Edinburgh Investment Trust is one of the oldest in the investment trust sector, having been launched in 1889, and like many trusts of this vintage it has traditionally adopted a generalist approach, seeking a balance of capital growth and income, albeit exclusively from a portfolio of UK equities.

However, the modern Edinburgh Investment Trust (EIT) is distinct from its peers in the AIC UK Growth & Income sector in that, since 2002, its portfolio has been managed by fund management giant Fidelity Investments International along multi-manager lines. This means that specific elements of the EIT portfolio are entrusted to Fidelity managers who specialise in the particular area.

Choosing the team
Overseeing the whole process is Rita Grewal, Fidelity’s UK head of multi-manager portfolios. She explains, ‘I run a range of multi-manager funds, both institutional and retail, totalling £4.5 billion, of which EIT represents around £1 billion. All are actively managed.

‘EIT is a multi-manager fund rather than a fund of funds. Each manager is allocated a sub-portfolio of the main fund. My role involves assessing the level of income required across the whole portfolio and the impact of changes in the portfolio on that income level – in cash rather than percentage terms. Then I assess the impact of manager combination on the fund’s overall risk profile, in terms of manager style, level of diversification and so on.’

Grewal then decides which of Fidelity’s teams of managers will be involved in running the portfolio and how much of it will be given over to their care. She explains, ‘We took over the management of the company’s portfolio five years ago, and initially there was a period of transition where we were bringing stability to the portfolio. We had agreed with the board that it would be a multi-manager fund, with the portfolio run by a mix of Fidelity managers. So what I am doing is picking and choosing between the best of what Fidelity has to offer.’

This gives her the flexibility to change personnel and the asset allocation of the fund to suit changing conditions, though Grewal points out that this is not going to be a frequent occurrence: ‘We started this approach at the end of 2002 and since then have had four changes of manager. The current line-up is John Stavis, who runs core UK income funds at Fidelity, and Sam Morse, manager of our open-ended Moneybuilder Growth fund.’

Understanding its investors
Reference to EIT’s board underlines the realities of managing an investment trust’s portfolio. The fund management house is effectively employed by the board, who are acting in the interests of the trust’s shareholders. Grewal is quick to underline the importance of understanding who the trust’s investors are: ‘EIT is a very widely held trust. Over 55 per cent of its shares are in the hands of private individuals, with many investing through savings and ISA schemes. There is comparatively little institutional holding. The majority are older investors looking for income with low capital risk.

‘This determines our overall investment policy, which would, therefore, tend to be more income orientated; and the levels of income generated by the trust’s portfolio have increased quite significantly in each of the past two years. We have also moved to quarterly income payments.’

This income-orientated approach has to be balanced with the long-term objective of generating a level of capital growth in excess of the market average. Grewal explains,‘The specified objective is capital growth, at least 1.25 per cent above that from the FTSE All Share Index on rolling three-year periods, while generating an income ahead of inflation, as measured by the RPI.

‘So our multi-manager selection has to bear both these objectives in mind. Currently, John Stavis is managing an equity income portfolio for EIT, while Sam Morse’s portfolio is targeted at dividend growth. The proportion of the trust’s assets split between the two varies, but currently it is split roughly 50/50.’

A collective effort
Grewal also stresses that Stavis and Morse are supported by an extensive in-house research base: ‘We have a very fundamentally driven stock selection process,
and the EIT portfolio is based on bottom-up stock selection. There is a team of 70 equity analysts at Fidelity, so each fund manager builds his convictions based on research provided by the team.

‘Our analysts are organised into industry teams and on a large-, mid- and small-cap basis, which means you have a lot of cross-fertilisation of ideas. The analysts conduct their own research, meet companies, speak to sell-side analysts, use third-party research and so on.

‘The vast majority of our fund managers have previously been analysts with Fidelity, so they understand the process. The analysts rate companies on a scale from “strong buy” to “strong sell”, but the final decision on which companies to buy and sell is left to the individual managers. My role is then to pick which of the managers from within the Fidelity team work best for our multi-manager funds.’

The net result is that Stavis and Morse can sift the ideas generated by Fidelity’s in-house analysts to see which best fit their EIT mandates. Grewal says, ‘For example, John Stavis has had a relatively higher exposure to banks than Sam Morse, because Sam does not have to chase high yield. A yield focus is going to mean a more concentrated portfolio, because half the market yield comes from just four sectors.

‘Similarly, the turnover of John’s portfolio is around 50 per cent, compared with 30 to 40 per cent for Sam’s, so the average holding period for an individual stock is one and a half to two years. This reflects our management style. We are looking for long-term winners – companies with strong balance sheets, good cash flows and long-term fundamental attractions.’

Walking the tightrope
Maintaining the balance between income and growth is not easy, especially during periods when income investments underperform. Grewal says, ‘Last year, the EIT portfolio was 60 per cent income and 40 per cent growth, but now it is 50/50. With the initial investment mandate we put together a relatively conservative portfolio, but it was always our intention to aim further up the risk scale, as we have been doing over the past year or so. There is now more than 40 per cent of “active money” in the portfolio, with a slight tilt towards mid-caps and a slight underweight in large-caps.

‘The UK equity portfolio has had a more challenging time recently, because the income style of management has suffered. The sources of yield in the UK stock market have narrowed over the past five years. Yield has mainly been found in UK banks and pharmaceuticals, which have suffered over recent months. At the same time, we have been very underweight in the oil sector; we felt it would see new supply coming on stream, which would affect prices, when, in fact, commodity demand has held up.

‘We have been overweight in support services. When you have a slowing economic outlook, you want to be exposed to stocks that have growth drivers independent of the economy as a whole – for example, companies involved in outsourcing. We are currently underweight in beverages, food producers and mines. We are selecting growth stocks with drivers  independent of the wider economy, so have holdings in tobacco stocks, for example, though we have been moving back into financials as we need the yield.’

Getting into gear
Grewal adds, ‘As an investment trust, the fund can have gearing, and currently the portfolio has around 13 per cent net debt to equity. This is in two tranches,
one to 2014 and the other to 2022, both of £100 million. We currently have a total of £80 million in cash, and the gearing position is regularly reviewed.

‘It is important not to lose sight of the fact that we have also delivered good share price performance. We are cautiously positive, but the board doesn’t want to appear too aggressive at this stage. And the important thing is being aware of what investors want. We are now promoting the fund as providing retirement income, as well as a useful vehicle for saving for grandchildren.’