Rarely can the aphorism “pessimists sound smart, optimists make money” have been truer than in 2023. The Eeyores came into the year insisting that rising interest rates would cause a recession in the developed world, corporate profits would be hit, stockmarkets would slump and the only safe haven would be in government bonds. Yet recession was averted, earnings dipped but returned to growth, equities, especially in the US, performed well and government bond yields continued to rise (reflecting falling prices).
The pessimists argue that most of the market’s gain was attributable to the “Magnificent Seven” stocks at the top of the US market (eight if you include Netflix), which make up 28% of the S&P 500 and jointly rose by 80%. This is, they believe, an unsustainable bubble that will pop when the recession, at last, materialises in 2024. Cue market mayhem and happy pessimists. Pessimists spend too much time telling investors why they are all wrong and not enough listening to what the market is telling them. Markets do occasionally charge off in the wrong direction, but not nearly as often as “expert” forecasters.
An improved outlook for inflation
That is the spirit in which to judge this year’s major surprise: the rally in government bond yields that has taken yields in the UK and the US for ten-year issues below 4%. Given the mountain of issuance that lies ahead and no evidence of the increased demand necessary to absorb it, it had seemed likely that real yields would have to remain high to attract buyers.
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The explanation is not that the market is “wrong”, but that the outlook for inflation is better than believed. It looks poised to drop back to 2%. There is plenty of evidence for that in the US and European inflation data already. Central banks are thus likely to cut interest rates, but short-term rates are not a driver of equities; yields on public debt, which have little scope to fall further, and corporate earnings, whose growth is accelerating, are much more important.
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Deposit accounts and bonds may look more attractive than they have for many years, but the best returns are likely to be earned in the stockmarket. It is tempting to invest in the many cheap areas: investment trusts on juicy discounts, private equity, infrastructure, small and mid-caps, the UK, and Japan. But start with a mainstream global trust. The Baillie Gifford trusts, such as Scottish Mortgage and Monks, are rallying but have been left behind in the renewed popularity of growth investing.
The surprise winner in 2023 was the 135-year-old giant Alliance Trust (LSE: ATST), with £3.5bn of assets. This has returned 20% in the last year, well ahead of its rivals and the MSCI All Countries World index’s 14.5% in sterling terms. Over three and five years, it has performed broadly in line with the index.
The shares trade on a 5% discount to net asset value (NAV) and yield 2.3%, the dividend having been increased for 56 consecutive years. The trust used to be self-managed out of Dundee and was something of a lame duck, but in 2017 management was taken over by Willis Towers Watson (WTW) using a “multi-manager” approach. This means that the portfolio is parcelled out to ten carefully chosen managers, though one manager, GQG Partners, runs an emerging-markets portfolio as well as a global one.
Each of the 11 strategies invests between 4% and 20% of the portfolio in up to 20 “best ideas”. Adjustments are made to the allocations twice a year, but the focus is on stock selection, not regional allocation or macroeconomic investing. The styles cover the spectrum from growth to value. WTW invests with managers who have good records in their speciality even if doing so is out of favour for a time.
The multi-manager approach does not have a great record, having worked much less well at Witan, with £1.5bn of assets (+8% over one year, +34% over five), and at F&C Investment Trust, with £5.5bn of assets (+11% over one year, but a respectable +58% over five). Around half of F&C’s assets are managed internally, but by different teams, and F&C has a rather unwieldy 457 holdings against just 205 for Alliance.
Alliance’s lead manager Craig Baker notes that this year’s performance has not been driven by the Magnificent Seven (or eight), to which Alliance has had an overall lower exposure than the global index. He points out that the winners in each decade do not stay at the top forever; the 1980s were dominated by global oil majors, the 1990s by Japanese financials and the 2000s by telecoms and the internet. “The leaders from each area had a smaller market weight a decade later.”
Alliance’s winners have mostly come from elsewhere, including Latin American giants Petrobras and Mercadolibre. A new allocation in the middle of the year to Japanese value and an older one to emerging markets are regionally specific, but otherwise, managers are either global or focused on the US (63% of the index). These are not normally managers or strategies available to private investors. Alliance seems unlikely to maintain this year’s rate of outperformance, but neither should it fall much behind global indices. That makes it an excellent one-stop-shop for global investment or a core constituent of a broader portfolio for cautious investors wary of bargain-hunting.
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