Case study

Merchants Trust

U had done your research and u knew that MRCH was a dividend hero, an Investment Trust that has paid regular gently increasing dividends.

Warren Buffet says “To buy when their is blood in the streets”.

The price to buy was around 320p and the dividend was 27.1p

a yield of 8.5%, which u should receive as long as u hold the Trust.

Without hindsight u have no idea if the Trust would fall further but

u are only a yield hunter, so the chance was worth taking.

The graph with earned dividends but not re-invested in MRCH.

When the Total Return reached 640p u decide to take out your

initial stake and re-invest in another high yielder.

MRCH current price is 523p and their latest dividend

Chairman’s Statement

Dear Shareholder

The Merchants Trust was established in 1889, so in 2024 we mark the one hundred and thirty fifth anniversary. We are all proud to be involved with a company that has not just endured for such a long time, but remains relevant to shareholders today. Merchants is one of the oldest listed investment trusts. Our name, as with some of our eldest peers, hints at our history and origins and Merchants was originally incorporated to invest in railroad assets in the burgeoning North American market. One of the most important factors in Merchants success over such an extended period of time has been its adaptability and its continued focus on the needs of investors and an ability to navigate investment markets to continue to deliver attractive investment returns.

Merchants shareholders have witnessed both World Wars, many smaller scale conflicts, and significant geopolitical and economic shifts in the world. During the past 42 years, including the proposal this year, I am proud to report that the company has managed to provide a rising dividend every year.

Whilst investing is never ‘easy’, the financial year to the end of January 2024 was especially challenging. Some days heralded recovery and others felt like economies and markets were falling badly backwards. The newsworthy events of 2023 could justify an article in their own right and included (overseas) bank failures, equal measures of utopian and dystopian views of a future shaped by AI, war & conflict (sadly now more than one major ongoing conflict) and natural disasters. Geopolitics often felt ‘on the brink’, but we seem at least to have stayed just the right side of the line for now, to avoid wider global involvement.

The market backdrop was generally one of concern over inflation and how central banks would use interest rates to control it, but at the same time maintain growth. Bond markets reflected the volatility of investor’s expectations and risk appetite oscillated during the year. In turn this drove equity market fluctuation. For global investors the year was positive, though those gains were generally narrow and led by a small number of US tech stocks, particularly on the back of ‘AI fever’ triggered by the launch of Chat GPT’s GPT-4 model in March. A new narrative for future economic development was born at that point, and markets followed it with eagerness.

The UK market was not buoyed in the same way by Tech and AI stocks. Its returns were more muted and produced only a modest positive total return. This positive total return was a great example of how dividends can make a difference. The FTSE All-Share started the period at 4,255.7 and ended at 4,173.1 – a fall of 1.9%. Total return however, including dividends of 3.8%, produced a positive total return of 1.9%.

Performance

Even though the UK market finished the period marginally up on a total return basis as noted above, Merchants’ Net Asset Value total return for the year unfortunately lagged the benchmark, recording a fall of 3.1%. This is obviously very disappointing and the board has engaged with the portfolio manager and the AllianzGI team to understand the contributions, both positive and negative, to this result. Whilst we clearly need to monitor short term performance, this disappointing result comes after two very good years when the portfolio outperformed the benchmark and we recognise that the longer term (3 and 5 year) track record of the trust is extremely strong.

Shareholders will be aware that the UK stock market is still a mix of both lowly priced stocks some of which offer ‘value’ and higher rated ‘growth’ stocks. Unfortunately, the period under review was a difficult one for the more modestly priced stocks that our manager tends to favour due to his ‘value’ investment style. Whilst this produced a relatively disappointing 1-year picture for Merchants shareholders, the longer-term record remains strong, with outperformance of both the industry benchmark, as well as the sector peer average, over 3 and 5 years.

For a value-oriented investor, a run of poor relative performance can often reflect simple under-pricing of particular types of companies, or certain cyclical sectors. With any disciplined, active management investment approach, there will always be periods when it is difficult to outperform the benchmark if the strongest performance comes from the areas of the market that do not meet the portfolio manager’s investment criteria. It should also be remembered that a period such as the year to January 2024 can often be a time when the best new ideas for investing are generated, often ahead of any improvement in sentiment or cyclical upturn.

Despite short-term headwinds, we were delighted to collect the Citywire award for Best UK Equity Income trust at their annual investment trust awards in November. The award is based around 3-year performance as well as other factors, and is therefore a welcome recognition of the returns to shareholders over the long term.

The board remains confident that the tried and tested investment strategy followed by the manager remains appropriate to meet Merchants’ objectives for shareholders over the long term.

Income

In terms of the income generated by the underlying portfolio, it was a strong year with revenue earnings per ordinary share rising 6.3% to a record 30.5p (2023: 28.7p) as dividend income received by the trust has fully recovered from the impact of the pandemic. This meant the dividend declared for the year was fully covered by earnings, as well as allowing the board to add 1.8p per ordinary share to revenue reserves.

I have written before about the importance of investment trusts being able to build revenue reserves in order to provide some protection against difficult times. This was amply demonstrated during COVID years when our revenue reserves built in good years enabled the board to maintain dividends to our shareholders even though dividend receipts from the Merchants portfolio of investments were weak. Now that dividend receipts from the portfolio have recovered the board thinks it important that we should build up reserves once again, as illustrated by the chart on page 6 of the Annual Report.

At the end of the financial year, the revenue reserve stands at 18.1p per ordinary share.

Dividend

The board is pleased to propose a final dividend of 7.1p for shareholder approval at Merchants’ upcoming AGM on 16 May 2024. Subject to that approval, that will mean a full year dividend of 28.4p (2023: 27.6p), a rise of 2.9%.

The annualised growth rate of the dividend paid by the trust over 42 years stands at 6.4%, remaining well above the rate of inflation over that period which stands at 3.8% annually as measured by the Consumer Prices Index (CPI) despite the particularly high inflation numbers evident over the past two years. The company continues to pay a high dividend, representing a yield of some 5.2% at the period end. This remains well above the sector average (4.5%), placing it in the top-ten yielders in the sector.

With 42 years of unbroken annual dividend rises, Merchants also retains its place on the Association of Investment Companies’ (AIC) Dividend Hero list – those companies having managed to consistently raise their dividend for twenty years or more.

If u had invested 10k u would have doubled your money.

The shares in MRCH which sits in your account at a zero, zilch, nothing

cost yields 5.2%

U could have another similar holding yielding around 8% a total

income of 13% on the amount invested.

Income of £520 and £800, £1,320.00. In around 7 years time u should

have received your initial stake back, again.

To grow the Snowball the 13% could be re-invested into other high

yielding Investment Trusts.

Or if u wanted to take the risk to grow your portfolio, into a Tech Trust

ATT or PCT where u know u will not lose any of your hard earned

if u can choose when to sell, although it could be multi years but that

would allow u to build up a meaningnful holding.