The Mercantile Investment Trust, established in 1884, stands as one of the oldest investment firms in the City. Currently managed by JP Morgan, the fund targets quality British companies outside the FTSE 100 that are attractively priced. Its longstanding history of dividend growth has made it a favored choice among income investors. However, with a reported double-digit discount, questions arise regarding the fund’s current health over its 141 years in operation.

The primary goal of Mercantile is to enhance its investors’ wealth over the long run by investing in a diverse portfolio of mid and small-cap British firms. Although income generation is not its principal focus, this investment style is deeply ingrained in the fund’s philosophy, as evidenced by its quarterly dividends intended to increase at least in line with inflation. The management team, comprising Guy Anderson and Anthony Lynch, employs a bottom-up strategy in stock selection, allowing for flexibility in sector allocations.

While the trust predominantly supports mid-cap companies, its portfolio includes significant investments in larger firms. As of December, its top holding was Intermediate Capital Group — a FTSE 100 alternative asset manager — representing 3.9% of its assets, followed closely by housebuilder Bellway at 3.8%, and private equity firm 3i Group at 3.6%.

The notion of ‘small’ is relatively defined; most companies in the portfolio have market capitalizations ranging between £1 billion and £10 billion, with only about 14% invested in businesses valued under £1 billion.

Recently, the fund has demonstrated robust performance, largely thanks to the managers’ strategic decision to increase investments in the consumer discretionary sector. This move aimed to capitalize on potential upsides from the UK’s economic recovery, with popular home retailer Dunelm in its top ten holdings. As a result, the trust has seen a net asset value return (NAV) of approximately 20% for the year concluding in November.

Despite these gains, the management team believes that stocks in the consumer sector remain undervalued. They continue to maintain exposure to entities linked to consumer spending, though there has been a slight retreat in performance due to concerns regarding the implications of Labour’s budget in October. Nevertheless, the trust adheres to a risk-on stance in the UK markets, with actual gearing standing at 15.6% at the end of 2024.

At present, Mercantile trades roughly 10% below its NAV, consistent with the average discount in its sector. Historically, it has traded at an average discount of around 9.5% over the past five years, while 2024 saw an average of 6.6%, according to Morningstar Direct. To manage this valuation gap, the fund’s board has made significant efforts, repurchasing nearly 27 million shares since the beginning of its current financial year, accounting for approximately 3.4% of shares outstanding as of the end of January 2024.

The appeal of Mercantile largely stems from its dividend offerings. Though it presents a historic yield of 3.3%, which is slightly lower than the 3.5% yield from the FTSE All Share, it boasts an impressive 11-year track record of annual dividend growth above inflation. By the conclusion of its 2024 financial year, revenue reserves reached £76.2 million, ensuring a dividend cover ratio of 1.3. This, alongside a diversified portfolio of quality British firms available at low valuations, appears enticing for investors looking to expand beyond the FTSE 100.

Advice: Buy

Why: Reliable dividend growth and a varied approach to British equities.

AJ Bell

AJ Bell, the investment broker based in Manchester, received a ‘hold’ rating from Tempus in April. Since that rating, the company has seen its market value increase by about 50%, posting record profits and initiating a £30 million share buyback program. The shares are currently trading at a forward price-to-earnings ratio of 20.4, higher than the broader FTSE 250 index, which stands at 14.1. This raises the question: is this stock worthy of a premium price?

AJ Bell has expanded significantly, gaining 66,000 new net customers in its 2024 financial year, bringing its total to 557,000. This growth has driven revenue up by 23% to £269.4 million and pre-tax profits up 29% to £113.3 million.

Expectations for 2025 are high, with a first-quarter update set to be released on Wednesday. Analysts are optimistic, predicting £1.5 billion in platform net flows in the first quarter, compared to £1.3 billion the previous year. The recent gradual decline in interest rates has slowed growth in cash ISAs, affecting larger firms in the financial advice sector like True Potential, which may lead smaller businesses to increasingly rely on platforms like AJ Bell.

With AJ Bell’s primary competitor, Hargreaves Lansdown, now privatized, it faces few rivals in the public market. Its closest competitor is Interactive Investor, part of the struggling Abrdn group, which trades at a forward price-to-earnings ratio of 11. This stark contrast with AJ Bell’s 20.4 reflects its status as a high-quality enterprise, characterised by strong brand recognition, growth opportunities, and solid margins, alongside a robust share performance over the past year.

Advice: Hold

Why: Valuation reflects its strength and growth potential.