Compass - October 2019
“The only uncertainty in life is uncertainty…” John Allen Paulos
By Annabel Brodie-Smith
“The only certainty in life is uncertainty…”
John Allen Paulos
This certainly sums up the world right now. Markets have had a wobble, the trade wars continue, economic growth is slowing down and the threat of recession is raising its ugly head. Let’s not even mention the never-ending saga of Brexit.
This month our esteemed investment expert, Ian Cowie, takes a look at the ‘shocking start’ to October but reminds us medium to long-term performance has been good, with the average investment company up 62% over five years. It’s good to see that, as ever, Ian is getting stuck in with a new investment company purchase which has nearly a quarter of its portfolio in renewable energy, highly appropriate in the week of Extinction Rebellion protests. He’s also staying with his “global exposure to different companies, countries and currencies” with a smorgasbord of investment companies.
So in these times where “market conditions are characterised by uncertainty, volatility and no small amount of nervousness”, according to Henderson Alternative Strategies, we thought we’d take a look at investment companies in the Flexible Investment sector. Some have an objective to preserve investors’ capital and deliver positive returns through different economic environments. They invest across different assets from quoted and unquoted companies to bonds, commodities, specialist debt and property. The managers told us how they are currently constructing their portfolios and their outlook for markets. They are finding opportunities in gold, emerging market debt and private equity.
Finally, we thought we’d take a look at Europe. Yes - there are plenty of reasons why investors would think twice about investing in the region but according to BlackRock Greater Europe the continent is home to many businesses that are “giants in niches”, dominating their end markets from their home in Europe. Companies in the luxury goods sector like LVMH with their brands Louis Vuitton and Christian Dior are amongst the opportunities managers are finding. And let’s not forget the strong long-term performance: the average European investment company has returned 176% over ten years and the European Smaller Companies sector has performed even better.
With all this doom and gloom, I’m looking forward to a trip to sunny Seville in half-term. It’s definitely time to treat yourself to a little of what you fancy, so a trip to Spain, a homemade blackberry and apple crumble and a good glass of red wine or two are all going to be enjoyed by me over the coming month.
Have a good October.
Communications Director, AIC
Investing around the world with Ian Cowie.
Global stock markets suffered a shocking start to October. The FTSE 100 index of Britain’s biggest shares fell by 3.2% in one day - its worst session since January 2016 - while America’s Dow Jones Industrial index retreated by 1.9%.
The immediate causes were poor manufacturing figures and a World Trade Organisation ruling that allows America to impose higher tariffs on European Union exports. This came in addition to an ongoing trade war between both global superpowers - America and China - plus, closer to home, continued uncertainty about Britain’s proposed exit from the EU. No wonder some pessimists gloomily recalled that the month of October saw the start of the Wall Street Crash in 1929. More recently, this month was also when Black Monday wiped 10% off the Footsie in a single day in 1987.
Now here’s the funny thing; despite recent setbacks, most medium to long-term investment company shareholders remain in profit. According to independent statisticians Morningstar, over the last five years the average total return from all conventional investment companies - excluding venture capital trusts (VCTs) - is 62%. Over the last decade, the average return was 192%.
Moving from the macro to the micro, or from economic statistics to personal experience, my first new investment company holding this year also remains modestly in profit. I bought shares in Ecofin Global Utilities & Infrastructure Trust at 152p toward the end of September. Despite all the drama elsewhere since then, these shares are trading at 160p and yielding over 4% at the time of writing. Nearly a quarter of this companies’ assets are invested in renewable energy but last month its shares were trading at a 12% discount to net asset value (NAV) when the average company in the renewable energy infrastructure sector was trading at a premium of 14% to NAV. That made Ecofin Global Utilities look like a bargain to me and, in the very short term, Mr Market seems to agree.
More importantly, I intend to adhere to my long-established strategy of holding a wide variety of investment companies, giving global exposure to many different companies, countries and currencies. This should enable me to benefit from income and capital growth opportunities, wherever they arise.
