InvestmentsApr 18 2018

Troy’s Harries on how to create a defensive equity portfolio

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Troy’s Harries on how to create a defensive equity portfolio

The world is blighted by debt, ageing populations, and deflationary trends that are likely to push asset prices downwards in the years ahead, according to James Harries, who runs the £100m Troy Global Income fund.

Mr Harries has focused his fund on “defensive” shares he thinks can do well in a world of low inflation and low growth. 

He said the economic policies of low interest rates and quantitative easing boosted asset prices created some inflation and economic growth in the system, but the extra production of goods and services in the economy as a result of the monetary policy will not be met by a similar, sustained, increase in the level of demand for those goods and services.

So, as the monetary policy tools deployed by central banks are withdrawn, Mr Harries said the level of prices and economic growth will fall.

He thinks the level of debt, the disruption of technology and the ageing populations in the western world are the reasons why demand won't pick up in line with supply.

In terms of what this means for investors, Mr Harries said, "the consensus view is that inflation will rise, and that will push bond yields upwards.

"That would be bad news for some of the sort of stocks we like - companies with reliable, dependable earnings. Those are the sort of stock we own, because, we don't agree with the consensus view.”

His portfolio includes investments in tobacco companies, pharmaceutical companies and consumer goods companies such as Pepsico.

Those shares are often regarded by the market as “bond proxies” because the income generated is regarded as being almost as secure as that of a bond.

The policy of low interest rates and quantitative easing, which involves central banks buying bonds, pushes bond yields downwards, he added.

This makes the income from those equities that perform like bonds more attractive, but Mr Harries said if yields rise then the equities would be expected to sell off.

Bond yields should rise if interest rates rise, but Mr Harries' view is that higher interest rates will lead this time to lower inflation. 

He is less keen on commodity companies and financial stocks, which require significant levels of capital to be able to grow. 

John Ferguson, analyst at the Economist Intelligence Unit, said as the unwinding of quantitative easing on this scale has never been attempted in history, investors should not be complacent about the potential for volatility.

He said: "Excess liquidity has pushed up the prices of all manner of assets, including bonds, stocks and property. Memories of the global financial crisis,
and the high asset prices that preceded it, are still sufficiently vivid for high property and stock valuations to be a cause for concern.

"The speed with which sentiment turned in early February when global stock markets suddenly dropped on fears that the Federal Reserve (the US central bank) would be compelled to raise interest rates aggressively showed that current sentiment, while buoyant, also remains fragile. 

"It also needs stressing that the effects on financial markets of withdrawing huge amounts of monetary stimulus are not well understood. Quantitative easing on this scale has never been attempted before and nor, therefore, has unwinding its effects."

Guy Stephens, technical investment director at Rowan Dartington, said wage growth is becoming evident in the global economy, which should push inflation and bond yields upwards.

He added that the protectionist policies of US President Donald Trump are also likely to create inflation, but will restrict economic growth, and as a result, prevent equity markets moving much higher. 

Kristina Hooper, chief global market strategist at Invesco, said protectionism is the “biggest concern” for investors, and that it will push inflation upwards through higher commodity prices. 

Jonathan Davis, who runs Jonathan Davis Wealth Management in Hertford, said inflation has "crept up” on the world, and the higher commodity prices mean there is little sign that the present higher levels of inflation will decline. 

david.thorpe@ft.com