The Mercantile Investment Trust: Flexible

The Mercantile Investment Trust

The home of tomorrow's UK market leaders

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The Mercantile is an actively managed investment company. This means the managers are free to diverge from the Company’s benchmark, the FTSE All-Share (excluding FTSE 100 and investment companies), by choosing the number and size of portfolio holdings, with a view to achieving long-term capital growth, and outperforming the benchmark, rather than slavishly tracking it.

This active approach means the managers have the flexibility to overweight sectors and stocks they particularly like and buy so-called ‘out-of-index’ stocks which are not included in the benchmark. They are also able to entirely avoid industries and companies that form part of the benchmark, but do not meet the managers’ rigorous investment criteria.

In fact, flexibility is integral to the Company’s investment process, beginning with the fundamental stock characteristics the managers target when selecting portfolio holdings. They seek out the UK market’s most nimble companies - innovators and disruptors who can adapt quickly to changing market circumstances. Such companies tend to be mid and small cap businesses with significant potential to grow over the medium to long term. This accounts for the managers’ bias in favour of companies in these areas of the market.¹

The managers also adopt a flexible approach to their task. They are always looking beyond the headlines and consensus opinion, closely examining the latest data and using their industry sources to acquire unique insights into the outlook for the economy, sectors and individual stocks. They are quick to respond to any investment opportunities as they emerge and take active positions that reflect the strength of their convictions in their ideas.

For example, the managers are optimistic that the outlook for the UK economy is improving, thanks to rising real wages, a resilient labour market and increasing consumer confidence. And they expect interest rate cuts to provide further impetus to activity, and equity markets, in the latter half of the year and beyond. ² This relatively upbeat viewpoint has prompted some meaningful portfolio changes over the past year. The managers have increased the portfolio’s overweights to consumer stocks likely to gain from economic recovery, via new acquisitions including Trainline, a rail booking service and Jet2, an out-of-index package holiday company. (Jet2 is listed on Alternative Investment Market (AIM), the London Stock Exchange's (LSE's) international market for small and medium size growth companies.)

Lower interest rates should be supportive for real estate, so the managers have also increased exposure to housebuilders and in real estate more broadly, including the purchase of construction company Vistry and top-ups to existing holdings in two other builders, Bellway and Redrow. They have also purchased two REITs (Real Estate Investment Trusts) - Tritax Big Box and Shaftesbury Capital. These purchases have served to reduce the portfolio’s underweight position to the real estate sector.

The Mercantile’s managers are also bullish about the prospects for tech-related companies. They expect corporate demand for IT infrastructure to remain robust as companies integrate artificial intelligence (AI) into their production and administrative processes. The Trust has significant positions in Softcat, a British technology company providing communications, software licencing, procurement and management services, and Computacenter, an IT services company, which have benefited from this trend. And the managers see scope for them to grow revenues at an even faster rate as customers adopt generative AI solutions. Elsewhere in the tech sector, they have added to their position in Bytes Technology, a technology reseller, and made a new investment in Moneysupermarket.com, a price comparison business seeing rising demand due to higher insurance prices. The managers also believe this company’s new web platform has the potential to lift profitability via direct-to-site sales.³

Active, flexible management also requires a readiness to exit positions where necessary, and The Mercantile’s managers have demonstrated their willingness to act quickly if a stock’s investment case weakens unexpectedly, or if more attractive opportunities arise in other parts of the market. For example, they recently closed a longstanding and profitable position in luxury watch retailer, Watches of Switzerland, after concerns about the company’s ability to meet its long-range growth target.⁴

Portfolio gearing (where investment trusts borrow to invest) is another form of flexibility at the managers’ disposal. It provides them with the means to amplify performance in rising markets and reduce market exposure to protect returns in declining markets. The managers have scope to gear the portfolio up to 20% of gross asset value, and to hold up to 10% net cash. Their current optimism about the UK economy and equity markets is reflected in a steady increase in portfolio gearing over the past year. It stood at 16.2% at end April 2024, the highest in a decade, up from around 10% at the same time last year.⁵

Flexibility, in all its forms, is key to successful active investment management, and combined with the managers’ stock selection skills and their proactive investment approach has enabled The Mercantile to outperform its index over both the near- and longer-term. It has decisively outpaced the market in the year ended 30 April 2024, and over the past five- and 10-year periods.⁶ And with flexibility built into the Trust’s investment process, and manifest in the managers’ approach to ideas generation, stock and sector selection and gearing, it should continue to support portfolio returns in future.