset classes for, although there is a growing awareness of these assets, equities are still where the best long-term returns are to be found, compared to investments like bonds or property.’

He concludes, ‘Although they can see the advantages of multi-asset type investments, they would be wary of investing in the wrong asset at the wrong time. For example, Scottish American ran a property and bond portfolio against its debt, to negate its effects, but it has moved out of commercial property recently and sold a lot of its bonds on valuation grounds, which underlines where it sees value at the moment.’

This article is from the July 2007 issue of What Investment.