Baillie Gifford’s plan for world domination continues. It has been put forward as the new manager of Keystone Investment Trust, which is set to adopt its ‘Positive Change’ investment philosophy.
Investors seem to like the idea. The shares closed up 9% on the day the news was announced, having at one point been 16% higher.
As usual with manager/mandate switches of this magnitude, shareholder approval is required.
(Update: Keystone’s shareholders have since voted on the proposals at the trust’s AGM on 10 February 2021 and approved the manager change. The ticker has changed from KIT to KPC and the trust has formally been renamed Keystone Positive Change Investment Trust)
A toe in the water
After looking at several of their trusts over the past year and liking their ultra long-term investment approach, I’ve been meaning to add something run by Baillie Gifford to my portfolio.
And this week, after doing some preliminary research, I bought some shares of Keystone, funding the move by selling part of my holding in Caledonia that I’ve had earmarked for disposal for some time.
Directors buying in
I like to see directors have a reasonable stake in the trusts they run. So it was encouraging to see three of Keystone’s five board members buy more shares on Monday.
- Karen Brade, Keystone’s non-executive Chairman, bought 5,989 shares at 332p. She only held 2,708 as of 30 September;
- John Wood bought 5,000 shares at 336p, doubling his holding to 10,000; and
- William Kendall bought 15,250 shares at 331.5p, adding to the 31,250 he already held.
Overall, the five directors’ cumulative holding rose from 48,100 to 74,300.
That’s more than token buying in my view although a scan of the directors’ bios suggest they aren’t short of a few bob.
Kendall is the longest-serving director, having been on the board since 2002. Wood joined in 2012 and Brade in early 2018 (becoming Chairman in January 2019).
Key stats for Keystone Positive Change
Some of the following data points may be less applicable, due to the manager change, but for completeness here’s my usual summary:
- New name: Keystone Positive Change Investment Trust
- Founded: 1954
- Ticker: KPC (was KIT prior to 11 Feb 2021)
- Previous manager: James Goldstone (from Apr 2017)
- Previous management firm: Invesco
- New managers: Kate Fox and Lee Qian (Baillie Gifford) from 11 Feb 2021
- 10-year net asset return: +101% (7.2% pa)
- Share price: 325p
- Indicated spread: 324p-326p (0.6%)
- Market cap: £201m
- Net asset value (NAV): 341p
- Discount: 5%
- Costs: 0.55% OCF and 1.1% KID
- Results released: May (interims) and Dec (finals)
- Current dividend and yield: 11.2p and 3.4%
- Dividends paid: Mar, Jun, Sep (interims) and Dec (final)
- Sector: UK All Companies: 9th out of 12 over 10 years
- Links: Website – AIC page
Price and NAV details as of 7 Dec 2020
Keystone engaged Stanhope Consulting in September 2020 to explore options for the trust saying:
We concluded that a UK-focused equities mandate did not represent the best longer-term investment opportunity, nor did it make best use of the unique features of the investment trust structure.
Based on our analysis, we believe the best long term opportunities are not geographically constrained and that secular developments in the industry – not least the growing desire among investors for a more responsible and sustainable approach to investment – also pose a threat to the Company’s core position in shareholders’ portfolios.
We have concluded that moving to a Global All-Cap approach under new management, with a commitment to achieving positive impact as well as capital growth would be in the best interests of our shareholders.
Keystone currently sits in the UK All Companies sector.
About 40% of its portfolio consists of FTSE 100 companies with another 40% or so in FTSE 250, Small-Cap, and AIM stocks. Around 15% is invested internationally, mostly in gold miners.
Should the manager change be approved on 10 February, then you would expect nearly all of its 60 or so holdings to be sold within a few days and be replaced with those chosen by Baillie Gifford’s new management team of Kate Fox and Lee Qian.
Out will go the fairly unethical choices of Barrick Gold, BP, Barclays, and British American Tobacco.
In will likely come the likes of Moderna (of COVID vaccine fame), Tesla (the quintessential Marmite stock), MercadoLibre (think Amazon+PayPal for Latin America), and Orsted (a Danish wind-farm company).
As the mandate of the trust is changing dramatically, expect to see a tender offer. This allows those who don’t want to continue holding to sell their shares close to their net asset value.
This happened with Witan Pacific a few months ago when it was transformed into Baillie Gifford China Growth.
In this case, the tender offer was for up to 40% of the company’s shares at a 1% discount to their net asset value. As it transpired, only 26.4% wanted out.
We should find out in mid-January whether Keystone is doing something similar.