For example, Aberdeen Standard European Logistics Income invests in warehouses across continental Europe, meeting rising demand from online shopping, and yields 5.2%. Henderson Far East Income is allocated across a wide range of businesses in Asia ex-Japan and yields 6.2%. JPMorgan Global Emerging Markets Income distributes dividends of 3.8% from developing economies around the world.
Meanwhile, as part of a balanced portfolio, two of my most valuable holdings - Baillie Gifford Shin Nippon and Polar Capital Technology - yield nothing at all but have generated substantial capital gains from, respectively, Japanese smaller companies and largely American new technology.
Worldwide Healthcare Trust, the third investment company in my top 10 holdings by value, also has a modest yield of just over 1% but boasts an impressive record of capital growth. As the global population gets older and wealthier, I expect more people to be willing and able to spend more on better healthcare.
While the future remains uncertain, investing internationally is the simplest and surest way to diminish the risks inherent in stock markets by diversification. Investment companies provide a convenient and cost-effective way to do so, while also gaining from professional fund management, often in sectors where I know little or markets on the other side of the world.
In the short-term, stock market shocks may sometimes make it difficult to sleep at night. But, over the medium term of five years or more, shares have usually delivered higher returns than deposits or bonds and I expect that trend to be repeated in future.
"While the future remains uncertain, investing internationally is the simplest and surest way to diminish the risks inherent in stock markets by diversification."
Better still, because the first step toward making a profit can be to buy low, the best times to buy shares are often when we least feel like doing so. When confidence is depressed, so are prices. So this long-term investor intends to continue buying on the dips.
Flexible Investment sector managers comment on navigating market stress.
With the US-China trade war, concerns about global growth and political turmoil in the UK, there’s been lots to make investors nervous in 2019. Markets have mostly made a positive return for the year, with the average investment company up 11%, but there’s much uncertainty about what could happen next.
At times of market stress, diversification is key. Investment companies in the Flexible Investment sector invest across multiple asset types, from quoted and unquoted companies to bonds, commodities, specialist debt and property. Some have a specific objective to preserve investors’ capital and deliver positive returns through different economic environments.
The AIC has spoken to managers from the Flexible Investment sector to find out how they are constructing their portfolios, which asset classes are presenting the best opportunities and their outlook for markets.
Outlook – caution warranted but attractive prospects for alternative assets
Alex Barr, Senior Portfolio Manager of Henderson Alternative Strategies Trust, said: “With an ageing bull market, recession fears at their highest for eight years, increasing corporate debt levels, ongoing US-China trade concerns and an extraordinary and ongoing Brexit saga, some caution is warranted on mainstream markets. What will be crucial in allaying investors’ fears is confidence in policy responses. Broadly speaking it’s a case of ‘ok so far’: the European Central Bank has returned to its QE programme and the Fed has been loosening rates. And, both the US and China have vested interests in damage limitation on trade talks. As such we see relatively better returns in equity markets coming from ‘mid-risk’ assets which have quality characteristics and stability of income. Returns from fixed income are more likely perhaps to come from investment-grade assets, high yield and emerging market debt.”
Charles Jillings, Manager of UIL, said: “We remain of the view that long-term global GDP is positive, that lower interest rates help most corporates as the cost of debt across the world falls and that well positioned businesses with strong management teams will deliver above average returns. We are of course concerned that an event, either financial or political, could cause a serious setback for equity markets and that negative interest rates and high sovereign debt are risk factors to monitor very carefully. As long-term investors, we attempt to look through the short-term noise with an eye on the longer-term value.”
Tony Foster, Senior Investment Manager of Aberdeen Diversified Income and Growth Trust, said: “Markets appear to be pricing in sluggish global growth and further easing of monetary policy. Valuations, which are the drivers of future returns, are generally very high. We see little value in UK government bonds yielding less than 1%, for example. By contrast, we see attractive return prospects from a broad range of less traditional asset classes. This includes infrastructure, emerging market bonds, asset-backed securities and a range of special opportunities.”
