Manchester & London Investment Trust (MNL) aims to generate capital appreciation and a reasonable level of income. Managed by Mark Sheppard (who also controls M&M Investment Ltd, which owns over 50% of MNL’s shares) and Richard Morgan, the investment policy has seen a seismic shift since 2015.
The investment process has become increasingly defined by a thesis the managers term ‘Long the Future’ (detailed under Portfolio). In essence, the managers’ conviction is that technological development is reaching a tipping point and that future economies will ultimately see machines exercising more economic power than labour. Therefore, MNL focusses on technology companies, using a highly concentrated approach. Over 90% of the portfolio is in the top 10 positions (as of 30/04/2020). The managers use derivatives (options, contracts for difference) to adjust the net equity exposure, ordinarily holding between an 80% and 120% net long position in equities and adjusting exposure tactically.
Options are also written to manage stock-specific risk. These helped MNL to mitigate some of the significant market downside seen in Q1 2020 (as discussed under Performance). Share price and operational momentum are closely monitored, and share-price momentum is used to inform decisions around deployment of derivatives.
An unusual additional feature of the trust is that every year shareholders with more than 2,500 shares (worth c. £15k as of 19/05/2020) are entered into a prize draw for centre-court seats at Wimbledon.
We think the trust’s broad thematic framework has a compelling logic, particularly in the current environment. However, whether this materialises into the investment outcomes anticipated is an important question. Although the managers have commented that the development of AI in particular is likely to pose structural questions for economies across the globe, historically the ultimate winners of the shifts in society-shifting technologies have not tended to be existing market leaders. Furthermore, whether these technologies are imminent remains debatable; we note that Facebook’s head of AI recently commented that “we are nowhere near matching human intelligence”.
Currently many of MNL’s holdings have strong momentum behind them. We agree with the managers in their assessments of the main risks to MNL (see Portfolio), but perhaps disagree with the managers’ sanguine outlook on the likely ultimate impact should the anti-trust risk in particular materialise.
The use of options as a tool for portfolio risk management is an interesting differentiator, but in our view the process is well founded and the deployment thus far appears to have been effective. It is reassuring to see the very real geopolitical risks to Western shareholders in Chinese share positions acknowledged, as these are not often considered in the wider market. The shareholder structure and low trading volume mean discount volatility may well remain elevated, but the desire to continue to grow through share issuance could ultimately help address this somewhat.
|Use of options in portfolio management has been effective||Dominant shareholder means discount is likely to remain volatile|
|Highly concentrated portfolio in leading growth opportunities||Gearing can exacerbate the downside (as well as amplify the upside)|
|Active monitoring of big-picture risks to main holdings||Single-stock risk is high|
Manchester & London Investment Trust (MNL) seeks to achieve capital appreciation with a reasonable level of income through investment in a global portfolio of between 20 and 40 securities, which will predominantly be in developed-market-listed equities. Managed by Mark Sheppard, Richard Morgan and Brett Miller, MNL currently seeks to identify trends and companies which will benefit from the perceived continued rise in the economic-value ladder of machines at the expense of man.
Whilst MNL has a longer history, the investment strategy underwent a fairly seismic shift around 2015. Prior to this the strategy was, similarly to the present positioning, high conviction but held positions across a range of industries. In the interim 2015 report, the managers noted that the traditional equity-valuation framework had been fundamentally disrupted by the twin (interlinked) forces of the emergence of new technologies and the secular decline in interest rates.
This caused a Damascene conversion to the present portfolio strategy, which is heavily technology-focussed. The most recent holdings show the delta-adjusted exposure, accounting for the impact of any options on the stock (more below).
top ten holdings
||P2P Global Invt.
|Smith & Nephew
||Smith & Nephew
*Polar Capital Technology Trust
Source: M&L Capital, at 31/07/2012, 31/07/2015, 31/07/2018 and 31/03/2020
This strategy of the portfolio is summarised by the manager as ‘Long the Future’. Thematically this is primarily driven by one major concept: the gradual, unstoppable rise of the machines. In this view, the move to an industrialised society over 200 years ago instigated a structural, long-term shift in economic power towards machinery at the expense of man. Although subject to fluctuations in investment fortunes, the managers of MNL believe ultimately investment into technical innovations leads to consistent outperformance.