A similar set-up to Baillie Gifford Positive Change
Fox and Qian currently manage Baillie Gifford Positive Change, which is an open-ended fund based on the same strategy. It seems likely that Keystone Positive Change will end up with many of the same holdings.
The investment trust version will have a “concentrated portfolio of 30 to 60 of the team’s ‘best ideas’, comprising both listed and unlisted securities”.
The open-ended version looks for “25-50 global high-quality growth companies”, so it’s slightly more concentrated than the trust is likely to be. It had 32 separate holdings as of June 2020.
However, the open-ended version doesn’t invest in unquoted companies (as their illiquid nature doesn’t suit open-ended funds).
With unquoted companies, the trust’s target is a 5-10% allocation within three years, but there’s a maximum allocation at the time of investment of 30% to provide some flexibility on the way there.
Also for liquidity reasons, the open-ended version doesn’t invest in companies valued at less than $1bn whereas Keystone Positive Change will go down to $500m.
The investment trust version will also be able to employ gearing to enhance its returns, up to a maximum of 10% of net assets.
Keystone Positive Change will have the same basic return target as the open-ended fund, namely a “NAV total return exceeding that of the MSCI AC World Index in Sterling terms by at least 2% per annum over rolling five-year periods”.
Given the amazing returns that Baillie Gifford has enjoyed this year, merely beating a global index by two percentage points a year seems a little tame. But 2020 was truly exceptional and we shouldn’t assume anywhere near similar returns in future years.
However, it’s a little unusual to see such an explicit return target for a Baillie Gifford investment trust. They are common across its open-ended funds but I think Keystone Positive Change will be the first Baillie Gifford investment trust to have one.
Changes to the charges
The fee on Keystone Positive Change will be 0.70% on the first £100 million of market capitalisation, 0.65% on the next £150 million, and 0.55% thereafter.
There will be no performance fee, in common with Baillie Gifford’s standard approach.
The trust’s market cap is currently £200m so that will make it marginally more expensive than the 0.5% that Baillie Gifford charges on the open-ended version. However, the open-ended version is currently several times larger, so that’s not entirely surprising.
Baillie Gifford has a good record of reducing its charges as it trusts grow in size and I would hope the same will apply here.
In addition, the management fee for the trust will be waived for the first six months and Baillie Gifford will make “a significant marketing contribution to the repositioning of the Company and will also fund all investor marketing activity undertaken on behalf of the Company during the first year of its management”.
I think that’s fairly standard these days when a new manager takes over. It’s akin to a commercial landlord offering a rent-free period.
The trust’s charges are set to rise at a little from where they are now. The basic management charge paid to Invesco is 0.45% plus a 15% performance fee tied to the FTSE All-Share.
I’d expect the ongoing charge to rise from its current level of 0.55% to around 0.75% but that’s still pretty competitive for a £200m trust.
A drastic drop in the dividend
The level of dividends paid out by Keystone Positive Change is likely to decrease significantly.
The plan is for a transition period of 12 months with the trust using its revenue reserves to support the dividend.
It looks like the annual payout will remain at 11.2p for 2021. If the pattern matches 2020, we’re likely to see quarterly dividends of 2.4p in March, June, and September then a 4.0p final in December.
The net yield on Baillie Gifford Positive Change is 0.3% so that suggests, all else being equal, Keystone’s dividend could drop to around 1p per share come 2022.
I’d expect the quarterly dividend payment structure to disappear as well.
A brief history of Keystone
Keystone was launched in 1954, making it respectably middle-aged as far as investment trusts go.
Perhaps the change of mandate is evidence of some sort of mid-life crisis?
The earliest accounts I could find were from 1975. The trust was managed by SG Warburg at that time and had investments of around £9m. Around 80% consisted of UK stocks, with roughly 10% in both Europe and North America — not too dissimilar from its current make-up.
Management of the trust was taken over by Mercury Asset Management, which was a subsidiary of Warburg’s before striking out on its own. It was known as Mercury Keystone during this time.
Merrill Lynch bought Mercury in 1997 and the trust became Merrill Lynch UK Investment Trust for a couple of years.
Invesco was appointed as the trust’s new manager in January 2003 with the name reverting to Keystone Investment Trust.
From 2003 to 2017, Keystone was managed by Mark Barnett, who of course worked closely with Neil Woodford for many years.
James Goldstone was appointed manager in April 2017. Goldstone was seen as a rising star at Invesco, similar to Barnett back when he was appointed in 2003.
Over the majority of Invesco’s tenure, from January 2003 to September 2020, Keystone’s performance has actually been pretty good.
Its shares gained 385% and its net asset value 350%. The FTSE All-Share returned 226% over that same period.
