I like impossible questions… and overly long article titles. The wildly gyrating share price of Lindsell Train Investment Trust has once again focused attention on its massive premium to net assets. How did it arise and is it justified?
The Hargreaves effect
The cause of the latest volatility was Hargreaves Lansdown announcing that it was removing two of Lindsell Train’s funds from its Wealth 50 list.
The Lindsell Train Investment Trust share price has gone from £1,952.50 on Thursday, 4th July to £1,280 as of today (Thursday, 1th July). That’s a drop of 35%, give or take.
Typically, this is an investment trust that sees 50-100 trades a day but the last few trading days have seen about 400-500 each.
Collectively, Lindsell Train’s funds own about 12% of Hargreaves Lansdown. The concern was this created a potential conflict of interest (as usual, Nick Train had a prompt and well-balanced take on the situation).
Lindsell Train Investment Trust (LTIT) has a significant holding in Lindsell Train Limited, the fund management firm that runs all of Lindsell Train’s funds. As of 30 June 2009, this holding accounted for an incredible 47% of LTIT’s assets.
It’s rare for an investment trust to have more than 10% in one position. Some even limit it to 5%.
47% of assets in one position is pretty much unheard of.
The theory is that exclusion from the Wealth 50 could hamper the hitherto rapid growth in Lindsell Train’s funds, and therefore in the valuation of Lindsell Train Limited.
Personally, I don’t think the exclusion from the Wealth 50 will have that great an impact in the long run. More and more people are now seeing such lists as a busted flush and Lindsell Train’s reputation should be enough to maintain a decent flow of funds through its doors.
Here’s how LTIT’s premium has changed over the past year:
Yes, the premium actually exceeded 100% for a brief time in May and June. And it’s rarely been less than 50% this past year.
LTIT’s premium first arose back in 2011, as far as I can tell. It was a sober 5-15% for a few years but started increasing in 2015, reaching 60-70% in late 2016.
The premium then actually dropped back for a while, and even went under 10% in late 2017 and early 2018, before its latest rise (and crash) shown in the chart above.
With LTIT’s share price at £1,280 per share and its latest net asset value being £1,068, that means the premium has shrunk from 83% to 20% in less than a week.
Lindsell Train Investment Trust’s portfolio
Here’s how LTIT’s portfolio is made up. I’ve used the version in the latest accounts, so it’s a few months old. But as Lindsell Train so rarely buys or sells investments, it’s likely to be much the same today.
Apart from the stake in Lindsell Train Limited (the single share shown above is an option), everything else is bog-standard equities.
As you can look at an investment trust’s portfolio and replicate any listed positions it has, there’s typically no reason for a standard equity fund to trade at a premium to its net assets.
If a manager is particularly well regarded, you might get a premium of up to 5%. Finsbury Growth & Income, the other investment trust managed by Lindsell Train and which has a number of the same holdings, trades at a premium of 0.6%.
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That’s a long-winded way of saying that the entire premium for LTIT is basically down to the value of the Lindsell Train fund management business. Or at least what investors perceive it might be worth in future.
For simplicity, let’s assume LTIT’s stake in Lindsell Train Limited is officially valued at £100m (it was £99.3m in June 2019 so that’s pretty close).
Here’s what a range of premiums imply the valuation is actually worth:
|Implied value of LTIT’s holding||£100m||£143m||£206m||£270m||£313m|
A 100% premium means investors buying LTIT shares were assuming its stake in the fund management business is worth more than three times its official valuation.
Back to the early 2000s
Before we look at the official valuation that LTIT uses, let’s take a break from the number-crunching and roll back the years.
Lindsell Train Limited was set up in 2000 by Nick Train and Michael Lindsell. They worked together at a firm called GT Management in the 1990s, which was acquired by Invesco in 1998.
Initially, it just managed two investment trusts, LTIT and Finsbury Growth & Income.
LTIT’s initial portfolio looked very different from the way it does today:
30% was in US and UK government debt and a further 11% in Halifax/HBOS preference shares.
But you can see the beginnings of Lindsell Train’s focus and consumer goods and media brands, with the likes of Cadbury Schweppes, AG Barr (the maker of Irn Bru and the only listed investment still in the LTIT portfolio today), and Reuters.
