InvestmentsJan 29 2019

Russell Taylor: Fresh thinking needed by investors as Brexit looms

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Russell Taylor: Fresh thinking needed by investors as Brexit looms

Shareholders had a thoroughly torrid 2018, but will this coming year bring worse? 

Last year markets were unpleasantly surprised by the switch from quantitative easing to QT, that is to say quantitative tightening, as central banks around the world stopped supporting stock markets with easy money policies. And as Warren Buffett famously said, it is only as the tide goes out that we see who has been swimming naked.

On the continent, the real economy may receive a shock in May when elections to the European Parliament are due. Latest Eurostat figures show despite unprecedented levels of employment, in-work poverty has continued to grow since the financial crisis. So the populist threat continues, as the gilets jaunes – the yellow vests – protests in France show.

If full-time workers throughout the EU cannot earn enough to feel safe in their homes, or avoid food banks, then the outlook for British investors is worse still. 

Within the next two months, the UK’s political class will need to make decisions that will affect the country for many decades to come. Yet the discussions about Brexit show the country is not only divided, but also badly informed on how the world has changed over the years since the collapse of the Soviet Union.

History restarts

Back then, books proclaimed the ‘end of history’ as a triumphant US and liberal democracy was assumed to portend a unipolar world. It was only a matter of time, they predicted, before every other country accepted that reality. Not only has President Donald Trump upended that expectation, but the world now has three military superpowers – the US, China and Russia – and also three economic giants – the US, China and the EU – as well as many regional power brokers such as India, Japan, Iran and South Korea.

Each of these giants has their vassal states – to use a description much liked by Brexiteers – but that has always been the normal state of affairs. Whether for trading or alliance, rules are necessary, and these are nearly always imposed by the stronger or richer partner. Within the EU, which is a single market rather than a trading alliance, such rules are required to avoid ‘free loaders’, and all members have a right to discuss and agree to the rules. 

Regionalisation has changed the world, and it is regions that trade with each other, rather than discrete nation states. As a medium sized-power, the UK might yet choose to throw itself into a world of antagonistic trading giants, while giving up a membership of a union that is both geographically logical and one with which it has been remarkably successful in setting policy.

Even this government admits, while still pushing for parliamentary support for its own proposed exit, that the departure will make the country poorer. What it must also know is that it is abandoning a policy that has kept the country free and successful for more than 1,000 years – that is, to prevent any one country or polity from either dominating Europe or controlling the Low Countries. 

The Netherlands and Belgium have always been the ‘forward defence line’ of England, which is why the Tudors opposed Spain, William of Orange and the Georges feared France, and a pacifist Liberal cabinet declared war in 1914. In addition, Europe and the Low Countries for centuries helped form the basis of English prosperity, and still remain so.

The impact

Although there are doubts over whether the US economy can continue to expand, the eurozone is definitely slowing, and a bungled Brexit might hasten this as well as possibly causing some inflationary pressures – so far happily absent from this economic cycle. 

More to the point, 2018 showed that traditional investment techniques failed: neither value, nor momentum, nor small cap produced the returns expected. Also, minute examination of the past failed to anticipate the future of an increasingly digital world, where increasingly disruptive business techniques require less and less capital to finance.

So perhaps UK investors should forget the FTSE and classic thinking, and concentrate on equity income generation instead. Ignore the hard-earned lessons of the past, and embrace the digital future. Reversion to the mean may never happen again to markets as a whole, any more than British high streets will revert to their former glory and prosperity.

Thus my anti-Brexit portfolio, shown in Table 1, will closely monitor the events of 2019 over the coming months, as political events unfold for good or ill, and not entirely without some caution. Half of the investment companies chosen are low risk, globally diversified and known for their prudence.

Table 1: An anti-Brexit portfolio for 2019

Investment company

Initial investment at December 31 2018 (£)

Share price at December 31 2018 (£)

UK exposure (%)

Witan

25,000

9.71

35

Alliance Trust

25,000

6.88

12.3

Personal Assets

15,000

391.50

10.5

Scottish Mortgage

15,000

4.67

3

Worldwide Healthcare

10,000

23.90

0.3

Polar Capital Technology

10,000

11.04

1.4

Source: AIC/Morningstar. Copyright: Money Management

 

No more needs to be said about Personal Assets, since it has long been a favourite. Witan and Alliance Investment trusts are both now ‘dividend heroes’, as judged by the Association of Investment Companies, having increased their payouts every year over several decades.

Selection strategies

Both offerings use Willis Towers Watson to select their fund managers, but in very different ways. Witan has a strong investment management team and asset selection policy, subservient to the board, but uses specialist fund managers to cover investment gaps that it identifies as necessary to its tactical needs. Not surprisingly, it has a considerable weighting of UK stocks, but its use of WTW enables it to cover specialist markets when it sees opportunities outside its own expertise. 

Witan investors therefore can use the company alone to cover their equity investment needs, whether emerging, technology, medical or whatever seems to be the most profitable and exciting.

Alliance, perhaps conscious of the mistakes of its boardroom predecessors, has passed all responsibility to WTW, hoping to attract investors who could never be rich enough to use WTW directly. Which of these policies work best in the uncertain economic future that faces the UK will perhaps become clearer over 2019, but hopefully the skills and techniques developed across the past 150 years by investment company boards will give investors a more comfortable ride than that of 2018.

The other three investment trusts in the portfolio will be regarded as riskier. None pay much in dividends, believing that well-chosen companies are best at reinvesting profits, rather than paying their shareholders. This certainly avoids taxes and improves the compounding of returns. It also reinforces the investment policy of Scottish Mortgage, which is to invest in the digital future by identifying those companies that are disrupting and destroying methods of doing business and living that have lasted for decades, and even centuries. Such creative destruction is the very essence of capitalism.

Early investors in Scottish Mortgage can no doubt now afford many luxury cars and houses. But they still have just one body, which is why the other two companies are included. 

The past few years have seen incredible developments in medical science, and the next decade will see even more. Good health is one product of which we cannot have enough, and the two trusts chosen have so far been adept at satisfying this need.