Powerhouse economies

Each trust is focused on a powerhouse economy — indeed, the two biggest economies in the world. China’s growth rate has slowed recently, as it transitions away from decades of colossal infrastructure investment towards consumption. However, an IMF forecast of 6.2% growth for 2019 is still impressive. The US doesn’t come near this, but its forecast growth of 2.5% still outstrips developed markets in the West, like the UK (1.5%).

The scale and growth of the US and Chinese economies provides a favourable backdrop for our investment trust managers to root out dynamic growth businesses.

Focus

As you can see from the breakdown of their portfolios in the table below, both trusts are tilted towards investing in companies with market capitalisations of less than £5bn.

Smaller companies generally have higher growth potential. Furthermore, in the case of the US and China, they have huge domestic markets to expand in. For example, a JPMorgan trust holding, Eastgroup Properties, is focused on developing and acquiring distribution facilities across the US ‘sunbelt’ states.

As I mentioned earlier, China’s economy is shifting towards domestic consumption, with the numbers and spending power of its middle class increasing rapidly. The Fidelity trust is very much focused on products and services that cater for this growth within the country. China MeiDong Auto, for example, is a car dealership, handling the likes of Lexus, BMW and Porsche.

Of course, there are companies in both trusts that aren’t focused solely on their domestic markets. But a good many are, or largely are, and with plenty of growth to go for on home soil, I’m not too concerned by Donald Trump’s trade war with Beijing.

Mis-priced quality companies

Another thing the two trusts have in common is that they lean towards businesses with strong management teams and competitive advantages that are profitable and cash-generative. You’ll find little, if anything, in the way of speculative (‘blue-sky’) companies — oil explorers, biotechs and so on — in their portfolios.

I like the trusts’ focus on quality businesses and their bias to smaller companies, which are less well-researched and lead to greater opportunities for mis-pricing. Furthermore, the management teams of both trusts have delivered returns above the average of their sector peers.

Performance

Over the last 10 years, the JPMorgan trust has posted a net asset value (NAV) total return of 430% versus a North American Smaller Companies sector return of 312%. Over five years the numbers are 93% versus 84%.

The Fidelity trust hasn’t been around long enough to notch up a 10-year record. Over five years, it’s delivered a NAV total return of 106% versus an Asia Pacific sector return of 99%.

I think both trusts have a lot going for them, and that they could serve growth investors well in 2019 and beyond.

Unfortunately for growth investors, nothing on the same scale has happened for investment trusts seeking to deliver long-term capital growth. There are fewer funds for growth-focused investor to pick from… but I believe I’ve found two exciting ones.

China’s growth story

Fidelity China Special Situations (LSE: FCSS) is a fund which seeks to offer direct exposure to China’s growth story. But instead of just investing in a broad market index tracker, this fund uses an actively-managed strategy in an attempt to beat the market.

Fund manager Dave Nicholls reckons there may be better investment opportunities from buying companies which are set to benefit from China’s structural shift away from a reliance on investment towards consumption. This is because, going forward, many analysts reckon China’s middle class will be the main driver of economic growth, benefiting companies which directly deal with consumers.

As such, the fund has an outsized exposure to the consumer discretionary sector, with a weight of 31.5%, compared to the benchmark MSCI China Index’s weight of just 9.5%. Technology stocks also dominate the fund (as it also does for the benchmark), with its two biggest positions being Tencent (14.7%) and Alibaba (13.7%).

On the downside, unbalanced, actively-managed investment trusts can have their disadvantages too. Firstly, there’s no guarantee that a specific sector will continually outperform the market, leading to occasional bouts of underperformance against the market index. Additionally, excessive focus on some sectors could reduce diversification benefits, potentially leading to higher portfolio volatility and risk.

Technology stocks

For investors looking to increase their exposure to technology stocks, the Polar Capital Technology Trust (LSE: PCT) may be of greater interest. The fund aims to maximise capital growth for shareholders through investing in a diversified portfolio of technology companies around the world.

Despite the recent sell-off in tech stocks over the past week, I reckon the technology sector holds plenty of promise for investors. Reflecting the impact of technology disruption on traditional industries, technology stocks have the potential to generate significantly faster earnings growth than the broader market.

Large-caps

Large-caps, companies with a market capitalisation of more than $10bn, dominate the fund’s top holdings, accounting for just over 75% of its portfolio. The fund is geographically diversified, although because of the sheer disparity in the number of large technology companies in the US compared to the rest of the world, the fund is heavily exposed to the North American market. US & Canada stocks account for 66.8% of its portfolio’s value, with 10 out of its top 15 holdings coming from there.

Its top five holdings are Apple (7.5%), Alphabet (7.4%), Mircosoft (6.2%), Facebook (6.2%) and Samsung Electronics (3.8%).