Paddy Dear, Manager of Tetragon Financial Group, said: “The composition of Tetragon’s portfolio is primarily made up of a diversified pool of alternatives. Often, we are buy-and-hold-to-maturity investors which, when combined with our long duration capital, affords us the opportunity to weather market cycles. Cycles are inherently unpredictable, both in timing and in magnitude. Our approach is to try to balance the risks in our portfolio such that we can weather the next storm and continue to compound capital.”
"...we see attractive return prospects from a broad range of less traditional asset classes. This includes infrastructure, emerging market bonds, asset-backed securities and a range of special opportunities.”
Tony Foster, Senior Investment Manager of Aberdeen Diversified Income and Growth Trust
A smoother return
Alex Barr, Senior Portfolio Manager of Henderson Alternative Strategies Trust, said: “Current market conditions are characterised by uncertainty, volatility and no small amount of nervousness. With an expectation that these conditions are likely to prevail for some time Henderson Alternative Strategies Trust offers the opportunity to access return profiles that are less correlated to more traditional asset classes. As such, the company can play an important volatility mitigation role within traditional portfolios.”
Tony Foster, Senior Investment Manager of Aberdeen Diversified Income and Growth Trust plc, said: “Our investments are carefully selected to have a wide range of return drivers and risk characteristics. Our truly flexible investment approach allows us to take full advantage of the beneficial effects of portfolio diversification. This means that we can potentially deliver a smoother return to our shareholders over the long term.”
Paddy Dear, Manager of Tetragon Financial Group, said: “We believe that Tetragon’s investment manager has constructed a portfolio that can generate positive returns in a variety of economic environments and across various credit, equity, interest rate, inflation and real estate cycles. Tetragon’s ability to invest in a broad range of asset classes and strategies, partner and invest with what we believe are superior asset managers, make investments directly on its balance sheet, adjust its cash holdings as appropriate to market cycles and maintain a long-term view, contribute to our long-term performance.”
Constructing a portfolio
Tony Foster, Senior Investment Manager of Aberdeen Diversified Income and Growth Trust, said: “We invest in a wide range of publicly listed and private market investments in both mainstream and alternative asset classes. Our approach has been designed to make full use of the powers of the investment trust structure to invest in less liquid assets that offer attractive long-term returns.”
Alex Barr, Senior Portfolio Manager of Henderson Alternative Strategies Trust, said: “Henderson Alternative Strategies Trust is a flexible multi-alternative investment company with an investment brief across a wide range of strategies. These include, but are not limited to, private equity, hedge funds, infrastructure and credit. We aim to deliver performance from three distinct sources: asset allocation, portfolio construction/timing and via underlying (or direct) positions held in the portfolio.”
Paddy Dear, Manager of Tetragon Financial Group, said: “Tetragon invests in a broad range of assets, including bank loans, real estate, equities, credit, convertible bonds, private equity, infrastructure and TFG Asset Management, a diversified alternative asset management business.”
Opportunities – gold, emerging market debt and private equity
Charles Jillings, Manager of UIL, said: “We are not driven by asset allocation but rather we seek out deep value, compelling investments. We are currently in favour of Brazil in the emerging market space as we expect its growth to accelerate. We are pro disruption in the fintech space. We like gold, and we are attracted to nickel, given battery technology disruption.
“Resolute Mining, an LSE-listed gold miner is an indicative example as it has been a core UIL investment for over ten years and represents 15% of UIL’s portfolio. We remain excited about its prospects as this company has enviable long-life mines and is in production in multiple jurisdictions. Led by John Welborn they constantly optimise their mining operations and are the first gold miner to fully automate an underground mine with the obvious benefits flowing to the bottom line. In an era of low and negative interest rates and with weakening non-US dollar currencies, gold offers a hedge for investors. Political volatility is underpinning demand, while a number of important central banks are buying physical gold. We expect gold to continue to rise over the medium term.”
