Oh, how the central planners are pleased with themselves now. Crowing about how they’ve tamed inflation, they really think they know what they’re doing.
And yet, as I look at my inflation indicators, they’re all pointing upwards again. Gold, silver, oil, and agri-commodities; after a couple of years of side/downward action, most key commodities have been rising during 2014. And it’s only a matter of time before the inflationary forces reassert themselves.
So today we’re catching up with one of my favourite inflation-busting investment funds – Ecofin Global Power and Water (LSE:ECWO). ECWO has put in a very respectable performance since I first wrote about it in April last year. In fact, the fund is up 29%, as well as providing a nice 5% yield.
Resource investments like this are a great hedge against inflation. And given that inflation is coming, I reckon there’s still plenty of mileage left in this investment trust.
Not least because it’s trading at 23% discount to the value of its assets!
Juicing performance with blue chip investments
ECWO is a substantial investment trust – its market cap is about half a billion pounds. Like all investment trusts, it can be bought through a regular stockbroker, either in a regular trading account, or within a Sipp or Isa.
Though it’s traded in London, it is very much a global play on energy and water. In actual fact, management have been under-invested in regulated UK utilities, fearing political influence.
Key geographic sectors comprise North America (nearly half the fund), continental Europe (a quarter of the fund) and emerging markets (nearly 10%).
Since launch in 2002, the fund has put in an annualised performance of 13.9% – that’s a great record.
When I first wrote about the fund, it was yielding a very healthy 5%. However, given the fund’s recent appreciation, the yield has fallen to 4.3%. But that’s still a handy return, especially when you consider the fact that there’s more scope for capital appreciation.
You see, nearly half the fund is invested in blue chip companies valued at over $5bn. And if you take the value of all its investments (less debt), ie the net asset value of the fund (NAV), it comes to £2.15.
However, if you want to buy the stock, all you have to pay is £1.65 – putting the trust on a discount of 23% to NAV.
Just think about that. If you wanted to go out and buy shares in the constituent parts of this fund, you’d have to pay nearly a third more for them. What’s more, given the discount, then the yield on each of the constituent shares is effectively leveraged up. That’s because we can use £1.65, instead of £2.15 as the denominator in the yield equation.
As well as the discount factor, the fund is also leveraged through financial gearing. Unlike most unit trusts, investment trusts regularly use debt to improve performance. It’s a bit like a homeowner who gears up his house price returns with a mortgage.
Now, understandably some investors may not like this feature. And there’s no doubt that in a falling market, a leveraged portfolio is likely to perform worse. But I will make three points that should put your mind at ease.
First, the fund is invested primarily in solid investments with decent dividend backing. The stated objective of the fund is to “Secure high dividend yield and to realise long-term growth… while taking care to preserve shareholder’s capital”.
Secondly, some of this gearing will not actually materialise. That’s because a substantial part of the borrowings are through convertible loan stock (ie it will convert to ordinary shares in the company). If you remove the convertibles, then the gearing falls to 21.7%, while only knocking a couple of percent off the NAV.
Thirdly, given the fact that most of this fund is invested in large-cap global stocks, it would be quite easy to sell down some assets to neutralise the debt. In fact, given that the fund is trading at such a big discount to NAV, liquidating some of the portfolio will actually increase the NAV itself.
And this is more than just theory. When I first wrote about the fund, it was operating with 50% gearing. Yet, as things stand, we’re down to 45%.
Still a buy
What we’ve got here is a fund that has provided a very decent performance over the last year, making the most of generally appreciating markets. A decent yield and decent capital appreciation. Of course, in a falling market, things will look different.
But given the central planners’ propensity to juice the markets, and given the fact that much of the stimulus continues to leak into the commodities area, I see no reason to be unnecessarily fearful.
The right way to play the stimulus-recovery has been to stay long equities and take any yield on offer. And with the central bank of Europe now gearing up for a stimulus charge, then why not stick with the theme?
As I say, over the 12 years since inception, the fund has delivered 13.9% (dividends reinvested) a year. Bear in mind that this period also includes a brutal stock market smash-down, then I think you’ll agree, the fund manager is doing something right.
The raison d’être for the fund remains intact. I’m sticking with it.