InvestmentsOct 23 2018

Russell Taylor: Investors must look forward, not back

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Russell Taylor: Investors must look forward, not back

As discussed in last month’s column, the theory – which maintains that markets reflect all information and are thereby impossible to beat – seemed good at the time and helped managers rethink their ideas at a time of institutionalised change for stock markets. But 70 years later, innumerable events have long since proved it false.

Investors need to discern the future, however thick the fog and rain, and be brave enough to invest in their educated guesses. 

The best way to do this is through investment trusts. Table 1 and Table 2, reproduced from last month, show how this can be done – and also how to hedge the bet. This hedging (similar investments in contrasting countries, or styles) is important because of the simple reason that the future could be especially challenging. 

Trade wars are now well under way, the US under President Donald Trump is pulling out of the post-war Pax Americana, populism is on the rise as western governments fail their economic and immigration tests, and countries are losing their tax base as nearly all large international companies find ways to legally avoid paying tax.

Twin troubles

Two of the world’s major economies have much in common, including each facing their own individual crises – a fast declining and ageing population in Japan, and Brexit for the UK. Both societies are stable and traditional, but that can also mean conservative and slow to change.

Japan has bet on robotics as the answer, not only to its own problems, but also those of the western world. And Prime Minister Shinzo Abe, with his so-called ‘Abenomics’ programme of reforms, has begun to address some of the uncompetitive elements of the economy and has been rewarded with electoral success.

The UK, on the other hand, has a badly skewed economy. It is home to some high-quality manufacturing plants, and some even more valuable and well-paid service sectors. But elsewhere prospects of decent jobs are poor, and these neglected cities have more in common with early 20th century Britain than the 21st century.

These are the differences that influenced the Remain and Leave votes in the 2016 referendum. As yet, neither of the main parties has thought through these economic weaknesses, both imagining that Brexit will help magically turn the UK into a new global powerhouse.

Those siding with the Brexit optimists should choose City of London IT, an equity income trust investing in middle-of-the-road companies, and one deemed a ‘dividend hero’ by the Association of Investment Companies because it has raised its dividend for more than 20 consecutive years.

Unless Brexit is a disaster, or the government fails to address the need for better education, better infrastructure and the rebalancing of the economy after the departure from the EU, then this investment company should serve investors well.

The choice for Japan is very different, since Baillie Gifford’s Shin Nippon trust is invested in small, entrepreneurial companies, outside the moribund grip of the large international corporates, and so free to take advantage of Abenomics. Which of these two island-based societies will prosper over the coming decade? No forecast can tell, so that is the guess the investor must make.

Domestic options

Another way to hedge the future of the UK is to invest in the Perpetual Income and Growth IT, a successful trust investing in small UK companies that ought to do well in the post-Brexit era. But this choice, in turn, could itself be hedged by going global, via a similar holding in F&C Global Smaller Companies trust.

Many investors look with envy at the most high-profile Baillie Gifford trust, the FTSE 100-listed Scottish Mortgage. The trust’s managers long ago settled on technology as their sector of choice, not least the Fang (Facebook, Amazon, Netflix and Google) stocks, and ran these holdings all the way. But a manager clever enough to do that is also clever enough to be aware of regulatory risks to these companies, and to adjust the portfolio accordingly. 

If this awareness is not enough to calm fears over technology, then the Personal Assets Trust may make for a wise complement. At the other end of the spectrum to Scottish Mortgage, the volatility of this portfolio is very low. This is because the overriding principle of Personal Assets is to secure the value of the shareholder’s money first, and only then try and maintain its value against inflation and a rising standard of living. In this regard it has been very successful indeed.

But those who voted Remain in 2016 may well wonder at the incompetence of the political class, and as a result question if the time has come to wave goodbye to the FTSE All-Share index entirely.

In that case, there are two global trusts with dividend hero status. Witan has a strong link between the board and the manager, and definite ideas on asset allocation. Alliance Trust, on the other hand, has chosen to rely completely on its investment adviser, Willis Towers Watson, which chooses a limited number of asset management companies to run the portfolio – each of these are limited to just 50 high-conviction businesses.

Yet if Remainers are to follow the advice given to young Americans to “go west, young man”, they might also allow themselves the exhortation to “go global and embrace technology”. In that case, the Worldwide Healthcare portfolio promises the products, while Polar Capital Technology offers the electronic plumbing that all such products need. 

All these options represent different ways of investing – some not trying to make a fortune, but to protect what you have – but each is focused on trying to keep up with a challenging future.