John Baron: Nine ‘special situation’ investment trusts

A theme running through these monthly articles is the search for situations where there has been a disconnect between sentiment and fundamentals – and, in all humility, to suggest opportunities when the former trails the latter.

There are periods when such opportunities are less abundant than others. However, perhaps in part because of the interesting times in which we live and the concurrent volatility, there appears to be a good selection of special situations offering potential at present. Given the often specialist nature of the sectors involved, these investments are usually found beyond the mainstream where investors sometimes tread with caution. And therein lies the opportunity.

For context, the trusts highlighted in this article have recently been bought in one or more of the 10 live investment trust portfolios managed in real time on the website www.johnbaronportfolios.co.uk – portfolios that achieve a range of risk-adjusted returns and income levels. As such, the extent of exposure is guided by portfolio remits including income requirements, for these are neither low-risk nor low-volatility investments – and ones that may also disappoint in the short term. Yet history suggests it is usually better to be too early than too late as sentiment can improve suddenly, and the upside can be significant given the extent of mispricing both of the underlying investments and trust.

Biotechnology

As regular readers are aware, the healthcare sector is one of my favoured themes and one that has rewarded over time. Yet recent performance has fallen away. Sentiment now fails to reflect the sector’s sound fundamentals, which include rising demand from an ageing population, strong innovation and drug development, and a growing middle class, especially in Asia.

The usual starting blocks for portfolios are the ‘generalists’, which cover the full spectrum of the sector, such as Worldwide Healthcare Trust (WWH). Yet I have been have been adding biotechnology exposure to my portfolios because this subsector looks attractively valued after its severe derating, and straws in the wind suggest optimism.

This is particularly so when it comes to smaller and early-stage companies, including those looking to raise finance and move on to the next stage of development, which are finding the economic environment less challenging. Meanwhile, this segment of the sector remains the engine room when it comes to innovation and productivity – around two-thirds of the biopharmaceutical pipeline is generated by small and mid-cap biotech companies. This continues to be the case even though sentiment towards this sector has been at rock bottom, with smaller biotechs’ underperformance since early 2021 having recently driven valuations to record lows.

A reversion to historical averages would appear to be deserved, in part because the macro environment has improved. Small and mid-cap stocks have been more adversely affected by the rising interest rate environment since 2021. Now that the Fed has pivoted to gradually reducing rates, small and mid-cap stocks should benefit disproportionately. The larger companies both within the biotech sector and wider healthcare sector generally have noticed. The better fundamentals and attractive valuations largely account for the strong M&A activity, which is increasingly evident as larger pharmaceutical companies bolster their product ranges.

Biotech Growth Trust (BIOG) is managed by OrbiMed, which is the largest dedicated healthcare investment company in the world. The team of around 130 professionals has an unparalleled depth of experience and network of industry contacts. Most of its exposure is to the US, but it also has a modest weighting to Chinese companies and some exposure to Europe. The company is very much focused on early-stage biotech businesses for the reasons highlighted above. Relative performance has suffered in recent years because of this smaller company bias, but this could now very well play in its favour as sentiment gradually improves.

International Biotechnology Trust (IBT) has outperformed its benchmark over most timeframes under its experienced team. The managers are positive about prospects: “Despite the recent rally, the Reference Index remains well below its peak of 2021… suggesting significant future upside potential, given the sector’s accelerating pace of innovation… The implementation of the US Inflation Reduction Act, which may negatively impact the pricing of key established drugs sold by large pharmaceutical companies, could increase the demand for innovative biotechnology still further.”

The company pays a dividend equivalent to 4 per cent of its net asset value (NAV), which equates to a yield of 4.4 per cent given its discount.

Fintech

Technology exposure for many investors consists of the larger investment companies providing broad exposure, even when focusing on smaller companies, like Herald Investment Trust (HRI) – which I own. However, dig below the surface and the fintech industry offers attractive opportunities. The sector is disrupting the banking, insurance and wider financial services sectors courtesy of its innovation, and many financial systems having not evolved. Assisted by artificial intelligence (AI), estimates suggest the sector is growing by 22 per cent a year, yet it represents just 3 per cent of a $14tn global financial services market. Little wonder incumbents are acquiring fintech challengers, and so crystallising good exit routes and driving growth.