Where previous technological innovations have generally, by their nature, had obvious limits to productive capacity that can be developed, this need not necessarily be the case for the current epoch of technological development. Previously, technological advances such as railroad developments necessarily had a limit to the level of track that could effectively be laid in the short term whilst generating a return on capital; additional capacity was likely to result in depletion of returns on capital (or even destruction). By contrast, Mark and Richard believe the next wave of growth will be driven by the increasing adoption of AI with the potential to self-perpetuate its own productivity gains. The managers note that machines are already capable of making better decisions than humans when allocated to specific functions.
In the managers’ view, the average corporate expenditure on information technology will ultimately exceed that on labour, with the COVID-19-related shutdown likely to accelerate this trend, having already demonstrated the resilience of software spending (with CEO surveys noting a majority of companies intend to increase it). When companies can add scale without needing to add significant production capacity (such as through software licensing), this allows for greater internal investment in productivity-boosting technology; this should ultimately offer the potential for exponential productivity increases.
When the managers observe the current market landscape, they note that technology companies, compared to the rest of the market:
- hold lower debt levels
- invest to a far greater degree in R&D
- prove more effective at growing profits
- have superior returns on capital and cash generation
They observe that this means technology companies display many typical quality characteristics which are usually ascribed to consumer-staples companies. We discussed this in our strategy note published this week.
To express this fundamental long-term outlook, the portfolio is driven by factors such as the coming and rising omnipresence of 5G, Artificial Intelligence, Software as a Service, Automation, and E-payments, amongst others. All of these focus on the integration of technology and machines into everyday life. At a secondary level, global niche consumer growth and the impact of ageing demographics will also be incorporated. However, the recent impact of the COVID-19 virus has increased the shift within the portfolio to increasingly focus on businesses where human involvement is lesser, with the managers selling holdings in Disney, LVMH and PayPal in recent weeks.
The portfolio currently includes Microsoft, Adobe and Salesforce, the three largest providers of ‘software as a service’ (SAAS), at a combined weight of c. 25.9% (as of 30/04/2020). Already the leading player in this space, Microsoft is also growing faster than the wider SAAS market.
Comparable to similar investment trust products which focus on technology and/or future consumer trends, MNL tends to have exhibited a greater correlation to US large-cap technology indices. MNL has become increasingly heavily skewed towards large caps on both an absolute basis, and relative to other trusts such as Allianz Technology (ATT), Polar Capital Technology (PCT) and Scottish Mortgage (SMT). As a nominally ‘go anywhere’ trust with an avowedly growth focus, the comparison to SMT is probably most apt: we can see below that since MNL largely completed the transition to the current strategy in 2017, it has consistently exhibited a greater R² than SMT to large-cap US technology indices (any reading above zero is indicative that the previous 12 months have seen MNL’s R² to the index at a higher level than SMT’s).
r2 to us large-cap tech index relative to smt, att & Pct
Whilst the portfolio is highly concentrated into relatively few positions, the managers point out that operationally many of these businesses are in fact fairly diverse. They regard Amazon, for example, as essentially having three key businesses within it: 1) Ecommerce & Advertising, 2) Cloud Computing, and 3) Digital Entertainment. With a roughly 40/40/20 split respectively across these areas, the managers believe the operational business is itself fairly diverse. This is replicated across many holdings, such as Tencent, Alibaba, Facebook, Alphabet and Microsoft.
Whilst there is a long-term thematic and strategic framework informing portfolio construction, the managers are cognisant of nearer-term market variability. A distinctive feature of the trust is the active use of derivatives contracts to manage position and portfolio risk. Derivatives are used on the basis of their potential to either increase potential returns or decrease risk (in certain instances, these may be mutually self-fulfilling).
MNL will ‘write’ (in effect, sell) both put and call options, but predominantly will write calls on stocks held within the portfolio as a downside mitigation strategy. Stocks with strong share-price momentum that is reflective of operational improvements may have put options written on them with a view to increasing upside. By contrast, if the managers feel share-price momentum on any particular stock has outrun the operational improvements and that valuations are stretched in the short term, they will be more likely to write call options to mitigate any potential near-term downside. Call options on stocks may also be used to reduce overall portfolio exposure to a broader-based market decline.