Yet many have been sceptical about the future prospects of these emerging nations. There’s been much talk of a slowdown in China, and political in-fighting in India. But if we dig a little deeper, we find that the fundamentals are remarkably resilient: Chinese GDP has still been growing at 6.7% per annum, while India has been growing at 7.9%.

China and India: industrial powerhouses

The broad picture is that these countries are now industrial powerhouses, and they’re set to boom relative to more developed markets for decades to come.

Profitability at a range of companies in these countries has been surging. Take China Pacific Insurance. Net profits were CNY9.2bn in 2013, and this jumped to CNY17.7bn in 2015. Revenue increased from CNY193bn in 2013 to CNY246bn in 2015. These are startlingly strong numbers.

Or take India’s Infosys. Net profits were INR104bn in 2013, and this rose to INR136bn in 2015, while turnover climbed from INR493bn in 2013 to INR630bn in 2015.

Rank after rank of businesses has seen rapid growth in both revenues and earnings.

I’ve chosen to invest in these countries with two investment trusts: Fidelity China Special Situations (LSE:FCSS) and JP Morgan Indian Investment Trust (LSE:JII). How well have these done?

On 1 January 2016 FCSS was priced at 121p per share. It has now risen to 170p. That’s an increase of 40%. On 1 January JII stood at 477p. It has now risen to 641p. That’s an increase of 34%.

Why have the shares risen so much? Well, part of this is currency fluctuations. Since January the pound has fallen by about 10% against the yuan, largely because of the Brexit vote on 23 June.

And this is a great time to invest

Also, stock indices such as the Hang Seng and the Sensex have been on the up. Plus, these are well-managed funds that have produced better returns than the overall markets in these countries. What’s more, a substantial amount of gearing for Fidelity China has added to the growth.

Yet the amazing thing is, in terms of equities, we’re still really only at the end of a 17-year bear market, and the next bull market hasn’t even got underway. That means there are likely to be many more stock price rises to come. Thus, if you haven’t bought in yet, this may be a great time to get on board.

And what makes investment trusts like these even more attractive than standard funds is that they currently trade at sizeable discounts. The current discount on Fidelity China is 14.8%. While JP Morgan India is 10.2% cheaper than its net asset value.

That’s why I’ve invested a large part of my portfolio in these funds, and I think you should too. People are often afraid of the growing power of these emerging nations. But if you’re an investor considering buying into China and India, I would encourage you to make the leap.

First, let’s think about the fundamentals. What determines whether a stock will rise or not? In one word, profitability. You need to invest in businesses that are likely to make strong earnings now and for years to come. You also want long-term investments that will trend steadily higher. Are these stocks that you can buy and forget about?

Go where the profits are

You need to consider where in the world the growth will be. Although you may know less about other regions, you need to be brave and look beyond the shores of the UK. And, wherever possible, think contrarian: when you genuinely believe in the prospects for a company, buy when others are selling.

Let’s look at the world today. The fastest growing economies in the world are emerging market economies. The two emerging engines of the world economy are China and India. The low salaries paid in these countries, combined with a highly skilled workforce, will produce a whole new range of global titans that will rake in the profits. Investing in these giants will be a key part of your portfolio.

There’s now a broad range of emerging markets funds, and I favour investment trusts in particular. Unlike unit trusts, investment trusts are listed on the UK stock market, and so can be traded like a common-or-garden share. Most emerging market investment trusts are now trading at a substantial discount, meaning you can buy them for less than their net asset value (NAV). This can add to your returns.

These are the picks

So, pick number one: Fidelity China Special Situations (LSE: FCSS). This is the leading China fund, and trading at a whopping 15.77% discount to NAV. The original Fidelity Special Situations was run by renowned fund manager Anthony Bolton and achieved an annual return of 19.5% over 28 years. Could Fidelity China achieve something similar? It just might.

Then, pick number two: JP Morgan Indian Investment Trust (LSE: JII). There are fewer options for investing in India, but this is the leading investment trust. And with a discount to NAV of 12.9%, again this is unduly cheap, and thus a strong buy.

Then, pick three: I would choose a few carefully selected UK companies with a large stake in the future. One clear trend is a boom in global consumerism. Another is growth in emerging market financial services. And another is the rising demand for healthcare services. Next is a global retailer that looks cheap at the moment. My contrarian instincts draw me to banks with a substantial business in emerging markets, such as BGEO and HSBC. And AstraZeneca is one of the world’s leading pharmaceutical companies. Pick a handful of these businesses for your portfolio.

Invest one third of your money in China, one third in India, and one third in these well-chosen British firms. Sprinkle well with cash, and wait, very patiently, for the bull market to get underway. In a few years, your investments should be blooming.

