The trusts that should prosper in a bear market

Market veterans who manage ‘stay-rich’ rather than ‘get-rich’ trusts have positioned portfolios to weather forecasts of a nasty setback.

On Monday 25 June, when global stock markets took a sharp turn south, the declines were attributed to the ongoing tariff spats between president Trump, China and other countries crossing his line of fire.

Many fretted that these steep declines could serve as the catalyst for the ‘Big One’, a collapse in global equity markets that could signal recession, or worse. But others saw the falls as nothing more than the usual pattern of summer volatility. Nonetheless, that week, the tremors caused investors to pull $29.7 billion (£22.4 billion) from global equity markets, the highest figure since February.

Those who predict the Big One are many. Crispin Odey, the UK hedge fund manager, warns of a coming recession ‘they’ll be talking about in 100 years’. Jonathan Ruffer, head of the eponymous fund management group, expects ‘an earthquake within months’, and Mark Mobius, the acclaimed emerging markets veteran, feels markets could fall by 30 per cent.

Dollar pincer

Sir Jon Cunliffe, Bank of England deputy governor, expressed fears in July that when the US ‘normalises’, the dollar will strengthen and emerging markets companies that borrowed in dollars will be caught in a pincer of rising exchange and interest rates. The Bank for International Settlements’ latest survey pointed to solid global expansion; but the longer it goes on, the greater the danger of a calamitous outcome: and the WTO now warns of a slowing in world trade, partly because of the scrap over tariffs.

Mix today’s stretched equity valuations with unprecedented levels of debt, plus a near-10 year bull market and the result is a dangerous cocktail.

Mobius, now 81 and showing the same verve as fellow octogenarian Warren Buffett, was probably the most feted emerging markets manager during his 30 years with fund management group, Templeton. He might have chosen a more propitious time to launch his own group, Mobius Capital Partners, given the coming shocks he predicts. The outcome, he feels, ‘will not be as bad as 2008/09, but investors have to be ready for it.’

Potential economic woes aside, he thinks exchange traded funds will be the villains. ‘They are now a huge part of assets under management, about half the market. They are forced to buy and sell depending on what the markets are doing. When they fall, you could get a snowball effect that can turn into an avalanche.’

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Higher US interest rates are a different threat. The US Federal Reserve places full employment alongside gradual inflation as its priorities, Mobius says, and plain people receiving scant returns on their savings will welcome better rates. ‘These people are Trump’s constituents. And if investors can get 4 or 5 per cent on savings, people are not going to risk money on ventures with no earnings. Yet many companies in the tech sector have raised money with no earnings to back it up. Some could hit the skids.’ Higher US interest rates will have significant impact around the world and the currencies of a lot of emerging markets countries have already weakened on the prospect of a rise, he says. ‘The reaction is to raise interest rates to protect your currency.’

Investment trusts best equipped to ride forecast storms are those that now focus on wealth preservation: stay-rich trusts, not get-rich trusts. With their multi-asset portfolios, they are sidelined in bull markets but show their value in bear markets. Today, with concerns mounting, the best-known of these command a premium to net asset value; this is the price of perceived safety. They include Capital Gearing, Personal Assets, RIT Capital and Ruffer Investment Company.

Personal Assets (PNL) executive director, Robin Angus, a man who carries gold coins in his pocket and has silver bars by his bed, has been predicting danger for years. He was spot on well ahead of the 2008/09 crisis. Now, he says: ