Brexit has once again cast a long shadow over the UK market. International comparisons suggest UK valuations are at the bottom end of a range of metrics. But just as the portfolios benefited from defying consensus and increasing their domestic exposure over the referendum period, they are hoping to again benefit from the market reaction to the sceptics presently holding sway – this time about the consequences of a ‘no deal’ outcome to the EU negotiations.
Groundhog Day
History often repeats itself. There were serious misjudgements from the Remain camp during the referendum campaign as to the immediate consequences of an ‘out’ vote. Yet, contrary to all the official predictions of gloom, the UK economy has since done very well. Record inward investment, record manufacturing output and record low unemployment has prevailed. And, of course, since then we have seen a host of very public apologies from across the spectrum, including from the Bank of England and the International Monetary Fund (IMF) for getting it so wrong.
The renowned economist JK Galbraith once said: “Pundits forecast not because they know, but because they are asked”. The historical data suggests a poor record at economic forecasting. Recent examples include the IMF, the European Commission (EC) and the US Federal Reserve all missing the biggest shock of the decade – the global financial crisis. As late as the spring of 2008, the EC predicted eurozone growth of 2 per cent in 2008 and 1.8 per cent in 2009 – the figures turned out to be 0.4 per cent and -4.5 per cent. The oil price collapse was also missed.
Part of the problem is that economists cannot accurately predict human behaviour – the so-called ‘animal spirits’ – when it comes to investment, spending, saving, etc. Accordingly, there is a tendency to extrapolate the trend of the recent past because this is the least awkward and perhaps safest approach. And this has proved to be folly.
Certainly when it comes to the stock market, it is better to focus on what we know (the company and fund manager in question) than what we do not (forecasts as to the economy and market). This is the philosophy that guides the eight live investment trust portfolios run in real time on my company’s website www.johnbaronportfolios.co.uk.
It should be likewise when it comes to dire predictions about the effect of a ‘no deal’ outcome. Suggestions the UK will ‘crash out’ of the EU if there is ‘no deal’ with the economy being on a ‘cliff-edge’, that the adoption of World Trade Organisation (WTO) rules would be negative, that complex supply-chains would be disrupted, etc, should again be treated with caution. We should instead focus on what we know.
Complex supply-chains already span various customs arrangements around the world, particularly in the Far East, and so should not prove an insurmountable problem. Likewise, the UK already trades very profitably with the majority of the world’s GDP (the US, China, India, Brazil, etc) on WTO terms, in part because the EU itself has such a poor record on trade deals.
And, as evidenced by our recent performance, we know economic investment is about relative advantage. One of the most competitive tax rates in the developed world, labour market flexibility, excellent universities spawning research and development (R&D), an innovative and industrious people, our language and the rule of law are just some of the reasons the world is knocking at the UK’s door – and why it is important to introduce a controlled and fair immigration policy, which no longer discriminates against the rest of the world outside the EU.
Then there are the specific upsides from a ‘no deal’. The £40bn no longer paid to the EU would be available for domestic priorities, including helping those less fortunate than ourselves. Because of our trade deficit with the EU, average tariffs of 3-5 per cent would provide additional annual revenue of many £billions. Because we would no longer have to impose EU tariffs on imported foodstuffs, shop prices could fall. And we would be free to benefit from trade deals, provided we modify the Chequers agreement.
Trade usually prevails. Those in business – particularly the small- and medium-sized enterprises (SMEs) – are doing well. The UK market is cheap in part because of unfounded concerns. Sentiment trails fundamentals, particularly given ‘no deal’ remains the least likely outcome. Good outperformance dawns.
Portfolio changes
During the first half of the month, Chelverton UK Dividend Trust (SDV) was sold in the Growth portfolio, as was Acorn Income Fund (AIF) in the Income, and both were replaced by Montanaro UK Smaller Companies (MTU). Prices achieved were £2.26, £4.62 and £1.17, respectively.
Both SDV and AIF remain good companies run by sound managements. However, narrowing discounts warranted caution given their structure.
MTU had drifted to an 18 per cent discount when bought courtesy of lacklustre performance over recent years. Speaking with Charles Montanaro, a number of factors now warranted support. These include an investment process focused on choosing quality companies, the return of Charles as the lead fund manager, a reassessment of the portfolio including an increased emphasis on Alternative Investment Market (Aim) stocks, and the introduction of a new dividend policy equating to a yield exceeding 4.8 per cent when bought.
During the second half of August, both portfolios sold European Assets Trust (EAT) while the Income portfolio sold Aberdeen Smaller Companies Income (ASCI). Their replacements were BlackRock Throgmorton Trust (THRG) in the Growth portfolio, and Invesco Perpetual UK Smaller Companies (IPU) and SQN Asset Finance Income Fund (SQN) in the Income portfolio. Prices achieved were £1.21, £2.85, £5.43, £4.94 and £0.93, respectively.
EAT’s close discount to NAV and concern about growth rates relative to market ratings suggested caution. Meanwhile, ASCI had performed well since its introduction a year ago when on a 23 per cent discount, and now only yielded 2.5 per cent. The time had come to take profits.
THRG aims to provide an attractive total return from UK SMEs. The company’s excellent management has produced one of the best one-, three- and five-year performance records in the sector. A 10 per cent discount when bought added to the attraction.
SQN’s aim is to produce regular dividends and capital growth through investment in business-essential equipment. Its 200 investments yield over 9 per cent and this covers the 7.25p dividend – representing a yield of 7.8 per cent when bought. Recent concerns about some holdings missing repayments are now receding. Speaking with Neil Roberts, the lead manager, SQN’s dividend would continue to have been covered regardless, which highlights a margin of safety. A discount to NAV, respected management and director buying all suggest support.
IPU invests in SMEs and has a very good performance record. A new dividend policy introduced in 2015 allows the company to distribute dividends equating to a yield of around 4 per cent. Fuller explanations as to all portfolio changes are available on my company’s website.
John Baron waives hisfee for this column in lieu of donations by Investors Chronicle to charities of his choice. As these are live portfolios, he has interests in all of the investments mentioned.
