Too many investors turn to high-performing stocks to weather the storms of any potential sell-offs without considering the negative consequences of this strategy, according to Investec’s Alastair Mundy (pictured). 
The manager, who runs the £705m Temple Bar Investment Trust, believes this is a mistake and says he is less-than-optimistic in terms of where the market is heading as a result of expensive valuations, poor balance sheets and large amounts of government debt.
In fact, he recently argued that the market is currently in the throes of “value hell” which has led to the underperformance of his trust and the presence of only very limited investment opportunities.
“I don’t think I’m saying anything particularly weird when I discuss my bear argument, but then I look at other people’s portfolios and they look nothing like mine. I think in general, everyone’s got their fingers crossed hoping that everything is going to be okay,” he said last week.
“Our industry always wants to be bullish, we always want to tell our clients that we’re either optimistically optimistic or cautiously optimistic, so we have got a bias. I just don’t see a huge amount to be optimistic about at the moment.”
One area of the market he has been buying into, however, is the large-cap banking space, which often turns even the most bullish investors pale following the near collapse of the banking industry during the financial crisis.
Performance of indices over 10yrs
Source: FE Analytics
This, combined with a string of scandals since 2008 including the mis-selling of PPI and complex insurance deals and the manipulation of foreign exchange rates and LIBOR has left the sector seeming untrustworthy to many.
Currently though, Temple Bar Investment Trust’s largest sector weighting is in financials at 23.1 per cent and its largest holding is HSBC, which has a hefty 7.3 per cent allocation alone.
“You might say, ‘okay, even if I sign up to your crazy outlook and that’s pretty bearish, what on earth are you doing holding banks?’” Mundy said, who highlights the example of Bellway, the housebuilder whose share price plummeted in the financial crisis.
“The reason I hold banks can be explained through Bellway in June 2008, when Robert Peston was telling everyone it was the end of the world and that we were all going to hell in a handbasket.”
“That was exactly the point we should have been buying housebuilders, not because from that point on housebuilders’ operating conditions drastically improved, but because housebuilders had taken so much punishment by then they just couldn’t take any more in share price terms.”
“When the market actually bottomed between February and March 2009, it had already outperformed extraordinarily from its lows.”
Performance of stock vs index over 8yrs
Source: FE Analytics
What gives Mundy hope is when stocks have already endured a significant amount of pain, although he explains that value stocks often bounce before bottoming out. As a result, he says the trust often underperforms during the first half of bear markets and outperforms during the second half.
“Typically what happens is that the good stuff goes up in bull markets and that’s everyone’s comfort blanket. As markets start to come down people stick with their comfort blanket, and it’s only as stocks suffer downgrades they decide they don’t want them and no one else is going to buy that off them because it’s at such a high rating,” he explained.
“My comfort blanket at the moment is Royal Bank of Scotland – it’s a very strange comfort blanket that no one would usually go anywhere near. Other people seem to have common comfort blankets, but the problem is when they disappoint, they’re all going to want to be throwing out that comfort blanket together and I’m not going to be buying that comfort blanket off of them.”
Royal Bank of Scotland (RBS) fared particularly badly after the financial crisis and required the government to take two stakes in the bank as part of a rescue plan.
In 2009, the bank reported a loss of £24.1bn, which is the biggest annual loss in UK corporate history.
Performance of stock vs indices over 8yrs
Source: FE Analytics
“What I think investors learned from 2007 is not to buy high-growth, large, opaque, lightly-regulated, expensive banks. And no-one wants RBS, which I find very strange because it’s low-growth, small, transparent, highly-regulated, cheap and unpopular. What more do people want?” Mundy continued.
“It’s pretty hard to get your head around what the perfect bank looks like nowadays. I’ve been looking at banks for the last seven years and it’s been like travelling to the Promised Land.”
“Mixing my metaphors here, the Promised Land has had a variety of rhinos, hippos and alligators stopping you from getting there. I think Lloyds Banks is crawling out of the water, I think RBS is not very far from getting out of the water.”
The manager says that once these companies are “out of the water”, the regulator will also allow them to begin paying attractive dividends as they don’t need to retain much capital as businesses.
Mundy predicts that certain blue-chip banks, including RBS and Lloyds, could be providing dividend yields of between 5 and 6 per cent in the near future.
“We’re always doing a lot of worrying about big companies cutting their dividends. I hold Glaxo, BP, Shell and HSBC in the portfolio. I’m not so sure that when those companies or if those companies do cut their dividends, their share prices are actually going to fall – their high yields suggest investors are ready for those dividend cuts,” he explained.
“I’m not sure the share price is going to fall, but what is going to be interesting is the income is clearly going to fall, then you’re going to get a whole load of equity income open-ended collectives and investment trusts trawling round the market and looking for dividends to replace the likes of dividends coming from very large companies, where typically, investors have reasonably large holdings.”
Because of this, Mundy says banks are an obvious place to be investing in from an income perspective and believes that investors are making the bank story too complicated as regulation has now transformed them into sturdy, reliable companies exhibiting low growth and achieving decent earnings.
“They earn super-normal profits because there are still core customers like me who have held the same bank account for years on end and haven’t been bothered to move since. I’m pleased to say I’m not alone and that most people are like that. Most people are far more likely to change their partner than their bank account, I think that says it all,” he pointed out.
“It’s extraordinary, people come up to me and tell me I must be crazy and that banks are the most opaque outfits out there. I smile at them and then I go home and I’m rude about them behind their backs, because typically these sorts of people are the people who were buying the likes of RBS in 2006 and 2007.”
While Temple Bar Investment Trust has been in the bottom quartile over one, three and five years, it has outperformed its average peer in the IT UK Equity Income sector and its FTSE All Share benchmark by 27.02 and 36.58 percentage points respectively over the last decade.
Performance of trust vs sector and benchmark over 10yrs
Source: FE Analytics
The trust is trading on a 4.5 per cent discount, is 2 per cent geared and yields 3.8 per cent. It has ongoing charges of 0.48 per cent.