Down near the bottom is Lindsell Train Limited, valued at just £0.6m and accounting for less than 3% of net assets.
The transformation begins
Lindsell Train Limited’s turnover exceeded £1m in the year ended 31 January 2002 but fell back below that level for the next few years. It didn’t top £1m again until the year ended 31 January 2006.
In 2004, Lindsell Train took over a Japanese open-ended fund. Then in 2006, it launched a UK open-ended fund and the scale of the business was transformed. This was followed by a global open-ended fund in 2011 (I’ve owned this fund since 2016, and it was the large premium on LTIT back then that prompted me to choose the global fund over the investment trust).
By January 2009, turnover had surged to £3.6m. The financial crisis caused a one-year blip, but turnover recovered and hit £8.0m by January 2012.
|Year ended 31 Jan||2019||2018||2017||2016||2015||2014||2013|
|Operating profit (£m)||55.4||37.9||27.1||20.2||12.4||10.2||5.9|
|Post-tax profit (£m)||45.0||30.6||21.7||16.2||9.7||7.8||4.5|
|Assets managed (£bn)||16.3||13.2||9.0||6.1||5.0||3.4||2.4|
|Turnover as % of|
What a fantastic business this has been, with turnover growing more than tenfold from 2012 to 2019. Operating profits did even better, going from £4.6m to £55.4m.
The UK and global funds are now the largest by a long distance, with £7.2bn and £8.4bn in assets respectively. Finsbury accounts for £1.7bn, the Japanese fund £0.4bn, while LTIT brings up the rear with £0.2bn.
Lindsell Train also runs funds for institutions (17 at the last count and with about £4bn in assets), bringing its total assets under management up to £21.6bn as of June 2019.
The current year to January 2020 will probably see turnover pass the £100m mark. It might even exceed £125m if markets continue to be buoyant, which could see operating profits in the region of £80m+.
Assets under management have already risen by more than £5bn in 5 months, boosted by rebounding markets and a surge of cash inflows. The latter is no doubt partly due to the troubles of Mr Woodford.
To generate all this cash, Lindsell Train Limited has just 18 employees. Woodford, once of a similar size in terms of assets managed, reportedly has 44 while Fundsmith has 28.
Putting pressure on the premium
A couple of decisions Lindsell Train has taken have also boosted the premium that LTIT trades at.
Firstly, LTIT doesn’t issue new shares. It had 200,000 in issue back in 2001 and has exactly the same number today.
Most investment trusts that trade at a premium issue new shares on a fairly regular basis. This can help to soak up investor demand and ensure the premium doesn’t get too big.
The risk with too big a premium is that it can cause the share price to collapse should a fund fall out of relative favour. No one likes that, especially as it normally goes hand in hand with a fall in net asset value as well.
Secondly, Lindsell Train has committed to not materially diluting LTIT’s stake in Lindsell Train Limited. LTIT started with 666 shares and it still has 645 today.
Overall, LTIT owns 24.3% of Lindsell Train Limited, Train and Lindsell’s families own 36.3% each, and employees the remaining 3.2%.
I’m not sure when this commitment was first made, but I wonder what would happen if you could travel back in time and told Lindsell and Train that this stake would account for nearly half of net assets. Would they have still made the same commitment?
However, you have to admire them for sticking to their principles on both of these matters.
Despite its success, LTIT is still pretty small
LTIT’s market cap is around £260m although it reached £400m for a brief time recently. That’s on the small side for an investment trust, so that ratchets up the pressure a bit more.
The shares don’t seem to be particularly tightly held. Nick Train, Michael Lindsell and Finsbury Growth & Income own 16% collectively. But among the biggest holders are clients of Hargreaves Lansdown (17%), Alliance Trust (5%), AJ Bell, and Interactive Investor (both 4%).
The exchange market size for LTIT is just 2 shares, meaning market makers are not obliged to honour the quoted bid and offer spreads for deals of 3 or more shares.
I suspect there may even be a few folks that don’t wish to sell because they have a sizeable capital gains liability. In its first eighteen and a bit years, LTIT has risen 23 times and it was up 487% in the five years to May 2019.
