Although Foreign & Colonial Investment Trust (FRCL), the oldest investment trust, launched 150 years ago the investment backdrop was surprisingly similar to today. "In the UK, interest rates were low, as were prospective returns," says Paul Niven, manager of the trust. "But by providing a pooled vehicle to invest in a diversified basket of overseas securities which had a higher yield and higher return, this trust gave investors access to opportunities they would otherwise not been able to access."
The trust started life as in effect an as an emerging markets bond fund and didn't primarily invest in equities until the 1960s, but nowadays its top 10 holdings include the most modern of listed equities – technology companies such as Amazon (US:AMZN), Microsoft (US:MSFT), Google, known as Alphabet (US:GOOGL), Facebook (US:FB) and Apple (US:AAPL). Although many investors worry that the valuations of these companies, the so called FAANGs, and global equities in general, are getting too high, Mr Niven argues that a sustained bear market is unlikely.
"Bull markets don't tend to die of old age," he says. "They tend to be killed by central bank action, or an inversion of the yield curve, recession, profits collapsing and the markets going down. That doesn't look likely in terms of the macro environment. Another reason bull markets die is because they collapse under their own weight, like in 1999, when the market got so extended it collapsed for no obvious reason other than it was a bubble that burst. But I don't think that’s the case today: valuations are rich but they are not at such an extended level."
All major markets – the US, Europe, Japan and emerging markets – are growing steadily and company earnings look healthy. And although some central banks, notably the US Federal Reserve, have started to tighten monetary policy this is still at the margins and therefore unlikely to puncture equity markets in the near term, argues Mr Niven. But the change in policy environment means investors should expect 2018 to be much more volatile than last year.
In this choppier environment companies with competitive advantages that operate within industries with high barriers to entry are the most profitable places to be, and there are many big tech examples of these.
"What you want is a business with what [renowned US investor] Warren Buffett calls a 'moat' – companies that have a strong market position they can exploit to generate profit for shareholders," explains Mr Niven. "People can debate Amazon's valuations, but what it is building is a moat that's as wide as possible which is why it's extending into several areas, not just to disrupt but to extend the competitive advantage it has. At some point, Amazon will need to start showing high levels of profitability, but other companies such as Facebook and Google are operating at high margins in terms of profits as they have very strong positions in terms of online search, where Google is absolutely dominant, and advertising, where Facebook is strong."
These companies' rich valuations mean there is not much room for error if they disappoint on earnings. And regulatory intervention is another possible risk, albeit a remote one according to Mr Niven.
"People are on Facebook because all their friends are on it, and not on Myspace because their friends aren't there, so that creates a natural monopolistic effect," he says. "If you've studied economics you know monopolies are bad for consumers because companies with too much market power exploit this position to generate excess profits. The challenge [for regulators] is that it's not obvious how consumers are being disadvantaged. Consumers are giving up their personal data but people don't value personal data as much as they might or arguably should."
It's not just in the tech sector that the strongest companies keep getting stronger, and the growing dominance of a few top players in each sector is having unexpected knock-on effects.
"There's strong evidence that company concentration has risen [over the last three decades]," says Mr Niven. "And the profitability of the top, but not the average, companies has risen too. Concentration means there are fewer employers in any given sector, so workers have got less bargaining power. That explains why profits are very high but workers' share of gross domestic product is very low. When you talk to equity market bears they point to high Shiller price-earnings ratios but they are assuming things will return to some kind of historic norm. There's actually decent evidence that there's been a secular change. This isn't to say valuations are not rich – they are – but the notion of a return to average levels is probably misplaced."
Although he is positive on the prospects for growth companies, Mr Niven aims to diversify Foreign & Colonial Investment Trust across different investment styles and geographies. This means the trust has a substantial weighting to value areas. These include European shares, in particular high-quality financials, which Mr Niven highlights as a potential opportunity.
"The financials' earnings growth in Europe is way off what it was pre-financial crisis, whereas the US has performed well up to this point," he explains. "While the US took quick action to clean up its banking sector and get rid of bad loans, Europe has been much slower to address its issues and that's part of the reason for the earnings difference. There's a lot of catch-up in Europe."
Paul Niven CV
Paul Niven has been manager of Foreign & Colonial Investment Trust since 2014 and is head of multi-asset investment at BMO Global Asset Management, where he has worked since 1996. He is also chair of the company's investment policy group.
Mr Niven has a BA (Hons) in Accounting and Economics and an MPhil in Finance from the University of Strathclyde. He is a member of the UK CFA Institute.
