Europe has once again failed to take off in any meaningful way, held back by the deflationary discipline of the eurozone. Even the German powerhouse is stuttering as its pre-eminent car-making business is hit by the double whammy of a dying diesel business and the complexities of the electric and self-driving future.
China itself is discovering the difficulties of switching from an export-orientated economy to one focused on consumer demand, as well as much lower saving rates. This extremely difficult transition is not helped by a US trade war, as well as the poor feedback mechanisms in its command and control economy. And much of the rest of the world is either enmeshed in war or trade sanctions of their own.
Economic growth and stock markets
Fortunately, there is no direct correlation between economic developments and stock market success, so equity markets are still riding high, even if extreme events – akin to those taking place in relation to the climate – are happening more frequently as investors become more nervous.
As quantitative easing is replaced by tightening, the expansion of low-quality bond issuance may become more difficult. For the moment, however, there is no liquidity crisis; there is nervousness but no fear.
This could all change if politicians make mistakes, as seems all too likely with the Brexit endgame now approaching. If they do, then British investors will face an old enemy – inflation.
Those with memories of the 1960/70s and pre-EU Britain will recall how difficult it was to eradicate inflation from a not particularly competitive economy.
Even with an agreed exit from the EU – currently looking less and less likely – the chance of temporary shortages and rising prices as trade connections of more than 40 years standing are broken or disrupted are high. With no deal at all this becomes a major risk.
Inflation risks
Consequently, UK investors must remain invested in equities, with their rising incomes, but not in British companies. Even this government accepts that Brexit will be bad for GDP, and it seems unlikely that the exchange rate can remain at current levels.
None of this can be good news for the FTSE, so my anti-Brexit portfolio (outlined in Table 1) is designed to keep the ‘best of British’ while reducing equity exposure to the country. These are all low-cost investment companies invested in the disruptive industries of the future; their small UK exposures should comfort the investor but concern the more gung-ho Brexiteer.
Table 1: An anti-Brexit portfolio update
Investment company | Initial investment at December 31 2018 (£) | UK exposure (%) | YTD share price total return (%, to February 8) |
Witan | 25,000 | 33.5 | 3.6 |
Alliance Trust | 25,000 | 15.1 | 5.4 |
Personal Assets | 15,000 | 10.1 | 0.8 |
Scottish Mortgage | 15,000 | 3 | 3.6 |
Worldwide Healthcare | 10,000 | 0 | 8.4 |
Polar Capital Technology | 10,000 | 1.4 | 8.7 |
FTSE All-Share | n/a | n/a | 4.2 |
MSCI World index | n/a | n/a | 3.8 |
Source: AIC/Morningstar. Copyright: Money Management
Investment that works
Yet for those who think that Brexit presages a glorious future for global Britain, there are plenty of alternative choices among investment companies.
This year alone five members of the Association of Investment Companies celebrate 130 years of successful life, while two reach their 110th birthdays. The five are Merchants, Edinburgh, British Empire, Law Debenture and BMO Global Smaller Companies; the two are Scottish Mortgage and Witan.
What is the DNA of investment companies that keeps them successful for centuries - when their modern descendants, such as unit trusts, pension fund managers and exchange-traded funds, come and go within decades?
Investment company history (all 150 years of it) suggests the answer is the Victorian and Edwardian insistence on a better-than-average income, combined with the capital security of international diversification. Initially this philosophy was spread throughout the empire; today it is everywhere.
Shareholders demanded simple structures to achieve this: a board of directors responsible to shareholders for meeting their needs, and an investment manager directly responsible to the board for achieving these investment aims.
These investment objectives were met initially through bonds, but as the years went by equity investment first became respectable and then necessary. However, the need for regular annual income never went away, and so while capital growth was appreciated by managers and investors alike, it never became the be-all of investment policy. That remained an annual income – itself a growing income to compensate the risk involved in equity investment.
This strategy has paid off in the number of AIC dividend heroes – investment companies that have increased their dividends every year for more than 20 years consecutively, and some for even longer.
Income and compounding
Recent research, discussed in this column over the past two issues, shows how vital this is.
The number of companies that have been successful in terms of producing above-average capital growth is a very small percentage of the total, so finding them is something of a lottery.
But income from treasury bills is regular, certain and compounds quickly, certainly compared with the irregular dividend income and capital growth from the typical company. This is where the planned and higher annual income of an investment company can pay off for the patient investor.
The anti-Brexit portfolio in Table 1 shows an expected annual income based on forecast dividends that are close to those of the FTSE All-Share index. Although one month is nothing to go on, the overall performance shows a good beginning both in percentage and cash comparisons.
Globalisation and regionalisation have worked well for the world since 1945, and Brexit appears to be a return to a simpler and less profitable world. This portfolio is based on a belief that Brexit is bad for Britain.
These figures will be updated monthly so that this belief can be tested over the coming year.
