Merryn Somerset Webb talks with Bruce Stout of the Murray International investment trust about how investors can protect their wealth and make money in our over-indebted world.
You can listen to Merryn’s full interview with Bruce on the MoneyWeek podcast
It’s a rare journalist who leaves an interview with Bruce Stout feeling cheered up. And as our meeting last month kicked off, it looked as if it was to be no exception. We started with the horrible build-up of debt across the world – and the monetary policy it has forced. You can divide recent financial history into “before 2008” and “after 2008”, says Stout. Before, a risk-free return was possible (interest rates were higher than inflation). After, it was not (interest rates are at, or lower than, inflation). And if there is no such thing as a risk-free return, everything goes haywire. Everyone with cash feels they have no choice but to “speculate”, even though most simply haven’t the knowledge to do so. Pension freedom has exacerbated this. We are, says Stout, effectively “abdicating responsibility for the pension-fund system to the individual”. That makes little sense: “it’s hard enough for professional money managers to get returns on capital, never mind people who have had no experience of it”. Worse, the core problem (no real interest rate) is unsolvable: with consumer debt and sovereign debt both insanely high, if you raise rates you get a “double whammy” hit to demand.
So what do we do? Stop “agonising”. We’ve been running a massive monetary experiment for so long now that while we know what the “actuality is – huge mountains of debt in all sectors of the economy”, we don’t really know what our “new normality” is.
Best then, says Stout, to stop fixating on “normalising” rates (pushing them up in the full knowledge that our economies are too vulnerable to cope). If we do that, we’ll get depressions. We need to look at how else to manage our troubles (there is, after all, “more to economics than monetary policy”).
Buy at reasonable prices – but what is reasonable?
So we move on – to the trust Stout runs, Murray International (LSE: MYI). Murray is a long-term MoneyWeek favourite. While 2017 and 2018 were not brilliant, it remains a long-term outperformer (an average annual return over the last ten years of around 11.5%, and 20% in the last three years). The aim, says Stout, is to “take advantage of the best opportunities anywhere in the world”, while targeting an “above-average dividend yield” (currently 4.4%). It’s equity-based, holding 50 stocks and 28 bonds, and gearing is actively managed – Stout borrows to invest when valuations are low and de-gears when they are not.
And now? “We’re de-geared from equities and have been for a couple of years.” The equities held are generally outside the UK. That’s not necessarily due to expectations of low growth. “It’s very difficult to make out the correlation between what happens in an economy and what happens in a market.” Look at the “strides that China has made in the last 15 years in terms of its share of global GDP… yet there have been many years where the Chinese market has been one of the worst-performing”. What Stout is looking for, then, is a business that might benefit from, say, growth in China, but not be affected by some of its political or governance issues. An example might be Auckland Airport in New Zealand, which is “benefiting from the growth in the Asian region, and the rise in disposable income in China”; or airport operator ASUR in Mexico, which is benefiting from increased disposable incomes and tourism across the region.
“The most money is lost by people who extrapolate recent growth far into the future”
Stout is interested in value, but not obsessed with it. Murray looks for “growth at a reasonable price, and growth that will support capital investment and dividend growth… We are not deep-value investors, never have been, and never will be”. So what counts as a reasonable price? That, says Stout, depends on the type of business. The most money is lost by people who “extrapolate recent growth into the future, and assume that it can happen in perpetuity”, when in fact the business they are looking at is cyclical. Believe, for example, that the semiconductor industry is a straight-line growth story (it isn’t – it ebbs and flows with the consumer-electronics sector) and you will make huge losses by paying too much at the top of the cycle.
So one key point to think about right now is just where there is unrecognised cyclicality in markets. Take tech, says Stout. Some of the big US tech companies have never been tested in a cyclical downturn. “Maybe people will give up food and still keep the Netflix subscription. Maybe not.” But if, after their initial high-growth phases, it turns out that these firms are cyclical too – that they are just normal companies to be valued in normal ways – “wow, that’s a different ball game altogether”.
