Beyond the noise: dealing with complex markets
Unpredictable markets have forced a reappraisal of some of the investment themes of the past few years, and a reminder to investors of some neglected investment disciplines.
Bruce Stout, Martin Connaghan and Samantha Fitzpatrick, Investment Managers, Murray International Trust PLC
- The unpredictable markets since the start of the year have forced a reappraisal of some recent investment themes
- Labels such as value, growth or quality are inadequate for investment decision-making
- Diversification and a focus on real assets are likely to be important in an environment of high inflation and rising interest rates.
Markets have been unpredictable since the start of the year. For investors, it has forced a harsh reappraisal of some of the investment themes of the past few years: extended valuations of technology stocks being a prime example. It has also forced investors to look again at previously unfashionable metrics such as cash flow, balance sheet strength and dividends. We believe that it should remind investors of some neglected investment disciplines.
The Ronseal test
Amongst the general market turbulence since the start of the year, investors have discerned three main themes: a weakness for ‘quality’ companies, the strength of ‘value’ and the difficulty of investing in emerging markets. As a quality-focused trust, focused on dividend growth and with almost half of our portfolio directly invested in emerging markets, this should not have been an ideal market. However, the performance of Murray International Trust has held up very well year to date, relative to the broader Investment Trust Sector and most importantly, in absolute terms.
We say this not to blow our own trumpet, but to point out the inadequacy of assigning labels when making investment decisions. Too many funds have seen mission creep as growth stocks have prevailed. We would suggest that the only real metric for shareholders is whether an investment trust manager delivers on their promises – the Ronseal test. Our commitment is to grow income and capital above the rate of inflation from a portfolio of fifty stocks. Our investors should judge us on that objective alone.
Dividends: helpful but not a panacea
An allocation to dividend stocks can look like the right approach when the economic environment gets tougher. The association between dividend stocks and ‘safety’ is strong. If companies have the cash flow to pay dividends, it often suggests capital discipline and economic strength. Equally, in an environment of high inflation, tangible income today is better than hoped-for earnings tomorrow.
However, it is not a panacea. In a recession, earnings go down. Where earnings go, dividends will sometimes follow. Sheltering in income trusts is not a solution in itself. Investors need to be sure their fund manager is paying attention to the sustainability of dividends in the long-term.
Interest rates are not rising universally
Investors are right to be concerned about the impact of rising interest rates. However, it is worth noting that rates are not rising across the world. They may be going up in the US and Europe, but Asian and emerging market central banks have already moved. Brazilian rates, for example, are at 13.2%, which is almost certainly at or near their peak. They are already through the most painful stage in the cycle and there are signs that central banks may now start to reverse direction.
There has been a prevailing view that if US rates go up, emerging markets suffer. This is not necessarily true. Emerging markets are only just emerging from the pandemic and have plenty of recovery ahead of them. We see a lot of pent-up demand, particularly in the relatively unleveraged consumer sector
Murray International continues to have around 40-45% exposure directly in emerging markets. We see stronger and more resilient consumption demand there than in the developed world, where household formation is static and household budgets are more sensitive to rising interest rates. Equally, emerging markets have seen valuations fall significantly, creating opportunities.
The importance of diversification
This particular investment cycle has seen passive funds become concentrated in a handful of technology stocks. This means any selling pressure is exaggerated. A strongly diversified strategy is vitally important in an environment where there are lot of intangibles. This is a difficult environment and the problems could grind on longer than many currently expect. For the 50 stocks in our portfolio, we strive to ensure that their economic fortunes are relatively uncorrelated with each other. They are being driven by their own business and their destiny is in their own hands.
Focus on real assets
A notable theme running through Murray International is real assets. This is not property in London and New York, but tangible areas such as a pipelines in Canada, an airport in Mexico or a telecoms network in Indonesia. In many cases this installed capacity is increasingly valuable because planning restrictions mean it is very difficult to build more.
Our telecoms holding in Indonesia, for example, has spent the last five to ten years putting money in the ground, building a high-quality digital network that can deliver data across the country. In the developing world, penetration of digital services is far lower and consumers don’t have the same debt levels. This gives a stronger runway of growth.
Be wary of concept stocks
The current environment of rising rates and high inflation is precarious for some of the technology stocks in developed markets. They may be great companies, but margins could be squeezed because they are operating in very competitive industries. The food delivery business is a good example: with wages and fuel costs rising, its margins are weakening. Some companies have negative cash flow because they are investing for growth. If the banks get twitchy and cut off financing, these companies could go wrong quite quickly.
This environment should revive some investment disciplines that have been lost in the loose money era following the global financial crisis. Investors haven’t been analysing cash flow because they haven’t had to, inflation has been low and credit readily available. However, this is a luxury they can no longer afford.
Risk factors you should consider prior to investing:
- The value of investments, and the income from them, can go down as well as up and investors may get back less than the amount invested.
- Past performance is not a guide to future results.
- Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.
- The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.
- The Company may accumulate investment positions which represent more than normal trading volumes which may make it difficult to realise investments and may lead to volatility in the market price of the Company’s shares.
- The Company may charge expenses to capital which may erode the capital value of the investment.
- Movements in exchange rates will impact on both the level of income received and the capital value of your investment.
- There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value.
- As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.
- With funds investing in bonds there is a risk that interest rate fluctuations could affect the capital value of investments. Where long term interest rates rise, the capital value of shares is likely to fall, and vice versa. In addition to the interest rate risk, bond investments are also exposed to credit risk reflecting the ability of the borrower (i.e. bond issuer) to meet its obligations (i.e. pay the interest on a bond and return the capital on the redemption date). The risk of this happening is usually higher with bonds classified as ‘subinvestment grade’. These may produce a higher level of income but at a higher risk than investments in ‘investment grade’ bonds. In turn, this may have an adverse impact on funds that invest in such bonds.
- Yields are estimated figures and may fluctuate, there are no guarantees that future dividends will match or exceed historic dividends and certain investors may be subject to further tax on dividends.
- The Company invests in emerging markets which tend to be more volatile than mature markets and the value of your investment could move sharply up or down.
Other important information:
Issued by Aberdeen Asset Managers Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Registered Office: 10 Queen’s Terrace, Aberdeen AB10 1XL. Registered in Scotland No. 108419.