InvestmentsApr 30 2019

Russell Taylor: Investment trusts as a play on Brexit

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Russell Taylor: Investment trusts as a play on Brexit

The anti-Brexit portfolio seems to be holding its own, despite the increasing fears that world growth is stuttering. 

Optimists can make a case for the UK, too. Public finances are sound, employment is high, consumer demand is solid enough and tax receipts (especially VAT) are buoyant.

Economists v politicians

The country’s principal economic forecasters, from the Office for Budget Responsibility to the Bank of England, are all convinced that Brexit will seriously affect the country’s future growth and economic prosperity. But no one really believes these gloomy predictions, and certainly not politicians. The sun is still shining, the rain clouds are far away, and the roof seems watertight.

In the meantime, the questions of Brexit are enmeshed in abstruse questions of parliamentary procedures, of interest only to constitutional lawyers, and the complaints of business people have yet to lead to wide-scale redundancies, or empty supermarket shelves. 

At the time of writing, we know that UK law means the UK will leave the EU within just a few days on April 12, but again no one believes that will actually happen. Some form of words will magically pop up to delay decisions yet again.

The bull run goes on

In stock markets, the band plays on. However fearful some investors may feel, this 10-year-old bull market is still running. Over the past three months, the MSCI is up by 7.7 per cent and the FTSE by 9.4 per cent, while the anti-Brexit portfolio I have discussed in recent months has increased in value by 10.2 per cent (see Table 1). 

Table 1: Anti-Brexit portfolio update

Investment company

Initial investment as at end-December (£)

YTD share price total return, to end-March (%)

Dividends per share paid, to end-March

Yield (%)

Witan

25,000

8.9

0

2.5

Alliance Trust

25,000

9.9

3.389

1.8

Personal Assets

15,000

4.3

140

1.4

Scottish Mortgage

15,000

11.8

0

0.6

Worldwide Healthcare

10,000

15.3

0

0.6

Polar Capital Technology

10,000

15.6

0

0

Total portfolio performance

100,000

10.2

1.44

FTSE All-Share

n/a

9.4

n/a

n/a

MSCI World index

n/a

7.7

n/a

n/a

Source: AIC/Morningstar. Copyright: Money Management

This portfolio has some advantages compared with the indices. The income yield based on quarterly dividends alone is 1.66 per cent, while two of the companies in the portfolio are ‘dividend heroes’ of the Association of Investment Companies and are expected to increase dividends substantially this year. The portfolio’s yield compares with annual yields of 2.21 per cent for the MSCI and 4.22 per cent for the FTSE.

These are some of the advantages of investment trusts for private investors. Most are focused on specific markets or sectors but are formed under company law, so that the investment manager knows, from day to day, the amount of funds that he has to manage. 

This is a much simpler task than that of the open-ended fund manager, subject to regular inflows and outflows. Such strategies, whether Oeics or unit trusts can be forced to liquidate strategically valued holdings if market panics affect their investors. But the only way out of an investment company is to sell the shares in the market.

Protecting the downside

Another valuable right for trusts is the ability to keep back earlier-year profits as company reserves. These profits can then be mobilised as extra cash for dividends in bad years – and stable dividend income is something that nearly all investors should crave. 

Stability of income underpins stable capital values, and this is the absolute difference between investment companies and open-ended funds.

Because investment trusts were created well before computer-generated theories of investment behaviour, managers developed their own style of investing. 

Like Bill Gross in his glory days at Pimco, they identified bonds with higher yields but in reality lower risk, and did the same with equities when they became respectable in the early 20th century. Portfolios with above-average and recurring income generate high compounded returns; this is the only sure way to make capital gains.

It is also a way of avoiding market disasters. No method of investing in stock markets can avoid human and market panics, dishonest managers, or physical disasters that destroy assets – whether through wars, volcanoes or floods. This is what ‘risk’ really means. Compare and contrast with the near certainty that the UK or the US will eventually repay their debts, albeit via an inflation-depreciated currency.

But no risk also means no reward, and the object of investment is to balance risk against reward. Investment trusts concentrating on stable and growing income is the most certain way for the private investor to achieve that end, with some of the AIC’s investment heroes achieving more than 20 years of annual increases in their dividend payouts.

Appreciating economic reality

A report from the Cabinet Office, leaked to the press at the end of March, suggested that the economists’ analysis of a no-deal Brexit was all too true – an immediate depreciation of sterling, a 10 per cent increase in food prices, and further slowing of GDP growth compared with our neighbours, in addition to the loss of more than 2 per cent (relative to non-Brexit levels) seen since the June 2016 referendum. 

This may have been intended to put pressure on the cabinet to vote for the prime minister’s withdrawal deal, or simply to protect civil servants when Brexit turns out to be closer to the predictions of economists than those of Brexiteer believers. 

Because the referendum succeeded on the basis of lies, and the negotiations for exit quickly turned into nationalist, anti-foreigner sentiment, there will be a political reckoning. That remains the case whatever happens: Brexit or no Brexit; an economically successful Brexit, or a return to the economic ignominy of the immediate post-war years – which, of course, was the reason the country joined the EU in 1973.

But some are convinced that leaving the EU means a new economy and prosperity for Britain. Since the future can never be foretold, but only dimly predicted, Brexiteers should back their beliefs by buying investment trusts concentrated on British assets. 

A recent AIC release identified 22 trusts on track to achieve dividend hero status – 20 consecutive years of dividend increases. All have between 10 and 20 years of regular dividend rises, and many of them specialise in smaller UK growth companies.

If the true believers are wrong, and the pessimists right, these investment companies will reduce their losses.