The writing of call options on stocks held can somewhat reduce upside in explosive moves higher, but the managers prefer to focus on the risk-adjusted return profile and are happy to accept a lower proportion of an absolute gain in such situations.
Share-price momentum is an important input for the managers, and this also helps inform the use of options. Stocks exhibiting weak relative share-price momentum are more likely to be hedged through the use of covered calls. This was the case when the team introduced Spotify to MNL. Spotify’s share-price performance was weak on both a relative and absolute basis, so the team wrote call options on the stock to mitigate downside risks. Ultimately, continued weak share-price momentum led to them disposing of the stock.
This momentum input to the use of options means that, in addition to running a concentrated portfolio, MNL tends to assign higher weightings to current strong performers. The managers do not believe that holding a limited number of stocks constitutes ‘risk’ in itself, instead taking the view that adding holdings in companies they view as low quality and highly vulnerable to the developing economic environment in the name of ‘diversification’ would actually be increasing risk.
MNL will also commonly hold short positions against baskets of (ordinarily) ‘old economy’ stocks. These are considered both from a structural basis (where long-term declines are expected), and a cyclical basis (where the manager has concerns over the wider market, and looks to reduce net equity exposure with a view to building again subsequently).
Portfolio risk is also considered from the standpoint of structural challenges to the investment thesis. Chief amongst these is the potential legislative threat of anti-trust activity and governments seeking to break up the monolithic corporates which comprise many of MNL’s key holdings. However, Mark takes the view that there is not yet any evidence of a shift in jurisprudential interpretation (which currently stresses that so long as market dominance is not being used to penalise consumers through excessive prices, then no abuse has taken place). Furthermore, sum-of-the-parts valuations might suggest to him that some stocks held would actually be worth even more as separate companies.
Geopolitics and rising tensions between the US and China are also considered a risk, particularly to the large holdings in Alibaba and Tencent. However, whilst the team are vigilant to signs of any risks to shareholders rising in these holdings, they view the current long-term structural opportunity these companies offer as too great to presently ignore. In their view, the growth of software in Asia represents the best growth opportunity over the coming ten years. Global USD liquidity pressures and the pressures facing a dysfunctional Eurozone are also considered market-level risks, but on a relative basis the managers’ expectations are that MNL’s holdings should prove relatively resilient to these issues.
Ordinarily the managers expect to have net equity-market exposure of between 80% and 120%, though in extremis they will lower this further. Accounting for near-term risks following the recent market rally from the lows, it is unsurprising that some options had been partially reintroduced by the end of April, with the managers having liquidated all previous hedges in March following a sharp drawdown in the market. However, the net portfolio exposure remains fairly neutral at around 103%.
MNL also owns debentures entitling it to two Centre Court seats for the Wimbledon tennis tournament. All shareholders with holdings of 2,500 shares or more are entitled to participate in a draw for the use of these seats, with 13 draws (one for each day of the tournament). The Sheppard-family shares are removed from this draw. On this basis, the estimated chance of a shareholder with 2,500 shares winning one of these draws in any given year is about 0.21%.
MNL does not presently have conventional gearing in place. However, the use of option and contracts-for-difference instruments for portfolio risk management gives the portfolio an element of gearing. The net long-equity exposure of the portfolio (adjusting for delta) is presently c. 103% (as of 30/04/2020). Net and gross exposures are actively managed, as detailed under Portfolio, with the aim of maximising opportunities on the upside and providing downside protection. This is applied at both the stock-specific level, and to manage overall portfolio exposure to equity markets.
This proved beneficial in the recent market sell-off in Q1 2020, as we have highlighted in the Performance section.
MNL’s articles of association and investment policy permit gearing of up to two times the adjusted total of capital and reserves. The managers prefer to achieve the effects of gearing through derivatives contracts as opposed to borrowing.
MNL’s returns must be seen in the context of the transformation of the investment policy. Ostensibly the trust is benchmarked against the MSCI UK Investable Market Index. This index is broadly similar to the FTSE 350 Index, and the board continues to make reference to this benchmark as it believes overseas exposure is an active management decision to reject ‘home bias’ when the majority of shareholders will be UK domiciled. However, we have looked to measure performance instead against indices with a more comparable overlap with the thematic approach.
