Investment Trust Portfolio: Taking the long view

Maintaining perspective

Markets are facing challenging times. US equities have seen their worst first six months since 1970 having fallen by over 20 per cent, while the Nasdaq has fallen over 28 per cent – its largest first-half decline ever. Parts of Europe and Asia have also seen steep falls. High inflation, rising interest rates, excessive debt, increased taxation, inadequate policy responses, a war in Ukraine and structural legacies courtesy of the pandemic and geopolitical tensions, including the need to shorten business supply lines, are some of the variables. Volatility persists and investors’ nerves are being tested.

While the current macroeconomic and geopolitical environments remain challenging, investors should retain a balanced view. Those claiming the end of globalisation need to acknowledge world trade as a percentage of global GDP remains close to all-time highs. The Ukraine/Russia grain deal may assist with the food crisis. Western resolve in response to the Russian invasion bodes well generally. And while many political systems and global organisations could be serving their people better, individual endeavour and progress is ongoing.

Markets also tend to be forward looking. The present uncertainties are essentially known and in some cases quantifiable. They have largely been factored into prices and markets often climb walls of worry. Furthermore, while the macroeconomic environment can influence short-term investment sentiment and style (for example, the switch from ‘growth’ to ‘value’) we should not forget that equities remain a key living embodiment of the human wish to progress across a broad range of sectors and disciplines. We sometimes lose sight of the worth of companies.

Time can aid perspective. The latest edition of the annual Barclays Equity Gilt Study reminds us that equities have trumped gilts and cash in real terms over all periods – the three assets producing real annualised returns over 10 years of 4.7 per cent, 1.0 per cent and -2.7 per cent respectively, and returns of 4.9 per cent, 3.0 per cent and 0.9 per cent over 50. The figures are similar over longer periods (UK data goes back to 1899). Markets have accommodated various challenges and made progress over time.

One can try to time the markets. Yet a recent study from Bank of America reminds us of the dangers. If an investor had missed the S&P 500’s best 10 days each decade since 1930 the total return falls from 17,715 per cent to 28 per cent. Unlucky, yes, but the figures reveal the opportunity cost. Time in the market is better than market timing. Put another way, the study noted that 10-year returns for the S&P 500 have been negative just 6 per cent of the time since 1929.

Pockets of value

Of course, valuations still matter when choosing markets. While recent falls have reduced the extent of exuberance, some markets remain expensive. Yet the FTSE 100 index trades at around 10 times forecast earnings – well below its average of 13 times. Indeed, recent figures suggest UK equities trade at a near-40 per cent price/earnings discount to the rest of the world. This is close to a 30-year high according to MSCI index data. Few other markets look as attractive. Although the FTSE All-Share is now outperforming world markets, one continues to question the extent of the discount even if allowances are made for its commodity giants.

The shadow cast by the doomsters as to Brexit is receding – inward investment remains robust, unemployment is at a record low, trade deals abound. The rebalancing in investment style from growth to value bodes well given the FTSE 100’s perceived ‘old economy’ bias. The market’s dividend yield compares well. Political uncertainty is receding while the extent and duration of the UK’s debt at least compares well. A debate about lower tax is rising up the political agenda. It is little wonder private equity bidders are on the hunt – they are capitalising on the wider mispricing.

Indeed, the UK market has always provided bountiful opportunities for those who knew where to look. Bloomberg data shows the 20-year sterling total returns on £1 invested for Finsbury Growth & Income Trust (FGT) to be £8.07 – this compares with £10.32 for the Nasdaq, £6.36 for the S&P 500 and £3.32 for the FTSE All-Share. Other portfolio holdings focused on the UK have also thrived, including BlackRock Throgmorton Trust (THRG), Herald (HRI), Henderson Smaller Companies (HSL) and JPMorgan UK Smaller Companies (JMI). All continue to offer long-term promise, with HRI and JMI on particularly attractive discounts.

There are other reasons to be positive. The UK market is home to many companies which specialise in other assets such as renewable energy, infrastructure, commercial property, commodities and specialist lending. And portfolio performance has benefited from their inclusion while assisting with diversification. The website’s Winter and Dividend portfolios have exposure of 90 per cent and 55 per cent here, and have outperformed the FTSE All-Share index by 13.2 per cent and 10 per cent respectively since their inception in 2014 and 2016. Such investments also help the portfolios achieve yields of 4.7 per cent and 6.2 per cent. Many companies continue to look attractive.

Market sentiment will continue to ebb and flow. Investors need to be canny. The traditional 60/40 index equity/gilt portfolio will continue to struggle. Appropriate diversification and market/sector choice is now paramount. The investment trust sector’s decline of 18.9 per cent in the first half compares to declines of 4.6 per cent for the FTSE All-Share index and 11.3 per cent for the MSCI World index (in sterling terms). Average discounts widened to nearly 10 per cent from 1.5 per cent, while underlying assets performed broadly in line with global equities. While continuing to recognise wider challenges, opportunities are now evident for long-term investors.

Further to last month’s column, the portfolios have been adding to their private equity exposure given discounts widened to over 40 per cent in some cases. We are now adding to our UK smaller company exposure given discounts of 15-20 per cent, the quality of many businesses, the rating and comparative outlook for the UK and the disproportionate number of good managers taking advantage of the investment trust structure. The sun is about to shine on the sector after a period of underperformance.