Augmentum Fintech (AUGM) unjustly suffers due to the wider travails of the private equity/venture capital sectors, which are suffering from a lack of companies going public. The trust’s managers have generated an internal rate of return of 38 per cent and 2.5 times capital invested from its seven exits since coming to market, with over £100mn realised​​. They’ve produced the goods. All members of the senior team have either been founders and/or senior executives at technology companies, including Flutter.com/Betfair and Covestor, and have collectively invested in more than 100 early-stage fintech companies. They remain well-positioned to capitalise on the many opportunities offered by the early-stage European ecosystem. 

The trust’s investments are well-diversified across the fintech ecosystem, and it owns businesses with high growth rates. Recent figures show the top 10 positions, representing nearly 80 per cent of NAV, saw average revenue growth of around 50 per cent over the previous 12 months. The combined annual revenue of these positions was £1.25bn. Cash burn is closely monitored to ensure future funding rounds can be supported. Importantly, recent news saw retail trading platform eToro list on Nasdaq and digital banking disrupter Chime file for an IPO. Despite slower growth, these are happening with significant premiums to AUGM’s company valuations. A 40 per cent discount to NAV does not reflect the company’s potential.

Specialist miners

Portfolio holdings include exposure across the commodities spectrum via BlackRock World Mining Trust (BRWM), which tends to focus on larger mining stocks. However, I have also recently been buying companies that favour precious metals and uranium. My article ‘How I’m adding precious metals to my portfolios’ (IC, 22 November 2024) explains why I remain positive on the outlook for gold and silver, despite the expected volatility. Meanwhile, company share prices have lagged metal prices and stand on near-record lows. Yet the rising gold price and easing cost pressures are making for record margins, at a time the larger producers have underspent on exploration and need to acquire smaller companies to replenish reserves.

CQS Natural Resources Growth & Income (CYN) is currently weighted c50 per cent precious metals and c11 per cent uranium, via mostly smaller companies. Following a strategic review, the board is offering shareholders on the register on 29 May a choice “between remaining invested in the company with value enhancing initiatives (an enhanced dividend, lower management fees), and/or exiting for cash through the tender offer” on 25 June. The portfolios will not be tendering their shares given the company’s peer-topping record, its experienced team and the portfolio outlook. I also look forward to receiving an increased dividend, which will distribute 2 per cent of quarter-end NAV – equating to yield of 8.5 per cent at current prices.

Golden Prospect Precious Metals (GPM) seeks capital growth mostly from the listed equities of smaller companies in the precious metals sector, with around three-quarters of portfolio exposure relating to production. A recent conversation with the managers highlighted the extent to which mining companies have trailed rising gold and silver prices, despite inflationary cost pressures easing and equities promising further margin improvement. The sector is now generating some of the highest free cash flow on record, which could be a catalyst for increased M&A activity as the larger producers look to increase or replace reserves. A good record and 24 per cent discount when bought suggest optimism.

Geiger Counter Ltd (GCL) reflects the strong long-term outlook for uranium prices. With global ambitions to triple nuclear generating capacity by 2050 set against a backdrop of limited supply growth, we added to our exposure to GCL as recent uncertainty has weighed heavily on uranium mining equities. Again, speaking recently with the management, the outlook remains promising. Short-term, inventory levels across utilities in established western markets, which generate some 20 per cent of their electricity from nuclear power, are approaching low levels. Before too long, these countries will need to undertake a further round of contracting to ensure electricity availability.

Longer-term considerations are also supportive. Although the advance of technology is helping to bring costs down, nuclear power plants tend to be high-cost long-term investments, with uranium supply typically tied to long-term contracts. Yet the uranium spot price makes up just 5 per cent of the overall cost of the production of nuclear power. Given this, and the fact that nuclear power stations are expensive to stop and start, demand for uranium tends to be price inelastic. Meanwhile, heightened geopolitical tensions, together with the fact that nearly half of the world’s uranium production is based in Kazakhstan, is encouraging a strategic reappraisal of its importance by various countries, including the US.