Tony Foster, Senior Investment Manager of Aberdeen Diversified Income and Growth Trust, said: “Emerging market debt is an asset class that many investors mistrust. It is true that these markets are periodically in the headlines – today, for example, it is Argentina which is heading for yet another sovereign default – but, in many cases, emerging economies are in good shape and bonds are trading on attractive yields of 5-6% or more. History shows that this asset class can usefully increase portfolio diversification. At the end of 2018, for example, when global equities fell by over 13% in three months, emerging market debt made a positive contribution to our portfolio returns.”
Alex Barr, Senior Portfolio Manager of Henderson Alternative Strategies Trust, said: “We remain optimistic about private equity, our largest sectoral allocation, though we are mindful that the current cycle is extended. With that in mind, within private equity we remain more focused on already proven business transformations more typically found in private secondary funds, or within listed private equity vehicles.”
On the continent
European managers explain why there are world-class opportunities closer to home.
There are many reasons why investors might want to avoid Europe. Slowing growth, political crises and the ongoing Brexit uncertainty present several challenges and could make investors think twice before investing in the region.
Despite the negative headlines, however, Europe is home to many well-run companies and world-famous brands and investment companies investing in the continent have performed strongly. The average investment company in the Europe sector has returned 70% and 176% over five and ten years. Companies in the European Smaller Companies sector have performed even better, generating returns of 85% and 195% over the same timeframes.
So where are investment company managers finding returns in Europe and how are they navigating the political and economic risks? Ahead of 31 October, the AIC has gathered managers’ views from the Europe and European Smaller Companies sectors on whether Brexit is having an effect and whether the outlook for European investing could be brighter than some think.
Why invest in Europe?
Stefan Gries, Co-Manager of BlackRock Greater Europe Investment Trust, said: “Europe is home to some world-leading businesses that are often overlooked due to the attention given to overriding issues within the market in which they reside. We term these businesses ‘giants in niches’ as they dominate their respective end markets from their home in Europe.”
Stephen Macklow-Smith, Portfolio Manager of JPMorgan European Investment Trust, said: “It’s well documented that Europe has been at the mercy of low growth and an ageing population for some time. Many European companies have sought to solve this macro backdrop by focusing their attention on investing capital outside of Europe, in faster-growing areas. The result? Many areas of the European stock market are seeing decent rates of revenue growth and profitability, in spite of a challenging backdrop for domestic growth. Europe also remains home to many global leaders.”
George Cooke, Lead Manager of Montanaro European Smaller Companies, said: “There is a huge amount of choice for investors in Europe, which is home to over 2,000 quoted smaller companies. Many are global market leaders, but identifying them in such a large pool can be challenging. There is little in the way of quality sell-side research. For investors with the patience and time to do their homework, however, discovering Europe’s small-cap ‘hidden gems’ can be rewarding. European small-cap companies have outperformed their large-cap counterparts by some 5.7% per annum since 2000.”
"Many areas of the European stock market are seeing decent rates of revenue growth and profitability, in spite of a challenging backdrop for domestic growth."
Stephen Macklow-Smith, Portfolio Manager of JPMorgan European Investment Trust
Where are you currently finding opportunities?
Sam Morse, Portfolio Manager of Fidelity European Values, said: “Against an uncertain backdrop in Europe I remain focused on investing in attractively-valued companies which are able to sustain consistent dividend growth; and most importantly can perform well across different market environments, irrespective of the macro backdrop. The challenge of finding companies that meet these criteria in the current environment has led to a reduction in the number of names in the portfolio over the past 12 months.