Five-year returns to 30/04/2020 are strong relative to the sector, with NAV and share-price returns of c. 128% and 172% respectively. This represents strong outperformance of the peer group, which has generated NAV and share-price returns of c. 49% and 55% respectively. Similarly, the trust outperformed the FTSE 350 and MSCI World indices over this time period, which respectively delivered returns of c. 4% and 59%. However, MNL’s NAV returns have lagged the NAV returns of the Morningstar technology sector, as well as those of the Invesco QQQ ETF (which tracks the NASDAQ-100 Index); these have returned c. 149% and 159% respectively over this same period.
In the graph below we can see how MNL has done on a cumulative relative basis over the past five years compared to two sectors and two market indices (the Invesco QQQ ETF replicates the NASDAQ-100 Index). A rising line indicates MNL is outperforming the named comparator and vice versa.
cumulative returns vs peers & indices
As detailed under Portfolio, the transition of the portfolio to the current investment strategy was a work in progress in July 2015, encompassing the start of this period. Similarly, the more systematic use of options appears to have been expanded around 2017 to include stock-specific positions instead of the use of options, primarily to adjust market-level exposure (based on what is available from annual reports in 2016 and 2017).
Three-year returns to 30/04/2020 have seen MNL outperform peers in the technology space but underperform the Invesco QQQ ETF, with NAV returns of c. 63% against sector returns of c. 16%. The average trust in the Morningstar technology sector returned c. 60% over this period, whilst the Invesco QQQ ETF returned c. 69%. The significant outperformance of Apple shares (with returns of c. 119%), which MNL has historically held at times but appears to have had no position in for much of this period, likely accounts for a significant proportion of the underperformance.
The convex nature of the options overlays is such that they will provide greater benefits in more volatile environments. Below we have shown the relative drawdown of MNL to the Global sector and indices covered above. This shows the drawdown of MNL from its previous peak at any particular time, relative to the drawdown of the other instruments from their own peak at that same date. We have shaded and added periods where the volatility in the wider market has spiked. During periods where volatility has moved sharply higher, relative drawdowns to the NASDAQ have tended to be milder or even positive than ordinary drawdowns.
nav drawdown relative to sectors & Indices
Conversely, examination of relative NAV returns shows that sharp market rallies from previously low-volatility environments see MNL lag in comparison to peers (on average). This seems to be a result of the protective options overlay; sharp rallies will cause negative repricing of call options written. The managers have noted that they think this is acceptable to improve the risk-adjusted profile of the trust, given they still largely participate in the rally in an absolute sense.
MNL’s relative performance has tended to benefit from periods where bond yields and inflation expectations are falling and yield curves are flattening (as has the performance of the wider technology sector).
Returns over the 12 months to 30/04/2020 were strong despite adverse market conditions in Q1 2020, with MNL generating NAV returns of c. 12.8% against a global sector average of c. -2%. This was broadly in line with the wider technology sector, which saw NAV gains of c. 13.7%, but lagged the Invesco QQQ ETF returns of c. 20.3%.
MNL currently yields c. 2.5% (as of 14/05/2020). The trust’s investment objectives include the aim of providing a reasonable level of yield, but dividends are likely to be a result of the investment process as opposed to a target. Accordingly, dividend distributions will likely be variable. Ultimately, the realisation of the investment process would perhaps expect the trust to see increased distributions from many of the core holdings in the future, on the expectation that exponential growth and the low cost of scaling new developments will enable the companies held to continue to reinvest to maintain and expand their market leadership whilst still having plentiful cash free to return to shareholders.
As discussed under Portfolio, the writing of options on stocks held within the portfolio will generate income streams. However, this is undertaken primarily as a stock and portfolio risk-management tool, as opposed to an effort to boost income streams.
Special dividends are paid out as and when non-recurring income is generated; we can see in the chart below that special dividends were paid out on several occasions in previous years.
An interim dividend of 7p per share has been declared for 2020 thus far.
MNL has very significant revenue reserves of c. £17.3m.
dividend per share fy 2015-2020
Mark Sheppard assumed management of MNL in January 2000, running the trust for a number of years as a co-manager alongside his father Brian Sheppard. Mark is a qualified chartered accountant with Deloitte, and previously worked at ABN Amro Hoare Govett. He has a degree from the Economics department at the University of Exeter.