If you’re thinking of dipping a toe into shares, there’s no better time to start investing. Here are my three picks for 2016.

HSBC

Perhaps one of the biggest disappointments of 2015 has been the performance of HSBC (LSE: HSBA). Yet this is one of the most profitable companies in the UK and one of the world’s leading banks. I see the price falls of the past year not as a warning to steer clear of this firm, but as a buying opportunity.

That’s why I’ve made HSBC one of my picks of the year. Analyse the numbers and you’ll see why I like this bank. The forecast 2015 P/E ratio of 10.43 falls to 10.19 in 2016. And the dividend yield is an enticing 6.17%, rising to 6.3%. This makes HSBC the ideal income share.

I wouldn’t expect fireworks from this company, but the stock is set to climb steadily upwards.

Fidelity China Special Situations

Regular readers will know that I’m a fan of investing in China. The reasons why are not difficult to see. This is already the second richest country in the world, it has the highest growth rate, and the momentum this nation is building is astonishing.

Yet stock markets in China have been in the doldrums. I expect this to change next year. Once momentum has built in equity markets, you’ll be glad you listened my advice and bought into the rise of China.

There are a wide range of funds to choose from, but I think Fidelity China Special Situations (LSE: FCSS) is still the pick of the bunch. The fact that this investment trust trades on a discount of -14.77% makes this a no-brainer.

International Consolidated Airlines Group

The falling oil price has been one of the headlines of 2015. As we hear stories of woe from the oil producers and oil services businesses, it’s easy to overlook the fact that there will also be many winners from the commodities crisis.

And one of the biggest winners is the airline sector, especially airlines such as IAG (LSE: IAG). The owner of British Airways and Iberia is expected to rake in profits as one of its main costs tumbles in price.

Whereas competitors such as EasyJet are budget operations that are dependent on volume to make money, premium airlines like IAG are more dependent on margin and so will benefit hugely as the oil price continues to fall.

The predicted 2015 P/E ratio of 11.58 falls to just 8.16 in the following year.

I expect oil prices to remain low for the next decade and more. Which means IAG is a strong buy now and for the future.

As investment trusts are traded like shares, their shares can trade at a premium or discount to the value of their assets. Demand and supply factors determine the value of the shares in investment trusts, and this usually means trusts that have been underperforming the sector usually trade at a discount to its net asset value (NAV). On the other hand, a strongly performing trust is likely to trade at a premium to its NAV.

Buying investment trusts that are trading at a discount to their NAV can be regarded as a bargain, as you are purchasing a collection of assets for less than the sum of its parts. But there is no guarantee that the discount will close and a sizeable discount could be regarded as a warning sign for poor management, excessive fees or lacklustre investment performances.

We will now look at whether it would be wise to invest in these five heavily discounted investment trusts.

Alliance Trust (LSE: ATST), the globally-focused investment trust, has been trading at a discount of more than 5% for a number of years now. With an investment return of just 1.4% in the first half of 2015, its recent performance has been underperforming its peers.

But management seems to be finally getting their act together. It has engaged with an activist hedge fund Elliott Advisors to tackle its bloated cost structure and improve its performance by increasing its share of equity investments.

The trust could take action to shrink its discount, by buying back shares in itself on the open market to reduce the discount in its shares. It did just that in 2011, when it bought back some £350 million worth of its own shares. With pressure from an activist investor, a return to share buybacks is quite likely.

Mercantile Investment Trust (LSE: MRC) is a UK-focused equity investment trust that has a long history of outperforming the sector. In the past year alone, the investment trust delivered a 20.9% after fees return on its NAV, which compares favourably to the peer average of 17.0% and the FTSE All Share total return of 5.0%. With an ongoing annual charge of just 0.50%, its 11.2% discount seems unjustified.

Templeton Emerging Markets Investment Trust (LSE: TEM) is one of the most popular emerging market investment trusts on the market, with assets under management totalling £1.63 billion. Unfortunately, its heavy exposure to China and Brazil has meant its investment performance has lagged its peer average in recent years.

Caledonia Investments (LSE: CLDN) has a significant proportion of its assets in private unquoted companies through direct holdings and private equity funds. Because of its heavy exposures to the UK, the rest of Europe and Asia, its investment performance has lagged the sector average. On top of this, it has a very high ongoing annual management charge of 2.61%.

Fidelity China Special Situations (LSE: FCSS) trades at a very substantial discount to its NAV, as the recent volatility in the Chinese equity markets and sell-off in emerging markets has reduced demand for the trust. As volatility settles down in China’s equity markets, the trust’s discount could narrow to its historical average of around 10%.

More information?

The Association of Investment Companies (AIC) publishes a wide range of data about investment trusts, including the premium/discount that they trade at, the amount of gearing used and their ongoing charges. Click here to see its latest published statistics.