2015 Investment Trust Awards: Best UK Equity Trusts

UK Equity Winner: JPMorgan Mid Cap

The FTSE 250 index of medium-sized UK-listed companies has been the strongest sector of the UK market over the last 10 years, and shows few signs of faltering.

It dipped sharply in mid 2014, but picked up well later in the year, and completed the three years to end January up 68.9% - more than twice the gain from the FTSE 100 index.

Actively managed gearing and good stock-picking helped JPMorgan Mid Cap pull well ahead of its benchmark and the two other mid-cap specialist trusts over that period, outperforming every other trust in the UK all companies and UK equity income sectors in the process. It thoroughly deserves the award.

Georgina Brittain has overhauled the trust since taking charge in March 2015. She adopts a high-conviction approach and warns there will be times when the trust's sector weightings are very different from its benchmark. The board's only stipulation is that at least 85% must be invested in FTSE 250 constituents.

"I cannot buy FTSE 100 constituents, but I can retain holdings in companies that have been promoted, and I currently have stakes in Ashtead Group and easyJet," Brittain says.

She searches for companies which are growing faster than analysts expect, and looks to buy them on below-average valuations.

As a result the trust's portfolio generally trades on a lower average forward price/earnings ratio than its benchmark, but average earnings per share growth is significantly higher. Her reluctance to overpay means she has been light on industrials, as she felt their valuations "had got ahead of themselves".

The trust did well last year because she had the courage to top up holdings such as Howden Joinery after what she considered unjustified summer setbacks.

She raised the gearing following the widespread sell-off, kept investing in London-oriented real estate companies, and benefited from bids for three companies, including CSR and Kentz. She is hoping for more takeovers this year.

"There is a time in the business cycle when it happens," says Brittain. "When growth is hard to come by, valuations are right, acquirers' balance sheets are strong, and business confidence is high - as it is now due to the strength of the economic recovery."

She believes the collapse in the oil price will add impetus to the UK recovery, and expects the FTSE 250 index to continue to perform relatively well, primarily because medium-sized companies find it easier to grow than larger ones.

Brittain has a sizeable personal stake in the trust, and believes its current double-digit discount represents a good buying opportunity. However, she is prepared for a period of "volatility" following the election, and has reduced active gearing so as to have funds to buy into any dip.

Highly Commended: Finsbury Growth & income

Annualised returns from Finsbury Growth & Income since Nick Train became manager 14 years ago have been double those of the FTSE All-Share index, and it has beaten the All-Share by between 5.2 and 14.9% in each of the past six years, so it deserves its premium rating.

Train warns it is likely to suffer a lapse at some stage, but the board is committed to limiting any discount with share buybacks. The portfolio is invested in just 23 companies, all of which have been held for at least three years.

Most are UK-based multinationals, headed by Unilever, but 15% is in overseas companies such as Heineken and Mondalez. Remarkably, 45% have substantial family stakeholders.

Train is bullish about the outlook, because of technological advances. For instance the holdings include a lot of global consumer brands, and technology is playing into their hands by allowing them to reduce costs while extending their coverage. For example, Burberry's sales are rising online, reducing the need for stores.

Holdings such as Reed Elsevier are also benefiting from the growing use of IT, while Train says shale technology is driving down energy costs. The trust's yield is modest, but dividends have grown at an annual rate of more than 5% over the past five years.

UK Smaller Companies Winner: Strategic Equity Capital

Strategic Equity Capital scoops this award with an impressively resilient showing during a difficult 12 months for UK smaller companies. This followed outstandingly good returns in 2013/14 and an average performance in 2012/13.

Overall, it pulled well ahead of its peer group and shareholder returns were even more exceptional, as its shares moved to a small premium.

SEC differs radically from most of its peer group in that manager Stuart Widdowson concentrates exclusively on companies that are too small for inclusion in the FTSE 250 index, for which the cut-off point is currently around £600 million.

Its investment approach is also different, as Widdowson and his assistant Jeff Harris use extensive due diligence to select just three to five investments a year, and then encourage value enhancement via strategic, operational or management change.

"Our engagement is undertaken in private and involves discussions and submission of written commentary and proprietary analysis to portfolio company managers, their advisers and, where required, other shareholders," Widdowson says.

"What matters most to us at the time of purchase is the quality of the companies. Do they have a strong cash flow and balance sheet? Is their business difficult to replicate due, for instance, to strong intellectual property or big customer lists, and can we see the potential to generate higher profits by making them more efficient? Our mantra is to buy into good-quality companies and sell excellent ones."

Widdowson says his focus is on smaller companies as they are more likely to be under-researched and be more attractively valued. The portfolio is concentrated on 19 holdings, with the top 10 accounting for 78% of assets, so individual holdings are chunky at up to £11 million. The average market capitalisation of the investee companies is around £300 million.

"With so few holdings, we know all our companies really well, so volatility in the market can be our friend," Widdowson says. The trust aims to sell a mature investment via a sale to a trade or financial buyer, or by selling the holding in the market. However, holding periods can be extended by adverse economic conditions or disappointing results.

The trust does not employ gearing, and tends to keep a meaningful cash position, ready to capitalise on suitable opportunities. Its focus on growth means the dividend is a residual consideration. RIT Capital's recent takeover of SEC's management company is a vote of confidence, and should ensure stability.

Highly Commended: Henderson Smaller Companies

Henderson Smaller Companies has continued to show its class, with a strong recovery in the latter part of 2014 ensuring that it was one of only five UK smaller company trusts to achieve positive NAV total returns over the 12 months to 31 January. As a result it claims the highly commended position, having won the award last year.

Manager Neil Hermon focuses on much larger companies than many trusts in the sector, with around 70% of the portfolio in FTSE 250 companies. The trust has over 100 holdings and gearing is normally at least 10%.

Hermon favours companies with good growth prospects, sound balance sheets and strong management. He expects them to prove relatively resilient in hard times, and the trust has outperformed its benchmark almost every year since he took charge in 2002.

Its 10-year NAV returns are among the best in the sector, and its information ratio - which measures longer-term NAV total returns against a relevant benchmark index divided by tracking error - is much the highest in the sector.

The trust is the second largest in the UK smaller company sector, and its ongoing charges are only 0.58%, including a performance fee. It is deservedly gaining a wider following among wealth managers, which is coaxing down the discount to NAV.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.