However, over the last five years, Keystone’s NAV has trailed the index each year, losing 3% in total while the All-Share gained an admittedly unimpressive 19%.
The share price performance has been even worse, with the discount widening to double-digit levels.
Tough times at Invesco
The last twelve months have not been kind to Invesco.
It lost the mandate for Edinburgh Investment Trust to Majedie while Perpetual Income & Growth was swallowed up by Murray Income. Both were managed by Mark Barnett at the time.
Invesco Income Growth, another of its UK mandates, is being merged into the multi-pronged Invesco Perpetual Select that runs four separate portfolios.
The loss of Keystone will mean Invesco’s roster will shrink from nine trusts to just five (two equity, one multi-asset, and two fixed income) with combined assets of just £1bn.
When you compare this chart of Keystone’s share price against Baillie Gifford Positive Change since it launched in early 2017, it’s not hard to see why the board decided a fresh start is required:
While it’s a little harsh to compare a UK trust against a global fund over the last few years, Keystone has failed to keep pace with the UK market and the majority of its sector rivals.
Over the last five years, for example, it sits in 11th place out of 12 in its sector, even including Monday’s big jump.
Turning things around
To be fair, the board at Keystone has been trying a few things to improve matters recently.
Expensive debentures with a few months (7.75% interest) and a few years (6.5% interest) left to run were redeemed and replaced with a cheaper revolving credit facility.
A 5 for 1 share split and quarterly dividends were introduced to make the shares (superficially at least) more attractive to retail investors.
The limits on international shares and when shares had to be sold to reduce the trust’s level of gearing were also relaxed a little, giving James Goldstone a little more flexibility when markets were at their most volatile.
Having run out of tinkering options, they’ve now pressed the big red button that is a change of manager.
Baillie Gifford is very much going in the opposite direction to Invesco.
Keystone will become its 13th UK investment trust. It also runs 33 open-ended funds and a host of institutional mandates coming to a grand total of £287bn of assets under management.
Baillie Gifford launched US Growth in 2018 and Schiehallion in 2019. It also won mandates of existing trusts that are now known as Baillie Gifford UK Growth, Baillie Gifford European Growth, and Baillie Gifford China Growth.
Over the last twelve months, its average gain across all 12 trusts is 59%, ranging from 14% for Scottish American to 132% for Pacific Horizon.
It’s keen on messages like “Actual investors imagine ‘what if?” not ‘what is'” and “think in decades, not quarters”.
Value investing, as traditionally thought of, this is certainly not.
Keystone looks set to follow the pattern of an investment trust closely following an established open-ended fund, but with the additional flexibility of investing in unquoted companies.
Baillie Gifford’s believes that many firms are choosing to stay away from public markets for as long as possible and that its size and experience in investing in unquoted firms puts in a very strong position to invest the big winners of the next few decades.
Although it’s a couple of months until the change of mandate takes effect, the make-up of the open-ended version should give us a pretty good steer of what to expect.
The money has been absolutely pouring into this fund in 2020, thanks to its great performance to date. It could even end up with ten times the assets it started the year with.
It’s worth highlighting just how good these returns are.
Both the fund’s 2020 and 3-year record places it fourth out of over 3,000 funds. It’s behind two other Baillie Gifford funds (American and Long Term Global Growth) and Morgan Stanley US Growth in both cases.
Compared to 300+ investment trusts, it’s only behind Pacific Horizon, Baillie Gifford US Growth, Scottish Mortgage, and JPMorgan China Growth & Income in 2020.
On a 3-year basis, only Scottish Mortgage, Allianz Technology, and Pacific Horizon have done better.
The Positive Change strategy
The first three are self-explanatory. The fourth is defined as “addressing the needs of the world’s poorest populations”.
So, how do the companies in the Positive Change portfolio meet these objectives? A short video on the fund’s website gives some examples.
For Social Inclusion, it cites ASML who have “contributed towards making computer chips smaller, more powerful, and cheaper … enabling microelectronic devices to be more accessible to many people across the world.”
Ecolab, a speciality chemicals business, “helps its customers to reduce water consumption, improve energy consumption, and reduce waste production. In 2018, it helped its customers save 190 billion gallons of water.”
Dexcom’s “continuous glucose monitoring devices enable patients and their carers to continuously monitor glucose levels … helping people living with diabetes to live a more normal life.”
Safaricom uses “digital technology to improve access to financial services and is Kenya’s largest mobile phone operator. It has a mobile payment system called M-Pesa … used by millions of people in the country to pay money to their family and friends and pay for goods and services. It’s helped lift 2% of the Kenyan population out of poverty.”
