Investing in Merchants Trust could add some Footsie firepower to your portfolio

This week, Chancellor Rachel Reeves changed her stance on the economy. Having previously adopted a view laden with pessimism, he now maintains that “the best days are ahead.” It’s a significant change that private investors cannot afford to ignore.

Reeves seems to have belatedly realized that Britain has a growing fan base, despite its challenges.

Major US banks are increasingly interested in the UK stock markets, seeing them as a time to acquire unwanted stocks, in the belief that they are about to appreciate.

A year ago, the main motivation for buying UK shares was the hope that the companies involved would succumb to foreign takeovers.

This merger activity has intensified. This year there have been up to 20 offers for FTSE 350 companies.

However, the belief is that more companies can evade such attempts and grow to their full potential, becoming too costly for predators. Dzmitry Lipski, fund guru at the Interactive Investor platform, sums up the mood by saying that “this time it’s different.”

Paradoxically, the new, more optimistic climate is partly due to the arrival of a new government that will likely be in power for five years.

Consequently, the United Kingdom is considered to be more stable than France, Germany or the United States. The belief that Britain has better prospects than other G7 nations is backed by the Organization for Economic Co-operation and Development (OECD), which this week raised the UK’s annual growth by between 0.7 percent and 1 .1 percent. The organization has also raised its forecast for 2025.

Alexandra Jackson, of Rathbone UK Opportunities fund, says: ‘The UK is no longer an economic outlier. GDP is recovering. Inflation is close to target and sterling is rising strongly.

‘But share valuations still suggest UK shares are still undervalued. The UK market is trading at a price-earnings multiple (a closely watched indication of value) of 11.5 times versus 18.7 times for the MSCI World Index. The United States is even higher.”

Fears that Reeves’ first budget, on October 30, will be full of tough measures are causing some investors to sit idly by.

But the opportunities are worth exploring, especially an investment fund that plans to make the most of current conditions. Simon Gergel, manager of Merchants, a UK business trust established in 1889, believes we may be at “the start of something special”.

Richard Knight, deputy director of the fund, adds: ‘We like to take advantage of moments of dislocation.

‘UK stock markets have been under a cloud of negative sentiment.

“But not only are they diverse, they are also undervalued and therefore are now a wonderful place to find brilliant ideas.”

The trust owns around 50 shares. Most are FTSE 100 names, such as BP, Lloyds and Shell.

But it is also investing in housebuilders like Barratt, who will benefit from Reeves’ promise to deliver 1.5 million homes over the next five years.

The portfolio also includes FTSE 250 companies such as IG Group, the spread betting platform.

Members of the FTSE 250 tend to be more domestically focused, but Keller, the geotechnical engineering contractor, operates mainly in the United States on projects such as building a stadium for the Dallas Cowboys football team.

Keller shares have doubled in the last 12 months.

The mission of merchants is to provide growth, but also income. It has paid dividends consistently for over 40 years, but companies aren’t bought just because they offer a good yield. Gergel says, “The main reason to buy a stock is that we think we can make money.”

In this search, Gergel, Knight and the team are looking at long-term themes, such as demographic change and decarbonization and the shift away from fossil fuels.

With this in mind, it may seem strange that BP and Shell are among the top holding companies, but Knight defends the decision.

‘The nation is going to need oil and gas for a long time, and getting it locally is cheaper and greener. Both companies also have incredible transition plans.’ he says.

As decarbonisation is driving demand for copper, an essential element in wind turbines, Merchants has a stake in Grupo Atalaya which exploits it in Spain.

Some investors may shrug their shoulders at oil and gas. Others will take issue with Merchants’ involvement in British American Tobacco (BAT).

Gergel acknowledges that this participation allows the trust to offer a dividend yield of 4.8 percent.

But he adds that he and his fellow managers seriously consider the social issues of investing in tobacco, putting pressure on producers to change labor practices on farms. He points out that BAT has a “next generation” product range with less harmful products.

The portfolio includes “oversold” out-of-favour stocks, with Burberry being a recent purchase.

Shares in the British fashion house, founded in 1856, have just enjoyed their best week since 2009, after falling 50 percent in the last six months.

This comes against a backdrop of slowing consumption in China and the lack of appeal of the current collection in almost all regions.

Knight comments: “This is a brand with heritage, thanks to its classic trench coats and check pattern design.”

The Merchants team believes Burberry can return to acclaim under its new chief executive Joshua Schulman and chairman Gerry Murphy.

Gergel says: “We think it’s a classic turnaround situation.”

Over the past three years, Merchants has returned 32p, compared to the 19 per cent average for its sector.

The trust’s shares have a negligible discount (0.7 percent) to the trust’s net asset value.

With other trusts seeing double-digit discounts, this underlines the traders’ appeal to those looking for a brighter future for UK plc.

OTHER UK PLC OPTIONS

The reassessment of the UK stock markets is a signal to take a critical look at your entire portfolio. It’s easy to assume you have a well-diversified range of holdings when in fact you are overexposed to the US tech giants, which account for a large percentage of many popular funds and trusts. F&C is a popular trust, but the American tech titans (Apple, Amazon and the rest) dominate the portfolio.

When building a portfolio in the UK, it also makes sense to check that a balance is being struck.

Interactive Investor’s top tips include City of London, a conservatively managed trust that backs big FTSE 100 names such as BAE, BAT, NatWest and HSBC.

Interactive Investor’s Lipski also cites the Artemis Income Fund, which also invests in FTSE 100 names such as Relx and Tesco, and the JP Morgan UK Equity Core Fund whose largest holdings are AstraZeneca, Shell and HSBC. FundCalibre favors Murray Income, another trust that invests in FTSE 100 stalwarts and one of my bets on the revival of UK markets.

If you are interested in getting a sense of the resurgence of smaller companies, you can trust Oydssean, whose managers deploy “constructive corporate engagement” to encourage companies to improve their performance.