Insight

Valuation is key: James Goldstone’s Investment Trust outlook

James Goldstone’s Investment Trust outlook
James Goldstone’s Investment Trust outlook

We had witnessed a torrid few years of Brexit negotiations ending with the general election delivering a political majority in 2019 and a date for the transition period written into law.  With the prospect of a more stable situation in Westminster and a marked shift in ‘soft’ economic data (based mostly on sentiment surveys), there had been clear grounds for greater optimism in the UK equity market. However, Covid-19 has delivered the market shock that no one could have foreseen, and this downturn is likely to be the worst in 100 years. 

The scale and the speed of economic decline is already unprecedented. The UK economy shrank by a record 5.8% in March as the lockdown to contain the spread of the coronavirus pandemic took its toll. Estimates of Q2 GDP range from -15 to -40%, but rather than focus on the depth of the downturn this year, I find myself asking if next year could see the sharp resumption of economic growth that consensus forecasts suggest.

The fiscal and monetary response has been hugely decisive and has represented an intervention by the authorities on a historic scale ($16 trillion, or 40% of global GDP, as at 12 April, and now nearer $20 trillion, see Figure 1). In my view, this could encourage the stabilisation of economic activity in the second half of 2020 and the resumption of economic growth in 2021.

The amount global stimulus has been breath-taking and we believe there is more likely to come
The amount global stimulus has been breath-taking and we believe there is more likely to come
Source: Cornerstone Macro as at 12 April 2020.

This outlook for the economy, however, has delivered chaos for financial markets. In terms of investment styles, prior to the pandemic, Value investing (buying stocks that appear to be trading for less than their intrinsic value) had already been under an enormous amount of pressure. It had underperformed Growth (stocks which are showing signs of above-average growth) on a rolling 10-year basis - the longest period of Value underperforming in a 100-year period. The impact of the virus and the lockdown has made this juxtaposition even more pronounced. It’s clearly been a difficult period for portfolios anchored in value, as well as a headwind for the UK equity market as a whole. 

How I’ve been evolving Keystone Investment Trust plc and Invesco Perpetual Select Trust plc (UK Equity Share Portfolio) in reaction to the unfolding pandemic

There are five themes within my investment trusts and together, UK Domestic Value and International Value account for 65%, which means the portfolios are anchored in Value. Gold names account for around 15%, with UK Mid-Cap Growth and Special Situations making up the remainder (as at 6 May 2020).

In recent weeks I have been repositioning my investment trusts in order to mitigate risk. As such, I have sought to create a 50/50 balance between ‘defensiveness’ and exposure to risk – though I acknowledge that they are very subjective definitions. There is risk in both directions, clearly downside risk if this lockdown persists and if the economic rebound takes longer than anticipated. There is upside risk too in terms of antibody tests and the hope of a vaccine. I believe it’s important that my investment trusts are balanced so as to not be unduly affected by one outcome or the other.

My biggest sector allocation is to Utilities, and in terms of Financials, the investment trusts have holdings in Barclays and RBS, though they are underweight relative to the FTSE All-Share index, and with a modest exposure to insurance companies. My Basic Materials exposure is a large overweight position relative to the FTSE All-Share index and is almost entirely weighted in four North American gold mining companies.

I have two reasons for holding the exposure to gold miners: 1. The historical inverse correlation between the gold price and equities. In times of crisis, equities tend to fall, and gold goes up. So, for general diversification purposes this has felt very appropriate to me and it has been borne out in recent weeks. Gold mining companies are geared to the gold price so their shares have performed very strongly. 2. Concern over levels of government indebtedness.

I’ve also been thinking about the implications for income. There’s no income mandate on either investment trust but since I’ve been running them (Invesco Perpetual Select Trust plc UK Equity Share Portfolio since October 2016), and Keystone Investment Trust plc since April 2017), they’ve both had a pretty respectable level of dividend yield. As companies look to shore up their balance sheets, we’ve already started to see them reduce dividend payouts (see Figure 2, which shows the impact on the FTSE 100 taking last year’s dividend and expressing those as a yield divided by the share prices on 30 April 2020). Royal Dutch Shell, for example, announced its decision to cut its dividend by two thirds (the first time it’s cut its dividend since the second world war). 

