The combined market capitalisation of the Magnificent Seven group of US mega-cap stocks – Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla – is now over $22 trillion, meaning these seven stocks make up about 37% of the S&P 500 and 23% of the MSCI World index. As a result, most investors are likely to be heavily invested in this handful of tech giants, which has worked well for the past five years. However, with the market looking increasingly frothy, it could be time to take some money off the table.
Mega-cap tech has sucked up capital at the expense of other businesses, meaning there are now some exciting opportunities appearing in corners of the market. STS Global Income & Growth Trust (LSE: STS) is one way to invest in these kinds of cheaper stocks and reduce exposure to more frothy areas of the market.
STS Global Income & Growth offers quality income
STS holds a fairly concentrated portfolio of between 28 and 34 names, selected for their predictability, resilience, quality and income potential. The strategy emphasises firms that have scope for persistent earnings and dividend growth, which should result in reduced volatility, say James Harries and Tomasz Boniek of Troy Asset Management, who have run it since early 2020. The same duo also run the Troy Global Income Strategy with a similar mandate, which has delivered an annualised volatility of 9.1% since its launch in 2016, compared with 11.2% for the MSCI World index.
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The top holdings today are British American Tobacco (BATS) and CME Group. BATS offers the “unusual combination” of a high-quality business trading at an attractive valuation, says Harries. CME, the operator of the world’s largest futures and options exchange, is a high-quality firm that offers a 4% yield comprised of regular and special dividends. More recently, the managers have added Nike, purchasing it at a low point when it was “out of favour” due to strategic missteps and tariff trouble. The shares had fallen 71% from peak to trough, making it a classic quality value play.
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The trust has a 33% weighting to the UK, an opportunistic allocation as “global investors have shunned the UK”. However, on a look-through, only 6% of sales come from this market. “So we’re not making a call on the UK economy at all, what we are doing is saying that we’re taking advantage of attractively valued global assets listed in the UK.”
STS Global Income & Growth: avoiding technology
Technology is just 10% of the portfolio – a conscious decision, as most tech companies don’t pay a dividend. However, the result is that STS has underperformed the market in recent years, with a net asset value (NAV) return of 36.3% versus 49.3% for its benchmark, the Lipper Equity Global Income index. Yet while the rest of the market is starting to look pricy, STS’s portfolio is anything but expensive. At the end of October, the trust’s holdings were trading at an average price-to-earnings (p/e) ratio of 18 compared with an average of 21 for the MSCI World. The estimated yield was 3% compared with the market’s 2%.
What’s more, Harries and Boniek have been able to fill the portfolio with quality names at low prices. The portfolio has an overall operating margin of 28% (compared with 14% for the market) and a return on capital of 16% (compared with 9% for the market). Quality names in the portfolio trading close to or at the bottom of the ten-year p/e range include the likes of Reckitt, Novartis, Roche, Unilever, Nestlé and Accenture.
Buying at “lower valuations means less volatility”, says Harries. With so many high-quality companies currently “out of favour for whatever reason”, the team has been able to “build asymmetry into the portfolio”. This means aiming for “limited downside and long-term decent upside”.
In a market that’s starting to look overexcited and overextended, STS offers an alternative for investors seeking quality, value and income. The trust is currently trading at a small discount to NAV and offers a dividend yield of around 3.5%.
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