Job Curtis hasn’t forgotten the lessons he learnt from the 1970s and so is taking the threat of inflation far more seriously in his City of London Investment Trust than most of his peers.
As central banks continue to assert that the recent pickup in inflation is a transitory phenomenon, Curtis warned it could result in a severe stress test for the equity market.
“There are dangers of having your money in a bank account with inflation picking up, even if it is only transitory,” he said. “This year you're suffering a loss in real terms to purchasing power.
“We haven't had to worry about inflation for most of my career. But I certainly remember it very well growing up in the 1970s.”
When Job Curtis started managing the City of London Investment Trust 30 years ago, UK inflation was 9.5% and interest rates were 10%.
“The view from the central banks and most of the people in the bond markets is that it is just transitory,” Curtis continued. “But I think it's difficult to be 100% sure. We could see this go on for a bit longer than people are hoping for.”
The Bank of England has recently warned that it expected inflation to rise above 4% by the end of the year due to rising energy costs, but reiterated that it believed this would be temporary.
CPI over the past 1 year
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Source: FE Analytics
Curtis said central banks may eventually be forced to react to rising inflation by reducing their quantitative easing programmes by much faster than markets expected.
“It has slightly underpinned markets, the fact that in the government bond market central banks have been a non-commercial buyer, just willing to hoover up the gilts that the government has been issuing,” he said.
“The extent that that gets tapered back and yields reach a more natural level – that could be a test for markets.”
Federal Reserve chairman Jerome Powell has already indicated that tapering will likely begin soon, and interest rate hikes could come as early as 2022.
As a result, Curtis has taken the gearing of the trust down to 8%, compared with a high of 16%.
He suggested that one way to offset the loss in purchasing power was to simply invest in dividend-paying equities: “People think of share price as just being capital gain or capital loss, but all the long-term data shows that dividends are an incredibly important part of the overall return,” he said.
“You're taking a bit of extra risk in equity markets and a bit of volatility, but you get the extra return.”
He contrasted the prospects of established dividend-paying companies in an inflationary era with those of fast-growing disruptors, which he said the market had an unhealthy fixation with.
He said: “Sure, they’re growing, but they’re on these sky-high valuations which are justified partly by very low discount rates.
“And it has left some of our existing companies – which are actually adapting quite well to the new world – at very distressed valuations in my opinion.”
David Smith, who has been newly appointed as deputy manager of the trust, added: “It's a classic case of when you're an income fund manager you typically own the disrupted, not the disruptor.
“When we look at the stocks that we want to own, we're trying to pick companies that are very hard to be disrupted, but if we get a sense that they are [getting disrupted], then it's making sure you engage with management teams to find out where their investments are going to make sure their business is going to be relevant in the longer term.”
He said British American Tobacco, the trust’s largest holding at 3.9%, is a good example of a business that has successfully dealt with attempts of disruption.
“Its business has been under pressure for some time obviously – it has always had pricing power to offset that to grow profits and, more recently, you've had new entrants in the market in the vaping business.
“But it hasn’t stood still. It has been one of the largest investors in new product development like vaping to make sure that its business is going to be sustainable for the foreseeable future.”
Similarly, he highlighted how UK food retailer Tesco has also managed to adapt and capitalise on the opportunity for e-commerce during the early part of the Covid-19 pandemic.
“It increased its online capabilities by 1.5x to meet that demand – which is quite phenomenal,” Smith said. “I think the market completely missed the ability to be as flexible as a company the size of Tesco could be.
“Companies aren't in a static state. They're always evolving,” he finished.
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Over the past decade, the trust has delivered a total return of 133.8% compared to 151% from the IT UK Equity Income sector average and 123.3% from the FTSE All Share index. It has ongoing charges of 0.36% – the lowest of the 23 investment trusts in the IT UK Equity Income sector. Based on its current share price, it currently yields 4.92%.