Lindsell Train Limited’s official valuation
The last piece of the puzzle is the official valuation. It’s laid out in a pleasing amount of detail in Appendix 1 of LTIT’s accounts.
Let’s look at how it is calculated and how frequently it is updated. If it seems to be on the cautious side, then paying a premium for LTIT is more understandable.
I’ve reproduced the relevant sections below for completeness but the tl;dr version is that it takes the average of two valuation measures.
One is based on assets managed, the other on a multiple of earnings (adjusted for higher staff costs that would be needed to run the business in Nick Train and Michael Lindsell’s absence).
And the valuation is updated monthly, which I was a little surprised to see at first.
I thought it might be quarterly or even six-monthly, meaning the valuation was always a little bit behind events. But monthly makes sense given the size of the holding and the ease of which fresh numbers can be plugged in.
There’s a fairly widely used rule of thumb that 2% of assets under management is a reasonable valuation for a fund management business.
LTIT uses 1.5%, which is a lot more conservative, citing the fact that comparable unlisted businesses have gone for 1.7% over the past decade.
I suspect the last, say, three years would see that comparative a bit higher, perhaps even 2%. But without seeing the breakdown of the number of transactions and their multiples is hard to know for sure.
The earnings multiple calculation seems about right I would say. Excluding all performance fees from the earnings calculation is perhaps a little cautious, but understandable. They accounted for about 10% of revenues in the year ended January 2019.
The 8.5% discount rate is the same as applying a profit multiple (P/E ratio) of 11.8. Adjusting a business’s profits for what might happen when its majority owners depart is standard practice.
If Lindsell and Train sold the business, it seems unlikely they would hang around for too long on the payroll. They certainly don’t need the money!
The issue of succession
Lindsell is 59 and Train is 60. Michael Lim, the chief operating officer, is 63 while Jane Orr, Head of Marketing, is 60. You could see them all departing within 5 years, although I suspect they wouldn’t all go at the same time.
The investment staff recently increased from 5 to 6 (that’s including Lindsell and Train). James Bullock is the heir apparent and has been co-managing the Global Fund since 2015.
However, you could argue that the sloth-like pace at which Lindsell Train buys and sells its investments makes succession a little less of a concern.
True, there is plenty of trading activity as the open-ended funds grow in size, but I expect there is a pretty good understanding within the investment team of what makes up the Lindsell Train special sauce.
So, a sensible premium is?
Let’s say we bump up the valuation assumptions to 2% of assets under management and use the likely adjusted profits for the current year to January 2020 rather than historical numbers.
This might give you a value of £450m to £500m for the entire firm and perhaps £110m to £120m for LTIT’s 24.3% stake. It’s finger in the air stuff, admittedly.
With LTIT’s holding valued at £100m as of June 2019, that’s not a significant difference. It suggests to me that paying a premium of up to 10% LTIT’s net asset value looks reasonable.
The current premium of 20% isn’t that far off this of course. But paying much more than this would be a turn-off for me, especially given the fact I already have largeish position sizes in Lindsell Train Global and Fundsmith. I wouldn’t want to become overexposed to this style of investing given its great run in recent years.
To its credit, it’s worth pointing out that LTIT regularly warns about the excessive premium in its results and in its monthly commentary.
A limit on growth
There’s an interesting commentary from Michael Lindsell on how big Lindsell Train’s funds might be able to get given their current investment strategy. It was published in May 2019, just before fund liquidity become such a hot topic of discussion.
Based on a self-imposed 15% limit in any individual company, the maximum size of the Global fund could be £15bn, a little under twice its current level of £8.4bn. So, there’s room for more growth, but certainly not at the pace that we’ve seen the past seven years.
The companies that Lindsell Train invests in may continue to do well, but it’s not inconceivable that the UK and Global fund could be closed to new money at some time in the not too distant future. That would limit the growth prospects for Lindsell Train Limited.
If you’re a long-term holder of LTIT, I’d love to hear your thoughts on the premium it trades at and whether it’s affected the position size you’ve had over the years.
Please note that I may own some of the investments mentioned above -- you can see my current holdings on my portfolio page.
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