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ETFs an accident waiting to happen, says Monks manager Plowden

Bankers are "suckering" investors with ETFs says Monks Investment Trust manager Charles Plowden
ETFs an accident waiting to happen, says Monks manager Plowden

Investors should spend less time worrying about a stock market bubble and more time worrying about the popularity of exchange traded funds (ETFs), according to Charles Plowden, manager of Monks Investment Trust (MNKS).

Mr Plowden, who has run the trust since March 2015, says the volume of "dumb money” invested in passive products reminds him of the ill-fated complex financial vehicles that led to the last financial crisis.

"I suspect the same clever bankers who came up with collateralised debt obligations (CDOs) and credit default swaps (CDS) have found a new bunch of suckers to sucker," he says. "ETFs are unthinking and put together by investment bankers mainly for their own purposes so that they have products to sell. It is not contributing anything to the wider economy, it's not making capital raising cheaper or more efficient, it's not protecting savers from volatility – it's just boosting investment bank revenues for that quarter."

"What’s troubling for us is that almost 30 per cent of the US market is owned by passive not active investors, and there's no thought gone into the selection of the underlying portfolio and no interest paid to what's in there," he says. "I'm not saying it's bound to go wrong, it feels really worrying in a way I can't quite explain."

However, the growth-focused manager is not worried about the high level of global markets.

"We are told that markets are at peaks and are too expensive, but we just don't see it that way at all," he says. "The S&P 500 is actually close to its long-term trend, which is to rise by 7 per cent a year – what it's done for 90 years. This clearly is not a bubble in any way. It's not [the Wall Street crash of] 1929, it's not 1999 [the dot-com bubble] and it's not even 2008 [the most recent financial crisis]. A market can depart from trend so there are no guarantees, but we don't think it’s expensive and if you look at Europe, Japan or emerging markets they are all well below trend.

Mr Plowden has a more bullish view on markets and holds growth stocks with higher price tags including tech giants Amazon (US:AMZN) and Facebook (US:FB). He has turned Monks on its head since becoming its manager in 2015 so that only 0.7 per cent of the trust's former holdings remain – two unquoted companies that he is trying to sell.

He has also introduced gearing (debt) – a lack of which he says historically led to underperformance. "The [former] managers and board had been conservative and worried about the level of markets so Monks had been too cautious," he says. "You can't blame people for being cautious in rising markets but it's not Monks' raison d'etre to be cautious."

The trust had no gearing but is now is at about 7 per cent and Mr Plowden would like to bring it up to 10 per cent.

And the trust is now outperforming its benchmark. Monks has made than double the return of the FTSE World index so far this year, delivering a share price total return of 31.7 per cent compared with this index's return of 12 per cent. Since Mr Plowden started running the trust its discount has narrowed so that at time of writing it was on a premium of 1 per cent, and he hopes to start issuing shares as soon as the premium reaches a consistent, sustainable level.

Like tech-focused Scottish Mortgage Investment Trust's (SMT) managers, Mr Plowden is keen to buy high-growth companies that are likely to disrupt major industries, and avoids companies he thinks are not investing in the future.

"The decline in bond yields means income starved investors are buying shares in stocks such as Nestlé (NESN:VTX) and demanding dividend increases," he says. "They don't care about research and development. For a research-based intellectual property company such as GlaxoSmithKline (GSK), for example, that's fine for five years but you cannot survive for 25 years like that."

He says that in 1990 the average global company was investing about 2.5 times more in the future than it was paying out but that figure has reduced to 0.6 times. So Mr Plowden has been adding to the 'rapid growth' section of Monks' – innovative stocks with earnings growth of between 15 and 25 per cent often at earlier stages of development, as he thinks it is those companies that are investing for the future.

"Facebook, Amazon and Google (US:GOOGL) are investing the most," he explains. "[Stocks in] the rapid growth section of the portfolio are investing six times more than they are paying out, so although they are admittedly capital light, they are spending on research and development. Amazon, Facebook, Google, [Chinese ecommerce giant] Tencent (700:HKG) and [Chinese internet company] Baidu (US:BIDU) are the leading investors in the space, autonomous vehicles, alternative energy and healthcare sectors. If it's a big potentially trans formative technology they are the ones pouring hundreds of millions of dollars in, while the incumbents in those industries are hardly investing at all and certainly not enough to avoid being taken over. It seems increasingly that there are a very small cadre of companies leading the way. Google, for example, is going to be one of the biggest healthcare companies in the world in five years' time."

Google has backed a private company that Mr Plowden added to the trust this year – GRAIL, a start-up that is developing blood tests for early-stage cancer detection. Just over 1 per cent of the trust's assets are invested in private companies as it cannot invest more than 2 per cent in these.

Mr Plowden says he is looking for "trans-formative businesses that you can't buy on public stock markets as "there is no point buying an unquoted stock where there is a more profitable cousin on public markets – it has to be a relatively rare opportunity."

MONKS (MNKS)   
PRICE:745.5pGEARING:7%
AIC SECTOR: GlobalNAV:738.3p
FUND TYPE:Investment trustPRICE PREMIUM TO NAV:1%
MARKET CAP:£1.6bnYIELD:0.20%
SET-UP DATE:6 February 1929MORE DETAILS:bailliegifford.com
ONGOING CHARGE:0.59%*  
Source: Winterflood, as at 24 October 2017 & *Baillie Gifford
Performance 
 1-year share price return (%)3-year cumulative share price return (%)5-year cumulative share price return (%)
Monks Investment Trust36104156
FTSE World Index1360109
Global investment trust average2264117

Source: Winterflood, as at 24 October 2017

Top 10 holdings, as at 30 September 2017 (%) 
Prudential3.2
Naspers3.2
Amazon.com3
Royal Caribbean Cruises2.8
Alibaba2.5
Alphabet2.3
SAP2.1
TSMC2.1
AIA 1.9
Anthem 1.9

Source: Baillie Gifford 

Geographic breakdown (%)
North America43.2
Emerging markets21.7
Europe17.5
Japan7.1
UK6.3
Developed Asia3.3
Net liquid assets 0.8

Source: Baillie Gifford