The annual reports of open-ended funds are a little light when it comes to explaining the overall investment approach. But Baillie Gifford Positive Change produces an Impact Report each year that has a lot more detail on each of these four objectives and where each portfolio holding fits in.
The third version, for 2019, can be accessed here. I’m yet to read it in full myself yet but I plan to soon.
There is also a recent video (18 mins) with Kate Fox describing the Baillie Gifford style of looking for big growth potential and how that fits into the positive change investing approach.
The circular due in January should have some more details as well, although I would suspect a lot of it will be more concerned with administrative details with just a few pages on the investing style. That was the case for the circular produced for Baillie Gifford China Growth at least.
The Positive Change portfolio
Here is the full portfolio of the open-ended fund as of June 2020:
|Deere & Co||US||1.6|
The top ten account for around 50% of assets and North American stocks for 47%. But there’s an impressive range of countries in the portfolio. Even the UK gets a look in, courtesy of the education and re-training services provided by FDM Group.
Europe represents 27%, Asia 17%, Latin America 4%, and Africa 2%.
One thing that surprised me was the relatively low weighting to China, given the fact that about 20% of its total assets under management are supposedly invested in this country.
Portfolio turnover tends to be fairly low, similar to most Baillie Gifford trusts and funds. It’s expected to be around 20% a year on average for the open-ended fund.
The top ten as of October 2020 looks pretty similar to the table above, with Unicore and Nibe dropping out at the expense of Teladoc and Moderna.
The question of Tesla
Interestingly, Tesla dipped from 9.7% to 8.6% of the portfolio between June and October 2020 despite the fact the Tesla share price increased by 80% over this time.
The Tesla share price has risen by nearly 70% since the end of October so it will be interesting to see the November and December factsheets and what weighting Tesla has then.
Other Baillie Gifford trusts and funds, most recently Monks, have been cutting back on Tesla, saying that now it has grown so big ($600bn+) its future growth potential necessarily has to be less attractive.
I’m happy having it as the largest position in one of my smallest trust holdings, from mid-February anyway, and allowing the good folks at Baillie Gifford to choose the most appropriate position size.
I suspect that the Tesla stake in Keystone Positive Change could turn out to be a little smaller than the open-ended fund, given it will be starting from scratch.
There’s no doubt that Tesla’s mere presence in a portfolio can put off some investors from buying a trust altogether. However, it’s the sixth-largest stock in most global trackers these days, with a 1% position size, so it’s hard to avoid completely.
The Positive Change management team
It’s a young management team, as you might expect. Both Fox and Qian seemed to have joined Baillie Gifford shortly after they graduated, in 2001 and 2012 respectively.
They are advised by two ‘impact analysts’ — Michelle O’Keeffe, who joined Baillie Gifford in 2015 and graduated in 1999, and Ed Whitten, who joined in 2018 and graduated in 2008. It’s not clear if they’ll be advising Keystone Positive Change as well, but it would seem likely.
Baillie Gifford Positive Change appears to be the only public-facing fund that Fox and Qian work on at the moment, so Keystone Positive Change should receive a lot of their attention.
Although Fox is the Baillie Gifford partner responsible for the fund, it was actually Qian who developed the original idea, inspired by his childhood in China and the impact certain business had improving the economy and provider greater access to healthcare and education.
I was pleased to see this proposed change from Keystone.
I’ve been looking to add a Baillie Gifford trust, some more technology, and something more planet-friendly to my portfolio. This trust ticks all three boxes.
My Keystone stake is small at the moment but I might add a little bit more in the run-up to the shareholder vote in February, depending on what happens to the share price.
I’d then look to build it up further once we see what its new portfolio looks like.
Witan Pacific saw its discount narrow when it revealed its plans to appoint Baillie Gifford as its manager back in late July. The initial share price move was somewhat less dramatic, however.
It then moved to a small premium after shareholders approved the change in mid-September.
However, the trust ran low on new shares to issue in November and the premium reached 30% at one point, which is pretty much unheard of for a trust that is nearly all invested in quoted equities.
The premium has fallen back a little since, to 18%, but I suspect the directors of Keystone have noted what happened and will make sure it has plenty of firepower to issue more shares if needed.
With a relatively small market cap of £200m, though, it doesn’t take too much buying pressure to make the share price overheat. A similar thing has happened in the past with Lindsell Train Investment Trust.
Until the switch to Baillie Gifford is approved, the share price will also be at the mercy of UK market movements, which could be a blessing or a curse depending on how Brexit is resolved and the market’s view of it.
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