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Bruce Stout: Preserving capital is becoming “harder and harder”

23 December 2016

The manager of the £1.5bn Murray International trust explains how he is positioned for a particularly tough environment for investors as we head into the new year.

By Lauren Mason,

Senior reporter, FE Trustnet

Diversification, continually recycling capital and a greater focus on absolute rather than relative returns are the best ways to navigate today’s tricky investing environment, according to veteran fund manager Bruce Stout.

Stout, who heads up the £1.5bn Murray International trust, says capital preservation is becoming increasingly difficult because bond markets are “completely wrecked” as a result of expansive QE.

Performance of indices over 10yrs

 

Source: FE Analytics

As such, he is diversifying his portfolio as much as possible in terms of both sectors and regions within his 70-stock portfolio, largely as a result of huge amount of debt on balance sheets globally.

“First and foremost [should be] capital preservation, but in this environment it is getting harder and harder to do,” Stout (pictured) said.

“If the bond markets are wrecked and if equity markets are up because people can’t make money in bonds, then you have to be very wary of valuations. We will continue to focus on capital preservation.”

“How do you do it? Obviously diversification is the investment manager’s main tool. For us from an equity point of view, that means different businesses in different companies in different parts of the world doing different things and hopefully if we can implement that, then we should be able to preserve the capital and hopefully grow dividends for our shareholders.”

The manager explains that, last summer, the Murray International trust was trading on a hefty premium to NAV and was an expensive portfolio because of the large number of consumer staples he held.

Because the price of these assets continued to rocket as investors scrambled for income, the manager diversified out of the sector in a bid to broaden out his exposure and protect investors from impending headwinds.

“With a global mandate, you have a choice and we all know that choice is not a good thing because we all know that choice means you can make more mistakes,” Stout continued.

“So, you start to diversify into countries such as Canada, such as Sweden and it doesn’t matter if it is in industrials in Canada or if its communications in Sweden, if the currency’s going down 20 per cent against sterling, then you’re going to lose money. But that’s diversification.”

“We continue to recycle corporates and all of those expensive stocks into things like material producers in Chile or telecoms companies in Canada or Thailand – wherever. Of course that didn’t work in 2014 and 2015 because markets weren’t interested, they got narrower and narrower and narrower into tech, biotech and healthcare.”

“But then suddenly in 2016, for whatever reason, I don’t know why, suddenly the market started to broaden out.”

While technology, biotech and healthcare were the darling sectors last year and in 2014, Stout says investors are now investing across other market areas such as emerging markets and industrials.


He says this is a prime example as to why portfolios need to be as diversified as possible, given that market sentiment inexplicably changes.

Performance of indices over 3yrs

 

Source: FE Analytics

“Focus on where your sector weightings are at, have the discipline to continually recycle capital from the things that have done well into the things that have lagged. Don’t worry about relative underperformance – relative underperformance means nothing when your shareholders are retail shareholders who need a dividend,” the manager continued.

“When I talk to our shareholders and ask what they do with their dividend, they say it goes out of their bank account and pays their gas bill. That shows me that the real dividend is very important.”

“If I tell shareholders the market’s down 15 per cent but guess what we’re only down 10, that’s no use to them, they’ve still lost 10 per cent of their money.”

“Our industry is obsessed with relative performance, but we have to approach it from the point of view of the saver and why they actually own this trust. It’s not us that makes that decision, they make that decision.”

If he were to ask an investor how much they could afford to lose, Murray says the answer would of course be ‘nothing’. He is therefore perplexed by the fact that, in Germany, investors can buy 10-year bunds that will return €90 on a €100 investment without a chance of gaining any upside.”

“You have to manage expectations. There was a period in the 1990s when the expectation was that financial markets would deliver 9 to 11 per cent a year, but the last time I looked at a gilt it yielded 1.5 per cent,” he said.

“So let’s assume the 10-year gilt yield in the UK is the risk-free rate of return. If you’ve got a company paying a 5 per cent dividend, you have to ask yourself why. The answer is probably because historically they did.”

“In the past if you go back 10 years, there was a great trade-off between gilts and equities and bond yields bounced around 4.5 to 5 per cent, the real return on savings was 2.5 per cent plus and it’s been -2.5 per cent since the financial crisis. But there was a relationship between bonds and equities in the UK.”

“Not that long ago in the summer of 2007 you got 5.5 per cent from gilts and equity markets were yielding 2.6 per cent. By the end of 2008 you got a dividend yield of 6 per cent, not because dividends went up, but because stock prices collapsed.”

Stout says the relationship between asset classes has broken down because of massive levels of debt in the system.

As such, he warns that a depression would be caused if gilt yields returned to 5 per cent. With yields hovering around the 1.5 per cent mark, he says the appropriate dividend for a company to pay is certainly not 5 per cent, which is what many FTSE 100 firms are currently yielding.


“The last time I looked, the dividend cover on the FTSE was one, it’s not been there since 2008,” Stout warned.

“People say it’s OK, it’s just because of oil and the miners, it doesn’t matter. But the last time I looked, Tesco wasn’t paying a dividend anymore, the pharmaceuticals aren’t investing.”

“It changes if we have lower gilt yields, then we will have lower equity yields. Let’s just all manage our expectations down. Because if you have high expectations, you’re going to be disappointed.”

 

The Murray International trust is in the top quartile for returns over the past decade, having outperformed its average peer by 72.78 percentage points with a total return of 176.38 per cent. Due to a particularly tough time in 2013 and 2015 though, it is in the bottom quartile over five years.

Performance of trust vs sector and benchmark over 10yrs

 

Source: FE Analytics

It is in the top quartile for its maximum drawdown (which measures the most money lost if bought and sold at the worst possible times), downside risk (which measures susceptibility to lose money during falling markets) and Sharpe ratio (which measures risk-adjusted returns) over the last decade.

Murray International is trading on a 3.5 per cent premium to NAV, is 12 per cent geared and yields 4 per cent. It has an ongoing charge of 0.75 per cent.

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