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A view on financial markets - 'A man for all seasons'

Friday, 22nd May 2020 16:33 - by David Harbage

The last blog ‘At the Crossroads’ prompted considerable conversation surrounding the immediate outlook for financial markets, with readers seemingly reflecting investors’ positioning in taking more polarised views, in the face of the COVID-19 pandemic.


These ranged from an unshaken belief that the fundamental merit of owning a stake in successful businesses – as a means of keeping pace with inflation or earning any meaningful income – to a fear that the economic damage, wrought by near-global lockdowns, indicates that “it is different this time”. The bullish tendency anticipate eventual recovery in share worth because theoretically they are priced to anticipate profits, dividend income and asset appreciation ad infinitum, rather than just over the next year or two. By contrast, the more cautious anticipate a step change in the equity-investing landscape as globalisation reverses (‘race to the bottom’ in manufacturing cost eases, as countries seek to become more self-sufficient) and governments address huge fiscal deficits and corporate failure (perhaps via higher taxation, public ownership). On the question of equity’s current attractiveness or otherwise, it is probable that most readers sit in the agnostic camp, but many have endorsed the need to be selective in the choice of business activities – given today’s heightened uncertainty.


The wish to avoid the perceived problem industries, or even ‘flat spots’, might persuade investors to reduce the level of importance which they would normally apply to diversification (best achieved by owning all constituents of an index, such as the FTSE100 or FTSE All Share) to only own favoured business sectors. The opportunity to out or underperform the market increases when uncertainty rises; the astute active fund manager can beat or lag a benchmark index by an appreciable margin in times such as these. While most collective investment funds do not have the flexibility to liquidate their assets (an individual investor has to accept that a fund will remain invested in its designated asset, rather than be able to switch into Cash), the manager can adapt their portfolio to reflect new expectations. 


The author has been asked to recommend a fund which captures a more cautious perspective on the global economy and the prospect of continued volatile stock prices. It should be appreciated that this blog never makes specific investment recommendations – but rather requires readers to consider any investment ideas against the appropriateness of their own circumstances, objectives and appetite for risk-reward. But before highlighting a fund which might appeal to the cautious investor - who is seeking to own real assets, but is wary about corporate health – a brief word on earnings-based valuations of company shares.


Readers will no doubt ascribe some level of market ‘efficiency’ in pricing stocks fairly - given the number of financial analysts who are studying larger stock market listed companies – typically illustrated in the premium price one has to pay for more reliable earnings and the seemingly cheaper valuations placed on lower quality assets. However, if one’s view is significantly different to the consensus (i.e. reflected in the market’s valuation) - perhaps on the depth, duration or impact of the economic trauma - the discriminating investor could outperform the overall market. For example, a belief that the downturn will be ‘tougher for longer’ could see higher quality, growth businesses extend their premium rating and cyclical firms become ever or apparently cheaper. This relative performance against the overall market should not be confused with actual returns or absolute performance.


It should be remembered that over the appropriate longer term, the ‘E’ of earnings drives the ‘P’ of price within the PE ratio or multiple. As such, a high PE (versus the UK equity market’s average) implies higher earnings growth, as well as the profits being more assured and sustainable, than the average company; a low PE indicates the opposite. Often when announcing trading results, investor expectations on the business’ prospects alter and broker analysts change their profit forecasts, which in turn causes the PE multiple to contract or expand. Some investors will aim for the highest prospective returns – which typically arise from a lowly rated stock becoming a premium priced one – while other individuals or managers of equity might place a higher priority on capital preservation. The latter is likely to result in the selection of businesses which feature more reliable sources of revenue and, dependent on the outlook for economic and corporate profit growth, may be rated more or less highly than the overall market.


Since the writer’s earlier ‘At the Crossroads’ article, news flow has been mixed and probaby biased towards the negative. We have seen Germany & France agree to support weaker economies within the Euro bloc, the US Federal Reserve Bank suggest ‘further financial ammunition’ lies beyond the $3trillion being borrowed in Q2 ’20 and, closer to home, the prospect of the Furlough scheme to support UK employment continuing until October. These rapid supports to the economy and liquidity of the financial system are to be applauded but, while current costs of servicing government debt is exceptionally low, the need to ‘balance the books’ (US government debt is close to $25tn, and UK debt equates to more than annual GDP) should not be overlooked. The prospect of slower economic activity, featuring higher unemployment, makes that task more onerous with near inevitable higher taxation and tariffs acting as a further drag on global prospects. Rising tensions surrounding the blame for COVID-19 and trade relations, in a world where co-operation in fighting the pandemic was somewhat lacking, may see at least a temporal reversal in globalisation (economically-driven efficiencies) as individual countries take greater responsibility for manufacture of essential product.


Against that backdrop, we return to the request that followed the previous blog’s mention of Herald investment trust (as a potential beneficiary of higher demand for technology in a world where remote working is increasing). The writer has searched for a fund that captures areas of the market which can survive and thrive in a protracted global slowdown. Scottish investment trust invests more widely across business sectors, as well as probably being more diversified by geography, than Herald but might appeal to the more cautious investor. The trust’s objective is to provide investors, over the longer term, with above-average returns through a diversified portfolio of international equities and to achieve dividend growth ahead of UK inflation. Assets are chosen on a ‘bottom up’ company stock specific perspective, rather than being driven by ‘top down’ macro-economic or thematic views, and a contrarian style often seemingly results.


However, the current mix of Alasdair McKinnon and his team’s portfolio has a clear defensive, low economically-sensitive ‘personality’ which would appear to fit the investor who wishes to focus on such more reliable earnings. As at 30 April, a breakdown of the trust’s portfolio shows that Healthcare accounted for 16.1% of total worth, via the likes of Pfizer, RocheGilead Sciences and GlaxoSmithkline, Consumer staples (15.9%) notably Japan Tobacco, Pepsico, Kirin and Tesco, Communication services (13.5%) via China Mobile, BT, Verizon and Telstra and Utilities (8.3%) via United Utilities, Severn Trent and Duke Energy feature heavily.  


In addition to this bias towards the more resilient industries, the three largest holdings in Scottish investment trust’s portfolio are amongst the world’s largest gold miners: NewmontBarrick Gold and Newcrest Mining. The prospect of appreciation in the price of the precious metal prompted the fund manager to increase exposure over the past half year - from 14.2% to 20.4% - of the trust’s total worth. Gold has risen by 20% to date this year, but the immediate prospect of deflation, low interest rates, weak economic activity and rising money supply suggests the all-time high price of US$1,900 in 2011 could be challenged.   


In geographic terms, the breakdown of assets reveals North American listed companies account for 34.7%, UK 15.5%, continental Europe 12.4%, Asia Pacific ex-Japan 10.2% and Japan 8% of the portfolio’s total worth. The shares are currently trading on an undemanding 12% discount to their net asset worth (NAV including income, but with borrowings priced at market value was 835p on 21 May 2020) – which compares with the peer group of global equity investing investment trusts’ average discount of 5.5%. Weighted by value, the peer group trade on a discount of 2.8% and if the fund manager’s positioning of the portfolio proves to be correct, there is a real prospect of Scottish investment trust shares’ relative performance progressing – via both the NAV performance and a tightening in the discount.


The descriptor ‘A man for all seasons’ was applied by Robert Whittington to the English statesman and scholar Sir Thomas More – and was used by Robert Bolt as the title of his play about More in 1960. The term is used nowadays to mean a person who is ready to cope with any contingency and whose behaviour is appropriate to every occasion. It would seem, to this commentator at least, that Alasdair McKinnon might be that man for 2020 and 2021.




The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.


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