Stout’s £1.26bn Murray International Trust has had a poor 12 months as the developed world and specifically cyclical areas of the market have outperformed.NAV is down 12.2 over the past year, compared with a peer group average of a 6.31 per cent gain, and the share price is down 15.2 per cent while its peers are up 7.7 per cent.
Last year was the first in 11 that the trust did not outperform its benchmark.
Performance of trust vs sector and index over 1yr
Source: FE Analytics
The manager says that the trust was punished for sticking with companies that deliver earnings growth in Asia and the developing world rather than chasing rallies based on “hope” in the West.
“Convinced global economic growth was gathering momentum and prosperity would follow, equity investors overlooked the harsh realities of declining real incomes and disappointing corporate earnings,” he said.
“Hope, sentiment and liquidity triumphed over reality for the second consecutive year. In one further ironic twist, an enormous wave of negative sentiment towards emerging markets began to gather disciples.”
“As if to justify excessive exuberance towards one asset class, another had to be vilified. So it was with Latin America and Asia being on the receiving end of constant criticism and derision from the financial chattering classes.”
“Consensus unequivocally concluded an imminent demise of emerging markets in a world of rising capital costs. Financial markets were in no mood to argue.”
“The resulting depreciation in equity prices and currencies reflected this rising risk aversion, but to suddenly write off the geographical custodians of 50 per cent of global GDP appeared somewhat extreme and premature, to say the least.”
Stout says that such polarised extremes in sentiment are seldom accurate and rarely reflective of reality.
“Such were the dominant influences on financial markets that fundamentals accounted for very little during the period under review,” he continued. “Hope springs eternal.”
“There is nothing intrinsically wrong with investing in hope. Most decisions regarding the future involve an assessment of the unknown.”
“The key to success requires matching expectations against reality, thus minimising the scope for disappointment. In the world of financial investment, it is no different.”
“The previous 12 months witnessed an enormous amount of hope being invested in equity markets in expectation that numerous challenges will be conquered.”
“Severely stretched valuations reflect belief that the developed world can successfully wean itself off its chronic dependency on printing money without threatening fragile economic recoveries: that savers continue subsidising the profligacy of governments and irresponsible bank-bailouts; that deflationary pressures abate, enabling corporate profit margins to breathe again; and that earnings will be delivered in sufficient quantity to satisfy high expectations currently baked in to equity prices.”
The manager adds that any rational analysis of current economic conditions would suggest such hopes are very unlikely to be fulfilled.
“For a world recovering from the worst economic crisis since the Great Depression, progress will be slow,” he said.
“The enormous debt legacy remains deflationary by nature, constraining spending and investment alike.”
“Essential debt reduction required across the board exerts a significant negative influence on growth and profitability.”
“If the challenge 12 months ago was how to preserve capital in an environment of rising bond yields, the focus is now compounded by how to protect capital when earnings expectations remain too high.”
“Protecting margins becomes of prime importance, so the portfolio will remain focused on those companies deemed well positioned to achieve this.”
“Unfashionable as it may be, most value is still to be found in developing markets where earnings and dividend growth rates remain realistic.”
Murray International maintains a 22.6 per cent weighting to the Asia Pacific region and 23.2 per cent to Latin America and emerging markets.
By contrast, it has just 3 per cent in Japan, 14.2 per cent in the US and 15.3 per cent in the UK.
The latter markets outperformed Stout’s favoured habitats last year, leading to his portfolio’s underperformance.
However, the manager says he won’t change tack, as developed world gains in the US, Japan and Europe in particular were built largely on sand.
Performance of indices in 2013
Source: FE Analytics
Stout says that Europe has struggled to implement practical solutions to its problems, and outside of Germany, most countries are struggling with a strong currency, record unemployment and high levels of debt.
“Toiling under the economics of austerity with predominantly woeful business conditions, aggregate profitability of European companies actually fell over the period,” he said.
“Ironically this didn't deter equity speculators driving the European composite index up over 25 per cent, with lower-quality financials leading the charge.”
Japan’s attempts to generate inflation are increasing living costs and constraining spending power, while its debt continues to grow.
“The safest place to observe evolving economic events in Japan is from the side-lines, so current low exposure will be maintained,” Stout warned.
The US is deceiving itself about the strength of its recovery, the manager adds, with 75 per cent of equity market returns in 2013 coming from P/E expansion and the debt burden continuing to rise.
“At the opposite end of the spectrum, widespread scepticism towards emerging markets constrained Asian returns to just 3 per cent and sent Latin America 10 per cent lower in sterling terms,” he added.
“Solid earnings, dividend growth and robust trading statements offered little support against deflating confidence towards this asset class within the global financial community.”
The best opportunities in the manager’s eyes remain in Latin America, where Stout has added to Vale, Badesco and Petrobras, and Asia, where he is also looking to add to his positions.
“Asian equity markets underperformed developed markets by the widest margin since 1998, the year of the Asian crisis,” he said.
“Not only was this strange, and arguably excessive, fundamentals bore no resemblance to those prevailing 15 years ago.”
“While history illustrates the folly of standing in the way of short-term capital flows, it also illustrates longer term pricing anomalies that present attractive investment opportunities when such practices persist. That point is rapidly approaching.”
“The portfolio remains focused on companies where earnings and dividend prospects are deemed robust regardless of the prevailing macro-economic backdrop.”
“Further price and currency depreciation will be viewed as an opportunity to add further exposure to the region should this materialise.”
Ewan Lovett-Turner, analyst at Numis Securities, says that shareholders have been hit by an erosion of the premium over the past year as well as by sluggish NAV growth.
He points out the long-term performance is strong, with the NAV up 211 per cent over the past decade compared with 123 per cent for the MSCI World.
“We believe the best time to buy a manager with a strong long-term track record is often after a period of underperformance,” he said.
“In the near-term, however, there remains a danger that the premium rating could slip further. In 2014 year-to-date, the NAV is down 2.5 per cent and the share price by 4.5 per cent, compared with a rise of 0.3 per cent in the MSCI AC World Index.”