“That said, there are still selective opportunities and we have seen the likes of LVMH perform strongly on the back of encouraging results from two of its bigger brands: Louis Vuitton and Christian Dior. The company seems to be taking full advantage of the growing consumption of wealthy Chinese customers. I am finding opportunity in the luxury goods sector where companies possess defensive qualities thanks to their quality franchises and growing revenues in emerging markets.”
Stefan Gries, Co-Manager of BlackRock Greater Europe Investment Trust, said: “We have uncovered a multitude of companies in Denmark which exhibit what we believe to be a ‘Danish management style’ of strong entrepreneurialism supported by a flat culture and decentralised decision making. To put this plainly, local management teams are compensated for making the right long-term and wealth-creating decisions for the business as well as all its other stakeholders, including minority shareholders. This has led to better returns on invested capital and cash flow management, supporting the long-term potential of the business and indeed the shares.”
Stephen Macklow-Smith, Portfolio Manager of JPMorgan European Investment Trust, said: “As growth and value investors, we currently gravitate towards a number of healthcare and consumer goods names. We also see opportunities in some specialist semiconductor companies which are key suppliers to companies such as Apple and Tesla. On the value side, we see a number of compelling opportunities in areas such as insurance and stock exchanges which benefit from higher volatility, with stock exchanges also witnessing a wave of consolidation.”
Is Brexit having an effect?
George Cooke, Lead Manager of Montanaro European Smaller Companies, said: “Not particularly, which is unsurprising when you consider that only about 5% of our companies’ sales come from the UK. Despite heightening tensions around global trade, we do not spend time trying to second guess the direction of political winds. As an example, the portfolio had a high exposure to Italy during the constitutional referendum of 2016. As other investors fretted about the outcome of the referendum, we built positions in Italian businesses with quality characteristics and strong growth profiles that we felt had become undervalued. They subsequently contributed significantly to performance.”
Stefan Gries, Co-Manager of BlackRock Greater Europe Investment Trust, said: “Given the length of time companies have had to adjust, both to Brexit and to US-China trade tensions, we have already seen many altering their supply chains to reduce disruption. We have a preference for companies with strong pricing power which will see less impact from any potential tariffs as changes in price will not have a significant impact on demand for their products.”
"Given the length of time companies have had to adjust, both to Brexit and to US-China trade tensions, we have already seen many altering their supply chains to reduce disruption."
Stefan Gries, Co-Manager of BlackRock Greater Europe Investment Trust
Managers’ outlook for the region
George Cooke, Lead Manager of Montanaro European Smaller Companies, said: “The example of the last few years really drives home the point that bottom-up stock selection matters most. It would be hard to find anyone who felt Europe had been great from an economic or political perspective over the three years to the end of June 2019. Yet during this period, the NAV total return of the Montanaro European Smaller Companies Trust has been over 75% and the share price total return well over 100%.”
Stephen Macklow-Smith, Portfolio Manager of JPMorgan European Investment Trust, said: “We’re well aware of the risks to the European growth outlook should the UK exit without a deal. Additionally, we’re also closely monitoring the spillover effects of US-China trade tensions and the knock-on implications for Europe. Whatever happens on the trade front, the global reach of European companies, making products that the rest of the world queues up to buy, should ensure they survive and thrive in the long term.”
Sam Morse, Portfolio Manager of Fidelity European Values, said: “While European equity markets rose strongly over the first half of 2019, the recent resurfacing of volatility has served a timely reminder that few of the issues previously troubling markets have been resolved. Geopolitical risks continue to beset investors, with no clear end in sight. When it comes to the trans-Pacific trade dispute, it is likely that some European industries may in fact benefit by picking up business lost to their US and Chinese competitors on the back of worsening tensions, with some examples being aerospace, technology and telecommunications.
“We remain generally cautious and continue to maintain a balanced sector exposure, with a marginal overweight in defensive stocks. Despite more optimism now priced into the market following the Fed ‘pivot’, shocks around trade or geopolitics are still probable.”