Ian Cowie: investment trusts to play this soaring sector

Fears of further bloodshed in Ukraine, with America shifting its focus away from Europe towards Asia, have helped propel continental arms manufacturers to record highs. For example, shares in Germany's biggest weapons-maker, Rheinmetall AG (XETRA:RHM), have soared by an eye-stretching 201% since the start of this year.

But investors can still gain exposure to RHM via an investment trust, where it is the biggest holding in the portfolio, and which remains priced 12% below its net asset value (NAV). That discount could prove cheap for a reason, although bargain-hunters might consider it is not a bad place to start.

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Next week's G7 summit, gathering seven of the industrialised nations, and the NATO summit later this month, are expected to see further commitments to boost European defence spending. That would be in addition to the £6 billion per annum extra announced by British Prime Minister Keir Starmer in his Strategic Defence Review (SDR) earlier this week.

This should be good for business at Britain's biggest weapons-maker, BAE Systems (LSE:BA.), RHM, and elsewhere. The bad news about the investment trust which has 5% of its assets invested in RHM is that European Assets Ord (LSE:EAT) is the worst performer in its Association of Investment Companies (AIC) sector, “European Smaller Companies” over the past decade, five years and one-year periods.

However, that dismal backdrop might tell us more about the past than the future, because EAT appointed two new managers last summer and their first year at the helm might indicate happier times ahead. Philip Dicken and Mine Tezgul managed to deliver a modest total return of 4% in their inaugural year, following the previous manager’s 29% over five years and 51% over the past decade.

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Here and now, EAT's 6.4% dividend yield - albeit without any sustained increase in income over the past five years - should pay this long-term shareholder to remain patient. Better still, these shares are in my ISA, so the income is tax-free.

Against all that, it is only fair to ‘fess up that this has not been a very happy experience so far, having paid the equivalent of £1.04 in February 2015, allowing for a subsequent 10-for-one stock split, for EAT shares that cost only 87p this week. Yearly ongoing charges of 1.01% are the highest in its sector, suggesting that the management company, Columbia Threadneedle, might be making more out of this £384 million fund than the shareholders.

EAT’s other underlying assets include the Anglo-Irish paper and packaging group Smurfit WestRock (LSE:SWR); the Irish house builder Cairn Homes (LSE:CRN), and the Swiss turbo-charging and fuel-injectors engineer Accelleron Industries AG Ordinary Shares (SIX:ACLN).

Returning to the business of war, the AIC has identified several investment trusts with significant exposure to global defence stocks. For the purposes of this research, the latter included the American drone-maker AeroVironment Inc (NASDAQ:AVAV; the French aerospace giant Airbus SE (EURONEXT:AIR); the British engineer Babcock International Group (LSE:BAB); the previously mentioned BAE Systems; the American aerospace giant Boeing Co (NYSE:BA), the British technology specialist Chemring Group (LSE:CHG); the French fighter jet-maker Dassault Aviation SA (EURONEXT:AM); and the Italian armaments firm Leonardo SpA Az nom Post raggruppamento (MTA:LDO), among others, including RHM.

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On that basis, Schroder UK Mid Cap Ord (LSE:SCP) offered the most exposure, with nearly 11% of assets allocated to defence stocks. This £266 million fund in the AIC’s “UK All Companies” sector yields 3.3% dividend income, rising by just over 3% per annum during the past five years, with total returns of 8% over the past year; 64% over five years and 73% over the decade. SCP remains priced nearly 8% below its NAV.

Global Opportunities Trust Ord (LSE:GOT), in the AIC’s “Flexible Investments” sector, ranked second with nearly 8% of its £111 million assets allocated to defence. GOT yields 3.3% income, rising rapidly by nearly 11% per annum, with total returns over the usual three periods of 3.5%; 34% and 45%. Bargain-hunters may note that it is priced 21% below its NAV.

Those numbers demonstrate that, despite recent explosive growth, it does not always pay to buy amid conflict, whatever Nathan Meyer Rothschild may have said during the Napoleonic era. Here and now, as the drumbeat of war grows ever-louder on the Continent, might fortune favour the brave?

Ian Cowie is a freelance contributor and not a direct employee of interactive investor.

Ian Cowie is a shareholder in BAE Systems (BA.), Boeing (BA) and European Assets Trust (EAT) as part of a globally diversified portfolio of investment trusts and other shares.