Buy quality UK stocks on the cheap with this trust

The end of US exceptionalism is the talk of the town. It’s too soon to tell whether this crisis will morph into a seismic change that permanently reshapes global markets, but investors can’t be faulted for looking at other regions with increased enthusiasm. If you are thinking of topping up your domestic exposure, Edinburgh Investment Trust (EDIN) offers access to UK quality companies at an attractive discount.

During downturns, investors tend to favour the UK market thanks to its focus on income and exposure to defensive sectors. This can make investment trusts in the UK equity income sector relatively expensive, the most obvious example being City of London (CTY) – a reliable play that sits at the top of the Association of Investment Companies’ dividend heroes table with 58 consecutive years of dividend increases. As at the end of April, City of London was trading at a premium of 2 per cent, and the sector’s average discount was about 3 per cent. Against this background, Edinburgh Investment Trust’s 7.6 per cent discount looks appealing.

The trust invests in a fairly concentrated portfolio of 40 to 50 companies, typically drawn from the “lower reaches of the FTSE 100, the higher reaches of the FTSE 250 and selected overseas stocks”. Roughly three-quarters of the portfolio is in FTSE 100 companies, 16 per cent in mid caps and 6 per cent in international stocks.

It has two objectives: beating the growth of the FTSE All-Share and increasing its dividend by more than inflation. The first has been prioritised over the second in recent years, with the trust opting for a dividend cut in the 2020-21 financial year as the income generated by the portfolio dried up during the Covid-19 pandemic.

The dividend has been raised many times since then, but the trust’s yield is among the lowest in the sector at 3.6 per cent. Its managers look for total returns, achieved through a mix of capital growth and income generation. Income is seen as “an important component rather than the primary driver of investment returns”. As such, the trust’s strategy may not be a perfect fit for investors who are after reliable dividends more than anything else.

But juicy dividends often come at the expense of growth. Edinburgh Investment Trust offers a more rounded approach, with the managers striving for a well-diversified portfolio that balances growth, value and recovery stocks, so that it can hold up in different market cycles and economic environments.

Manager Imran Sattar is on the hunt for “structural growth” companies that offer attractive return margins, are able to protect those through “economic moats”, and are reasonably valued. As of March, the trust’s top bets – companies to which it had the highest exposure compared with the index – included home furnishings retailer Dunelm (DNLM), consumer healthcare company Haleon (HLN) and Tesco (TSCO).

A complicated history

There is some justification for the trust’s discount. Mick Gilligan, head of managed portfolios at Killik & Co, points to its recent net asset value (NAV) performance, its yield and its discount control policy. Unlike others, the trust does not have a formal policy to try to reduce its discount, although it has been buying back shares.

It has also had some ups and downs in its history. If you look at its 10-year record, the returns appear frankly unimpressive. However, the underperformance occurred when the trust was managed by Invesco. Five years ago, James de Uphaugh, co-founder of Majedie, was appointed manager. Majedie was later acquired by Liontrust, but the management team stayed the same. In the five years to the end of April, the trust was the third best performer in the sector, well ahead of its FTSE All-Share benchmark.

De Uphaugh retired in February 2024, after a 36-year career and just a few months after his deputy Chris Field. As a result, the trust is now led by a fairly new team, with Sattar at the helm and Emily Barnard as his deputy. At the time of the change, Numis analysts noted that de Uphaugh had an “exceptional” track record, and that while Sattar was “well ingrained in the investment process”, which was not going to change, he also had some big shoes to fill.

“The further change in manager a few years after appointment is further disruption that may not be welcomed by some investors and is unlikely to help the discount narrow,” they said.

Indeed, the discount has not narrowed much, but on the portfolio side, it’s a case of so far, so good. Since February 2024, Edinburgh’s NAV has increased by 18 per cent, against the benchmark’s 15 per cent. However, the outperformance had not carried on into 2025, with the trust slightly underperforming the index since the start of the year, which Gilligan thinks has contributed to the discount.

Sattar told the IC that his focus remains on finding businesses that have a competitive advantage and can prosper whatever the economic landscape. “The majority of the businesses we own in the trust have made very strong operational, financial and strategic progress over the past few years and are well placed to weather the storm,” he argues.

Kepler analysts recently said Sattar “truly believes in the total return philosophy” and has been “unashamedly” focused on building a well-diversified portfolio. In the six months to September 2024, the managers trimmed positions that had outperformed such as Marks and Spencer (MKS), Centrica (CNA) and BAE Systems (BA.) to top up “the most attractive long-term growth opportunities in the portfolio”, namely London Stock Exchange Group (LSEG), corporate caterer Compass (CPG) and US-listed Verisk (US:VRSK), a data and analytics supplier to the insurance sector.

Barnard recently spoke to the IC about why the managers love London Stock Exchange, branding it “a global financial markets infrastructure and data powerhouse”. The trust has also bought new positions in accounting software provider Sage (SGE) and UK build-to-rent company Grainger (GRI).

The latter is the result of the managers’ search for opportunities resulting from shifting supply-side dynamics, which they argue receive less attention than demand forecasts.

“When capital exits an industry, the improved supply-demand dynamic can enhance returns and profitability for the remaining players as well as strengthening their competitive position,” explains the trust’s investment analyst, Tom Gilbey. The investment case for Grainger was based on the fact that the number of small private landlords is falling, while demand for rental properties remains strong.

This is a good example of how the trust’s team works to find companies that have structural opportunities to grow. If you are after exposure to domestic businesses with the potential to do well, but with an eye on resilience in tough economic times, Edinburgh Investment Trust feels like a good place to start.