This week’s Investment Q&A is with Elite Rated manager Richard Parfect, co-manager of the VT Momentum Diversified Income fund. Richard talks to us about current opportunities available to multi-asset managers and, most importantly, comments at length on a critical issue within the investment trust industry – the inclusion of investment company costs in the reported costs of funds.
(Recorded 22 September 2023)
Your largest holdings are in high yield and emerging market debt which most wouldn’t immediately consider defensive sectors, what’s the appeal?
Ultimately the fund is a multi-asset fund, and so you would ordinarily expect a broad range of asset classes in there anyway. But at this time, with rising interest rates across the world, fixed income is an improving asset class in the competition for capital. The names that we have invested in are houses that we’ve been very familiar with over many years and we have a very high level of respect for them in terms of their ability to add alpha, to avoid the accidents that can happen in fixed income; they additionally have a very granular knowledge on the bonds that they hold.
So, the Royal London Short Duration Global High Yield fund is, as the name suggests, at the short end of the yield curve, where rates are higher. And also, because it’s at the shorter end, the credit quality tends to be better because credits tend to refinance and secure their financing some years ahead, so there’s no imminent likelihood of refinancing this as well because the credits are running their finances accordingly. Spreads are wider as well right now in the marketplace, so, you’re getting decent reward for risk is the bottom line.
As for our exposure to emerging market debt, we’ve got two holdings. The more active one is Absalon Emerging Markets Corporate Debt. They’re value investors in credit and as value investors ourselves, they’re playing to our own bias. With emerging market debt in general, you’re seeing yields of about 7.2% versus a 20-year average of 5.7%. Again, the pricing and the timing opportunity feel ok now. We also have a more generic, cheaper fund in terms of cost: Jupiter Global Emerging Markets Short Duration Bond. Again, it’s a short duration fund, so at the shorter end where yields are higher and the credit quality is probably a bit safer. The two names combined gives us about 4.7% in emerging market debt which feels not unreasonable, given where yields are right now.
This fund has an inflation target of CPI+5% which in recent years, although not easy, was probably more achievable. As economic conditions have changed dramatically, how do you manage that target today?
When that objective was set, it was some years ago and pre-pandemic and pre-the current world order. It was probably fair to say that the degree and pace of inflation rediscovery was not anticipated. Perhaps it should have been! But I think it still has a value as a handle because essentially, no investor can realistically pretend to say that they can achieve a given investment objective it is, whether it be an absolute return or a relative return, over a short timeframe. Over the medium to longer term, given the nature of the underlying assets within the portfolio, there should be a degree of inflation linkage to those returns, either implicitly or explicitly.
And so the risk is the reputation risk, as it were, to the fund, that when you have a short term period like this, that you will have dislocation of pricing and value as we’ve seen. That sort of pricing should normalise over the longer term. For example, investment trust companies which have blown out to very wide discounts to net asset value – 30%, or even 40% in some cases – have had a significant short-term pricing event, but the underlying net asset values have not moved by anything like that. And, as yields fall as we would hope, then those net asset values should start to recover. And then, pricing share prices would recover and discounts narrow and maybe get to net asset value or even at premium once again. So, you’re kind of seeing a back-ended recovery performance relative to that inflation.
Momentum has been quite vocal in the press recently, alongside Baroness Ros Altman and Baroness Bowles of Berkhamsted, criticising the government and the FCA about synthetic costs on investment trusts and how they are stifling wider investment into these vehicles. Why are you specifically concerned about this?
It’s very important for investors to understand this issue about synthetic costs. Take the VT Momentum Diversified Income fund as an example; we’re reporting an ongoing cost of around 1.54%. That number is comprised of Momentum’s own fee of 75 basis points in the B shares. On top of that, there’s perhaps 25-30 basis points of cost from Value-Trac as the ACD, auditors’ costs, legals, etc. But then on top of that, there’s about 49 basis points, about half a percent, of look through costs on investment companies. And it is only recently that that 0.5% of fee from investment companies has come into scope and has been shown into our cost.
The problem is that when we buy investment companies, we pay the share price, we don’t pay their NAV. It may be that the share price happens to be the NAV, but that’s purely a temporary coincidence. We buy the share price. And a share price of any company, whether it be Marks & Spencer’s or HSBC or an investment trust, such as Greencoat UK Wind Plc, that share price is a reflection of multiple factors, one of which would be its cost of operation. If all things were equal, you would expect that if Marks & Spencers, for example, became suddenly highly inefficient and doubled its cost and its margins fell, the share price would fall; so, you are paying a price that reflects those inherent costs.
Previously those costs were not included. But now, for the sake of openness and disclosure, those already disclosed costs are being included, but they’re not actually being paid by investors; they’ve already been paid through the share price. Including them in the reported cost of our fund of 1.54% in total, half percent of which is from investment companies, has not been paid, it’s a purely optical number. Otherwise you’re double counting; to include them, it’s implying a double counting effect.
As an example, if I as an investor wanted to buy SSE Plc, an operating company name many people will know that operates wind farms and power generation. It’s a listed company with an internal management structure. That company reports, in its report and accounts, £1.1bn of operating costs, because as an operating company, it naturally has staff, employees etc. So, with £1.1bn of cost, but as it’s not an investment company, it is optically free; I could buy that and there would be no cost for me to disclose.
However, if I look at Greencoat UK Wind which is a very similar company – it also operates wind farms, some of which were bought from SSE Plc, and continue to be operated by SSE, but Greencoat Wind UK owns the wind farms – that’s an investment trust, and that has to – by regulation – disclose costs of, let’s say, 1%. Greencoat Wind UK accounts for about 1.5% of the VT Momentum Diversified Income fund, so, by bringing that into scope, it then adds about 1.5 basis points. So, that’s a member of the 49 basis points of our costs, and that has made my fund look a little bit more expensive, despite the fact that it’s not doing anything different from SSE, but it has to report a cost and SSE doesn’t.
So, there’s this understandable implication that cost is bad. Clearly if you double cost, returns have fallen, but I’m just trying to explain where it’s been disclosed; you don’t want to have this double counting effect. And, as it happens, Greencoat Wind UK, since its inception, has outperformed SSE by 1.5% per year, in terms of shareholder return.
Quite rightly, there needs to be consumer understanding on the costs – but the trouble is we’ve now got a situation where some funds are looking optically expensive just by the coincidence of how they happen to decide to invest in wind farms, for example, whether it be SSE or Greencoat Wind.
Listen to Richard expound further on this critical issue for the investment industry, explaining how the guidelines have not been taken up by everyone, thus creating ‘an unlevel playing field’ which is why Momentum and other companies are engaging with the government to ensure that consumers are able to understand the differences in cost.
He closes his interview with FundCalibre simply stating, “If investors are going to make investment decisions based on cost, it needs to be very clear that the number they’re looking at may not actually be the fair number that they think it is.”
You can listen to the full interview in Episode 283 of the ‘Investing on the go’ podcast series, with Richard covering all the points below.
- The largest holdings in the VT Momentum Diversified Income fund
- How high yield and emerging market debt can be defensive
- Why the fund is leaning towards fixed income
- The importance of specialist assets, including an airline leasing company
- The role of gold in the portfolio
- The fund’s inflation target of CPI plus 5%
- Managing expectations around inflation
- Synthetic costs on investment trusts
- Why trust costs could be misleading to investors