Mark is assisted in the management of MNL by Richard Morgan. Richard is a CFA charterholder and has previously worked at EIC. He has a degree from the Economics department of the University of Manchester and has passed all the modules of the first year of a BSc (Honours) Computing & IT degree at The Open University.
MNL currently trades on a discount of c. 1.1% (as of 30/04/2020). The discount has narrowed significantly in recent years after widening considerably between c. 2014 and 2016. Given the significant change in portfolio strategy around this time, it seems fair to theorise that there was significant shareholder turnover during this period. However, an examination of the previous annual reports and accounts does not suggest this is particularly the case; Rathbones sold down a stake of around 5.3% of MNL shares in issuance to below 3% between August 2013 and July 2014, but no other significant seller over this period was readily apparent. This did not appear to materially impact the discount, likely because there was a ready buyer: Manchester & Metropolitan Investment Ltd (M&M Ltd), a private company controlled by Mark Sheppard.
M&M is the dominant shareholder of MNL, holding c. 55% of the shares in issuance as of 31/07/2019. The share count was reduced slightly over the financial years 2014 and 2015, with M&M increasing its proportional holding as a net buyer over that period.
M&M: Change in shares held minus net issuance
||NUMBER OF SHARES HELD
||CHANGE IN NUMBER OF SHARES HELD MINUS NET ISSUANCE
||WEIGHTED AVERAGE SHARES IN ISSUANCE
Source: M&L Capital
As can be seen above, M&M Ltd had been reducing its relative exposure over the period 31/07/2015–31/07/2017, but has been buying in recent years. With such a significant proportion of shares held by one shareholder (controlled by the manager), the manager in effect acts as a market-maker for growing assets; there is clearly a desire to grow the share count but also to grow concomitantly liquidity.
M&M Ltd has subscribed for new shares on several occasions since the most recent annual results.
subscription share rights exercised since 30/07/2019
||number of shares
Source: London Stock Exchange
Subsequent to these subscriptions, Mark has consistently sold smaller batches of ordinary shares into the market, growing the trust’s share count whilst managing M&M’s position size. For example, Mark made net sales of 1,031,461 ordinary shares (as of 11/05/2020) across 40 transactions, at a weighted average discount of c. 0.91%, subsequent to the 12/02/2020 subscription for 1,250,000. MNL has thus been able to increase the share count at a time of market distress without adversely impacting the discount. We estimate that at the current time Mark, through M&M Ltd, holds around 18.7m of a total share count of c. 33.9m (c. 55%).
As a thinly traded stock (with an average daily turnover of c. 50k shares, representing c. 0.2% of the free float over the 12 months to 30/04/2020 (Source: Bloomberg)), the spread on MNL tends to be quite wide. This low trading volume also likely contributes to discount volatility being somewhat higher than that of the peer-group average as measured by the standard deviation of the discount on a rolling monthly basis (though averaging across a peer group will somewhat mechanically reduce volatility levels).
The trust has ongoing charges of 0.83%, making it more expensive than the 0.53% weighted sector average of the UK All Companies sector, according to JPMorgan Cazenove statistics. The management fee is 0.5% p.a., calculated monthly on the last business day of each month. A performance fee (‘uplift’) of a further 0.25% p.a. will also apply over periods where MNL has outperformed the benchmark index over the previous 36 months to each month end. The Key Information Document Reduction in Yield (KID RIY) figure is 1.23%, compared to a sector average of 1.08%, although we caution that methodologies vary. Management fees are charged to revenue.
The managers of MNL (M&L Capital) believe that high standards of corporate responsibility tend to be aligned with shareholder interests and strong operational business performance. MNL’s ESG considerations are expanded to the management team themselves: all members of the senior investment team only own cars which are electric vehicles, and they try to maximise their use of public transport. The team also prefer to communicate with shareholders via electronic communication in place of paper missives, and periodically make charitable donations.
M&L Capital views responsible investment as conducive to maximising returns for shareholders, and seeks to gain an understanding of the ESG issues applicable to their various holdings and prospective holdings as a function of the investment-research process. This is also viewed as defensive in nature, as M&L Capital seeks to avoid any possible issues with ESG considerations in any company that could prove destructive to shareholder value for that company. Company engagement and an active approach to exercising shareholder voting rights are used for holdings.
Negative stock screens are applied to filter out companies not meeting certain ESG criteria.