The hunt for “good” volatility
What about the tobacco stocks Murray holds? What’s attractive about them, I ask, given that it’s hard to see long-term growth? In the last ten years, says Stout, the growth has all come from restructuring the operational side of the businesses (pushing operating margins up from 30%-plus to 40%-plus); taking advantage of rising “heated tobacco” (old-fashioned cigarettes) demand in the developing world; and new delivery methods (vaping). But surely there’s a point when restructuring runs out? Sure, says Stout, but then it comes down to what you pay for what you get. Around 18 months ago, tobacco firms were very expensive. But since then, the price/earnings (p/e) multiple has “compressed”.
We move on to portfolio turnover. It’s generally low, but Stout is “no hostage” to low turnover; he looks to “capitalise on volatility”. In 2017, stockmarket volatility (as measured by the Vix index) hit all-time lows. “When there’s no volatility in stockmarkets, we don’t sell expensive stocks to buy expensive stocks. No opportunities arise because there’s no mispricing… But when you get something like the fourth quarter of 2018, then it becomes quite interesting… people were prepared to pay incredible multiples in July and August for certain businesses. Yet by the end of December…” What, I ask, did you buy and sell? “You’ll have to wait until the annual report.” Gah!
Is he expecting more of this “good” volatility? Perhaps – and this, I’m afraid, brings us back to debt. “The two most important issues today… are protectionism and the almost-mesmeric belief that there is no cycle any more.” Mention recession these days, says Stout, and you are “described as some kind of doomsayer”. But “we’re ten years into a business cycle here. Do we really believe economies don’t have cycles any more?” It’s very clear, says Stout, that hiking interest rates is not a science but an art, one that is easy to get wrong – ten of the 13 last recessions have been caused by overtightening. And today “we’ve got more debt than we’ve ever seen”.
“The big issues today are protectionism and the belief that there is no cycle any more”
If this has been a consumer cycle based on credit, and the price of debt servicing is now rising, shouldn’t that suggest to us that the risk is high? Can the world really cope with rising rates? Take Germany out of the figures and the eurozone “hasn’t grown for 20 years”. Can its banking system cope with a bad debt cycle, “as a recession takes excess capacity out of the system and restores profitability to those companies that operate more efficiently?” And what about the UK? “The authorities assure us that capital adequacy ratios are really strong, and the banks have been tested in stress situations. Well, let’s see, shall we?” The key question for markets is: how safe are the banks? If “the banking system really was bulletproof, then you might have the flexibility to do quite a lot of things”. But it isn’t. How much better, Stout and I agree, it would have been to have dealt with some of this problem in 2008/2009 – perhaps by allowing a bad debt cycle then.
How developing markets could prevail
We haven’t done a particularly good job at steering our conversation away from the issue of the debt (how can you when you are talking about economies?). But the lack of a solution to it does at least offer pointers to investors. In the shorter term, any pull back from tightening in the US could lead to some outperformance in emerging markets – several raised rates in 2018 in response to currency weakness (driven by dollar strength). A reversal of that could be good news for them (although they are hardly immune from credit-driven troubles in the US).
But over the longer term, what our failure to deal with our long-term problem might well give you, says Stout, is a “massive shift” in competitive advantage to those countries that, unlike us, have invested heavily in education and training; that, again unlike us, actually manufacture something (the UK’s biggest Achilles heel, reckons Stout, is that “all we’ve ever done is run a bigger and bigger trade deficit”); and that don’t have the hideous debt obligations that we have.
Those emerging from poverty in the likes of India are doing so into a growing low-debt economy where they will be able to buy a house, fill it with stuff, and create a real consumer economy. Stout sees “enormous capital investment in human capital in places such as China and Vietnam”. And (a cheerful note to end on) from that “human capital investment comes innovation, businesses and wealth generation”.
Who is Bruce Stout?
Bruce Stout, 59, is a senior investment manager on the global equity team at fund management group Aberdeen Standard Investments. He joined Aberdeen in 1987, following the acquisition of Murray Johnstone, and has held a number of roles at Aberdeen, including investment manager on its emerging markets team.
Stout was appointed manager of the Murray International Trust in June 2004. Since then, the trust has beaten its benchmark in eleven calendar years (including the first nine under Stout’s tenure), only underperforming during 2013, 2014, 2015 and 2018. Between 30 June 2004 and the end of December 2018, the trust has made a total return of 424%, versus a benchmark return of 199%. Bruce graduated with a BA in economics from the University of Strathclyde, and completed a graduate training course with General Electric Company UK.