London’s high-flying FTSE 100 hit a record high in May, closing above 7,500 for the first time and currently trades above 7,400.

Many large, liquid, internationally-diverse companies are in demand at a time of economic uncertainty, particularly as beneficiaries of lower sterling. Their overseas earnings are worth more when translated back into pounds.

This is manifesting itself in stretched blue chip valuations but the finest fund managers at the helm of investment trusts are still unearthing value from the market’s upper echelons.

Merchants’ magic formula

One fund with proven pedigree in finding value and providing plump payouts is The Merchants Trust (MRCH). Managed by Allianz Global Investors’ Simon Gergel, the trust provides an above average level of income and income growth, together with long term growth of capital, through investments mainly in higher yielding UK large caps.

Classed by the Association of Investment Companies (AIC) as a ‘dividend hero’, having grown the shareholder reward for 35 successive years, Merchants trades at a 4.5% discount to net asset value (NAV), offers a 5.1% dividend yield and has the lowest management fee in the UK Equity Income sector at 0.35%.

‘Merchants has one of the highest dividend yields in the sector and we make no apologies for that,’ says Gergel. ‘We are genuine income investors – we try and buy companies with a good yield as part of our investment process. We yield significantly more than the market (the FTSE All-Share), but we also yield more than other income trusts.’

Gergel stresses that a high yield strategy has delivered strong long-term performance. ‘But we don’t buy companies just for the yield. We’re always looking at the total return we can get and we won’t buy a business we think has structural problems just because it has got a good dividend yield.’

An active investor prepared to take strong views, Gergel says the portfolio isn’t high turnover, but he doesn’t have a buy and hold approach. ‘We will move the portfolio around to where we see value. We’ve sold out of many companies where we just find the valuations are too high. And therefore, our portfolio looks very different to many equity income funds.’

One example of an exit

Merchants recently sold its remaining position in British American Tobacco (BATS). As Gergel argued in his recent factsheet: ‘BAT has been a very strong performer and is now highly valued on almost any measure. The industry faces unprecedented change, with healthier e-cigarettes and next generation tobacco products disrupting the traditional cigarette business. Whilst these innovations are not necessarily negative for the companies, the outlook is more unpredictable than in recent years, and both the large UK tobacco companies carry considerable debt on their balance sheets,’ he says, also referring to Imperial Brands (IMB).

He is however enthused by the likes of FTSE 100 insurer Prudential (PRU) – ‘a high growth stock and a very high-quality company’ bought following a Brexit-related de-rating.’

One recent purchase is the FTSE 100 media giant WPP (WPP), a formidable dividend growth stock whose strengths include leading positions in the digital and new media sectors and in emerging markets. WPP was bought following some disappointing trading updates which lowered the valuation to levels which don’t reflect the growth potential, in his opinion.

An alternative trust with a similar remit is City of London (CTY). A fellow ‘dividend hero’, the Job Curtis-managed fund has increased its shareholder reward for half a century. The trust’s leading holdings range from Royal Dutch Shell (RDSB) and Vodafone (VOD) to AstraZeneca (AZN).

Canny contrarians

Prowling the market for value opportunities, sometimes at the mega-cap end of the market, is Investec Asset Management’s Alastair Mundy. Quick-witted and quirky, Mundy manages Temple Bar (TMPL) with a contrarian style, seeking undervalued, out-of-favour companies with strong balance sheets. Typically, he wants at least 50% potential upside from his against-the-grain investments. Mundy uses enterprise value (EV) rather than market capitalisation to ensure his analysis allows for debt, pension deficits and other liabilities.

While the majority of Temple Bar’s portfolio is invested in the FTSE 100, Mundy is happy to delve into FTSE 250 and small cap stocks and runs the rule over international stocks too. Top 10 holdings include mega cap bank HSBC (HSBA), recovering grocer WM Morrison Supermarkets (MRW) and Lloyds Banking (LLOY).

Fellow contrarian fund manager Alex Wright is also alive to value opportunities across the market cap ranks. Fidelity Special Values (FSV) is a special situations fund that thrives on volatility and uncertainty and offers an exposure to large cap names. The likes of Royal Dutch Shell, Citi and Ladbrokes Coral (LCL) all nestle in the portfolio.

Elsewhere, The Scottish Investment Trust (SCIN) also pursues a firmly contrarian strategy under lead fund manager Alasdair McKinnon. Trading at an 8.8% discount to NAV, holdings include Tesco (TSCO) and Marks & Spencer (MKS), as well as Japanese gaming giant Nintendo.

Great companies, great value

Any discussion of large cap value would be remiss without mentioning revered buy-and-hold investor Nick Train. His Finsbury Growth & Income Trust (FGT) includes great companies offering attractive long-term value, stemming from their ability to compound earnings and dividends over time.

The portfolio is spearheaded by veritable dividend machine Unilever (ULVR). Kraft-Heinz’s attempted takeover highlighted the underappreciated value in the consumer goods colossus, which Train argues is only in the foothills of its opportunity to distribute its brands across emerging markets.

Kraft-Heinz’s tilt offers a positive valuation read-across for other Train holdings with great brands and emerging markets exposure. These include alcoholic drinks giant Diageo (DGE), luxury leader Burberry (BRBY), lager leviathan Heineken and biscuits, chocolates and beverages behemoth Mondelez.

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