What would the FTSE 100 yield be, based on last year's dividends, adjusting for dividend cuts announced in 2020 to date?
What would the FTSE 100 yield be, based on last year's dividends, adjusting for dividend cuts announced in 2020 to date?
Historical Yield 5.52%
Implied current yield 3.55%

Source: Bloomberg as at 30 April 2020. *Implied Current Yield is subject to change should further dividend cuts or suspensions be announced.

What lies ahead?

I believe that the combined fiscal and monetary package means that we are at a major turning point and that it has the potential to fundamentally change the attractiveness of equities versus corporate bonds. Within equities, the biggest fiscal and monetary stimulus package in history also has the scope to change the attractiveness of certain investment styles. If it generates inflation, that inflation is expected to be a rising tide that lifts all boats and it could ultimately be very positive for Value investing versus Growth. 

Investment risks

  • Keystone Investment Trust

    The value of investments and any income will fluctuate (this may partly be as a result of exchange rate fluctuations) and investors may not get back the full amount invested.

    When making an investment in an investment trust you are buying shares in a company that

    is listed on a stock exchange. The price of the shares will be determined by supply and demand. Consequently, the share price of an investment trust may be higher or lower than the underlying net asset value of the investments in its portfolio and there can be no certainty that there will be liquidity in the shares.

    The product uses derivatives for efficient portfolio management which may result in increased volatility in the NAV.

    The product invests in smaller companies which may result in a higher level of risk than a product that invests in larger companies.

    Securities of smaller companies may be subject to abrupt price movements and may be less liquid, which may mean they are not easy to buy or sell.

    The use of borrowings may increase the volatility of the NAV and may reduce returns when asset values fall.

    As a result of COVID-19, markets have seen a noticeable increase in volatility as well as, in some cases, lower liquidity levels; this may continue and may increase these risks in the future. In addition, some companies are suspending, lowering or postponing their dividend payments, which may affect the income received by the product during this period and in the future.

     

    Invesco Perpetual Select Trust (UK Equity Share Portfolio)

    The value of investments and any income will fluctuate (this may partly be as a result of exchange rate fluctuations) and investors may not get back the full amount invested. This applies to all four share classes.

    When making an investment in an investment trust you are buying shares in a company that is listed on a stock exchange. The price of the shares will be determined by supply and demand. Consequently, the share price of an investment trust may be higher or lower than the underlying net asset value of the investments in its portfolio and there can be no certainty that there will be liquidity in the shares.

    The products use derivatives for efficient portfolio management which may result in increased volatility in the NAV.

    The Invesco Perpetual Select Trust plc UK Equity Share Portfolio invests in smaller companies which may result in a higher level of risk than a product that invests in larger companies. Securities of smaller companies may be subject to abrupt price movements and may be less liquid, which may mean they are not easy to buy or sell.

    The Directors intend that each portfolio will effectively operate as if it were a stand-alone company. However, prospective investors should be aware that in the event that any of the portfolios have insufficient funds or assets to meet all of its liabilities, such a shortfall would become a liability of the other portfolios. In addition, should the investment trust incur material liabilities in the future, a significant fall in the value of the investment trust’s assets as a whole may affect the investment trust’s ability to pay dividends on a particular class of share portfolio, even though there are distributable profits attributable to the relevant portfolio.

    The use of borrowings may increase the volatility of the NAV and may reduce returns when asset values fall.

    As a result of COVID-19, markets have seen a noticeable increase in volatility as well as, in some cases, lower liquidity levels; this may continue and may increase these risks in the future. In addition, some companies are suspending, lowering or postponing their dividend payments, which may affect the income received by the Invesco Perpetual Select Trust plc UK Equity Share Portfolio and the Invesco Perpetual Select Trust plc Global Equity Income Share Portfolio during this period and in the future.

     

Important information

  • This document is marketing material and is not intended as a recommendation to invest in any particular asset class, security or strategy.

    Regulatory requirements that require impartiality of investment/investment strategy recommendations are therefore not applicable nor are any prohibitions to trade before publication. The information provided is for illustrative purposes only, it should not be relied upon as recommendations to buy or sell securities.

    Where individuals or the business have expressed opinions, they are based on current market conditions, they may differ from those of other investment professionals and are subject to change without notice.

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