Merchants Trust: May 2024 trust update

• Simon Gergel is an experienced income investor and has managed Merchants Trust since 2006

• The trust increased its dividend by 2.9% to 28.4p per share in the year to the end of January 2024, the 42^nd consecutive annual increase

• The trust aims to provide a high level of income, and to grow the income and capital over the long term

How it fits in a portfolio

Merchants Trust invests mainly in larger companies listed in the UK with an aim to provide a high level of income, and to grow the income and capital over the long term. It could therefore fit as part of an income-focused investment portfolio or add larger UK companies exposure to a broader, diversified portfolio.

Manager

Merchants Trust has been managed by Simon Gergel since 2006. He works closely with Richard Knight, Andrew Koch and with the wider investment resource at Allianz Global Investors (AGI). They carry out individual company analysis in addition to looking after the management of the trust.

Gergel is Chief Investment Officer for UK equities and head of the UK Equity Income & Value Team. He joined AGI in 2006 from HSBC and previously began his career managing UK equities at Phillips & Drew. He also co-manages the open-ended Allianz UK Equity Income fund and is deputy manager on the Allianz UK Listed Opportunities fund.

Knight joined AGI in 2014 and is lead manager of the Allianz UK Listed Opportunities fund and co-manager of the Allianz UK Equity Income fund with Gergel. Koch joined AGI in 2023 from Legal & General where he spent nine years as Head of the Value & Income team, working on European, UK and Asian strategies. The team can also draw upon the wider group’s research and analysis in the credit, Environmental, Social and Governance (ESG) and macroeconomic areas.

Process

Merchants Trust mainly invests in larger UK companies with small allocations to some overseas companies and higher risk smaller companies. As of the end of April, these stood at 3.8% and 2.4% respectively. Gergel looks for quality companies, which can be bought at a reasonable share price and pay a high dividend. If they don’t pay a high dividend now, they are bought on the basis they will yield in line with the market within 18 months unless there is an exceptional circumstance.

Gergel’s investment process focuses on three key areas. Firstly, he aims to understand the fundamentals of a company, including its competitive position and financial strength. Valuation is a key element, and the manager aims to buy shares at a price he believes is much lower than what the company will be worth in future. He looks at valuations compared with both the company’s own history and its peers. Finally, he considers industrial and consumer themes together with the economic outlook. Themes describe the environment in which a business operates and help Gergel to understand the likelihood of various scenarios happening in the future.

Investments are sold if the share price no longer offers enough value, if there’s a change in the investment case or if there are better opportunities elsewhere with greater return potential.

In the trust’s last financial year to the end of January 2024, the manager made some changes to the portfolio. Seven new positions entered the portfolio, with nine investments being sold. The additions included new positions in the likes of building materials business, Marshalls, car distributor Inchcape and Lloyds Banking Group. Defence business BAE Systems and fund management company, Ashmore, were among the investments sold.

Investors should be aware the trust can borrow money to invest with the intention of increasing returns (known as gearing), but this could magnify losses in a falling market and increases risk. The average level of gearing in the year to the end of January 2024 was 13.8% of the trust’s assets. As of the end of January 2024, gearing stood at 12.3%, this is towards the lower end of the 10-25% range investors can expect gearing to sit in. The manager can also use derivatives, which adds risk.

Culture

Allianz Global Investors (AGI) is the asset-management arm of Allianz SE, the German-based financial services and insurance company. As with any large asset manager, the investment resources are substantial and spread globally across asset classes. AGI manage a number of investment trusts and Kleinwort Benson, which was acquired by AGI, were appointed to manage Merchants Trust at launch in 1889.

ESG Integration

Simon Gergel aims to identify and analyse environmental, social and governance (ESG) factors that could impact a company’s prospects. This helps him understand the extent to which a business is exposed to reputational issues and if they are reflected in the share price. Companies with a low score on any ESG factor, are sold or if they are to be included in the trust, need to be justified. The manager actively engages with companies included in the trust with these factors to promote best practice. Over the course of the Trust’s financial year, Allianz Global Investors has conducted 34 meetings with portfolio companies to further their understanding of ESG issues and engage with company management.

ESG factors have become increasingly prominent within the investment community over recent years. Allianz Global Investors has incorporated ESG into company analysis since 2000, which makes them somewhat of a pioneer in this area. As long-term stewards of investor capital it makes sense for them to closely consider these factors in their investment analysis.

Cost

The annual ongoing charge to January 2024 was 0.55%. Investors should refer to the latest annual reports and accounts, and Key Information Document for details of the risks and charging structure. If held in a SIPP or ISA the HL platform fee of 0.45% per annum (capped at £200 per annum for a SIPP and £45 for an ISA) also applies. Our platform fee doesn’t apply if held in a Fund and Share Account or Junior ISA.

Part or all of the annual charge is taken from capital rather than income generated, increasing the potential for your investment’s capital value to be eroded.

Performance

The trust has performed well over Simon Gergel’s tenure as manager, delivering a return of 213.25%* to investors, ahead of the FTSE All Share’s 177.60% return.

In the trust’s last financial year, the dividend paid to investors increased by 2.9% to 28.4p per share, which was covered by its revenues The board have also increased the annual dividend every year for the last 42 years, which is one of the longest records of dividend growth in the UK Equity Income sector, an impressive feat. Although this shouldn’t be taken as an indication for future payments and past performance is not a guide to the future.

Over the trust's last financial year to the end of January 2024, the trust’s net asset value (NAV) fell by 3.1% with the share price falling by 3.4%. This compares with a return of 1.9% for the FTSE All Share index over the same period.

Rising interest rates over the year impacted the trust’s performance and an underperformance of some companies more reliant on a positive economic backdrop. This also hurt the performance of some small and medium sized companies the trust is invested in.

One of the main detractors from the trust’s performance was its investment in wealth manager St James’s Place. The company made significant changes to its pricing structure in response to regulatory developments, impacting profitability and denting the manager’s confidence in the company’s outlook, leading to a sale of the position. Distribution company DCC was one of the main positive contributors over the year following increasing optimism about the position of the company’s energy business in aiding the transition of its customers away from fossil fuels.

At the time of writing the trust trades at a discount of 1.82% and has a dividend yield of 4.87%, although remember yields are variable and aren’t a reliable indicator of future income. All investments and any income they produce can fall as well as rise in value, so investors could get back less than they invest.