When Peter Spiller took over the management of the Capital Gearing Trust (LSE: CGT) in 1982, it had assets of just £500,000. Now, 39 years on, the fund is valued at £864m and its shares have multiplied 237 times in value, equivalent to a compound annual return of 15%. Under Spiller, the trust has only had one down year, 2013, when it lost 2%. This performance far exceeds that of all stockmarket indices, both in terms of performance and volatility.
Returns have been more pedestrian in recent years. A five-year return of 41% reflects a compound annual return of 7.1%, a little ahead of the FTSE All-Share index, but well behind global markets. This has not prevented the shares from trading at a persistent premium to net asset value (NAV), currently 3%, which has enabled CGT to continue issuing shares. Its management fee of just 0.35% adds to the attraction.
Inflation is a key concern
In recent years, CGT’s managers have been very cautious. They have feared the return of inflation and believed that equity markets are overvalued. The trust’s exposure to “funds and equities” comprises just 42% of the portfolio: this includes 17% in property, 4% in loan funds and 5% in infrastructure funds, and just 17% in pure equities. Index-linked government bonds account for 30% of the portfolio, conventional government bonds 14%, corporate bonds 7%, cash 4% and gold 1%.
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Concerns over inflation and equities’ valuations are now widespread, so these allocations seem prudent. But exposure to equities and funds is now the highest it has been for ten years and double that of 2011. CGT’s managers have been crying wolf for a long time, but perhaps their time has now come.
“People get what they are not worried about,” says Spiller. In 1965, the focus was on employment, not inflation. Only after 15 inflationary years did the focus switch to rising prices. In the 1960s, US inflation built gradually thanks to “relentless” fiscal expansion and negative real interest rates; it was “aided but not caused by oil prices”. Inflation became the “cancer of modern civilisation”, creating “tremendous social tension”.
The turning point came in 1979. “Subsequent disinflation lasted longer than expected, helped by demographics (notably the fall of the Berlin Wall and opening up of China), globalisation and technology, but those factors are now largely spent, if not reversing. Instead, we have green inflation, structural change, such as Brexit, and the possible pricking of asset bubbles.” The consensus is that inflation will fall, but perhaps not back to target.
A sensible investment
America’s total debt-to-GDP ratio has doubled to 296% since 1980 and higher real interest rates are likely to be needed to control inflation. A recession next year is increasingly likely, but the probable response will be higher fiscal deficits, lower rates and more quantitative easing, causing a ratcheting up of inflation. Eventually, central banks and governments will be forced to clamp down, as they did in 1980. Spiller believes that low asset values will open up another era of investment opportunity.
CGT’s strategy focuses both on making money and, more importantly, on not losing it. The exposure to gold is surprisingly low, but Spiller argues that gold is not undervalued relative to historic inflation. Also “gold behaves very like US Treasury inflation-protected securities (TIPS) and we find it easier to analyse TIPS”. US TIPS are preferred to UK index-linked gilts as they offer better value and Spiller expects sterling to fall. Still, exposure to sterling is 54% of the portfolio. Some might think CGT’s strategy is too cautious. But, as one happy shareholder said, “I trust you to hold my coat while I fish in riskier waters”. On that basis, CGT should have universal appeal.
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