Important: What follows is not a recommendation to buy or sell the Rights and Issues Trust. I’m just a private investor, storing and sharing notes. Read my disclaimer.
Rights, Issues and complications
The Rights and Issues Trust is a small, split-cap investment trust with a market value of about £33 million. It specialises in UK smaller companies, investing in firms listed on the London main market and on AIM.
Split-cap trusts divide income and capital returns between different share classes. That structure can include specific payout rules or redemption arrangements and, historically, split caps suffered in the dotcom era when interlinked holdings amplified losses. However, structurally the Rights and Issues Trust appears straightforward: its split-cap mechanism is explicit and, putting aside the higher risk of its small-cap holdings (which have performed poorly over the last 12 months), the trust’s structure is no less robust than that of many other investment trusts.
Name: Rights and Issues Trust Ticker: RIII / RIIC Listed: London Business: Investment Trust (Split cap) More info: Digital Look / Google Finance Company: Rights and Issues website
The trust’s chairman and public face is former chess grandmaster Simon Knott, who has earned a following for his stock-picking record.
Getting into Rights and Issues
From an investor’s perspective the trust effectively comprises two tradable share classes: RIIC (capital shares) and RIII (income shares). Each class prioritises income and capital differently, so your choice depends on whether you want higher capital growth or a larger income stream.
RIIC – Capital shares
- Income entitlement – A supplementary dividend: 2.75% net on capital reserves in complete units of £160,000 above £382,536, plus 1/31st of the distribution of all profits after payment of preference and supplementary capital dividends by way of dividend.
- Capital entitlement – 42.2278p per share and 75% of the surplus assets on liquidation.
RIII – Income shares
- Income entitlement – 30/31st of the distribution of all profits after payment of preference and supplementary capital dividends by way of dividend.
- Capital entitlement – 29.0650p per share and 25% of the surplus assets on liquidation.
The market prices of RIIC and RIII move closely together. In short, choose the capital shares if you prefer capital growth with lower current income, or the income shares if you prioritise dividend income.
I hold Rights and Issues income shares in an ISA. Because capital shares have seen steep price falls, their forecast income yield is also attractive and could be worth holding within an ISA if you have allowance available.
The trust can technically be wound up, but the board has stated there is no intention to do so before July 2011.
Why invest in Rights and Issues Trust?
UK investors who want exposure to small-cap companies face a limited choice: there are currently no UK small-cap index trackers comparable to those available in the US. As a result, exposure typically comes through buying individual small companies or investing in a fund or investment trust.
Collective vehicles reduce the risks associated with single-stock holdings and require less ongoing work than picking many individual small caps. They also give you exposure to a manager’s stock-picking skill—either a benefit if they succeed or a drawback if they do not.
I prefer investment trusts to unit trusts for lower ongoing charges, potential use of gearing, and the chance to benefit from discount narrowing—though those same features add risk.
Hunting for small-cap value
The board of Rights and Issues follows a long-term value approach: they favour established, profitable companies with solid balance sheets and attractive yields that trade below perceived intrinsic value. They typically avoid speculative, unprofitable start-ups and hold stocks for extended periods.
Academic and market evidence suggests small-cap value stocks have delivered superior long-term returns among equity categories. The trust’s approach aligns with that evidence by focusing on durable, lower-rated businesses that appear undervalued.
Here are the trust’s largest holdings from its recent final results:
Rights and Issues Trust: Major investments
- RPS Group
- Hill & Smith Holdings
- Thorpe F.W.
- Celsis Int’l
- Intelek
- Colefax Group
- Scapa Group
- Aggreko
- Eleco Holdings
- VP
- Spirax Sarco Eng
- Treatt
- Brammer
- Domino Printing Sciences
- RPC Group
- BSS Group
- Low & Bonar
- Logica CMG
- Dawson Holdings
- White Young Green
Most of these names appear attractively rated to me, and several have fundamentals that seem stronger than their depressed valuations would imply. Many also feature in my own value screens when searching the market.
That said, low ratings for small-cap companies can be justified by their greater sensitivity to the domestic UK economy and to sterling. Smaller companies typically feel downturns more acutely than large-cap firms and rely more on bank financing, which has become constrained during banking stress—although the trust’s portfolio does not appear heavily impaired by funding issues.
Market fear and opportunity
Much of the recent de-rating reflects risk aversion: with headline failures on Wall Street, tighter bank lending, plunging global growth and rising unemployment, many investors have fled small-cap exposure. That fear is often short-term in nature and may not reflect five-year prospects.
If you can tolerate volatility and invest for the long term, this environment can present opportunities to buy quality small-cap value at discounted prices. The important caveat is that prices can fall further, as Rights and Issues has already demonstrated over recent months.
Past performance and recent plunges
Historically, Rights and Issues delivered exceptional long-term performance. Between 1985 and its 2006 peak the capital shares’ net asset value (NAV) rose roughly 25-fold, and income shares showed similarly strong gains. Over that same multi-decade period the broader FTSE All Share increased by a much smaller multiple.
However, more recently NAVs have fallen sharply. According to the trust’s final results, as of 31 December 2008 the capital shares’ NAV had declined to £16.43 and the income share dividend was cut to 33p. Over the previous 12 months the capital and income shares fell about 67% and 69% respectively.
Rights and Issues Trust over the past 12 months (click to enlarge)
For short-term holders the recent performance has been brutal. The chairman summed up the year in blunt terms, noting that small-cap indices plunged far more than the FTSE All Share and that the trust suffered a very substantial decline in NAV.
Discounts and wide spreads
The trust traded at a premium in 2007, but that has reversed and the shares now trade at a sizeable discount—roughly 30% at the time of the report—so new buyers can effectively purchase the underlying portfolio at a substantial markdown.
One practical deterrent, however, is the wide bid-offer spread. The published market spread can mean an immediate paper loss when buying, so this trust suits very long-term investors who are prepared to hold through volatility and wait for market conditions to improve.
I bought Rights and Issues income shares to diversify and to collect dividends, holding them in an ISA with no immediate plan to sell.
Is now a good time to buy?
Short-term market direction is unpredictable. Global economic stress and political responses make outcomes uncertain. The board has prudently reduced dividend levels to a sustainable base—33p for income shares and 1.65p for capital shares—while maintaining a supplementary capital dividend for capital shares where feasible.
The chairman’s outlook remains sober: a sharp UK economic contraction and a weak capital goods cycle were highlighted as risks, alongside continued banking dislocations. Even so, a double-digit yield and the potential for recovery could be attractive for patient investors.
The trust’s management fees are modest: total expenses were reported at 0.96% for the year to 31 December 2008, comparable with a specialist index tracker. Directors receive simple, transparent remuneration without complex options or incentives.
My view is that the current discount could present a rare opportunity for long-term exposure to UK small-cap value, provided you accept the significant risks involved.
Accordingly, I topped up a holding I first bought in September 2008. Despite the apparent valuations, I remain cautious and have kept my position small—under 1% of my portfolio—so total small-cap exposure across all holdings remains around 5%.
Note: I take no responsibility for the accuracy of this post. Read my disclaimer.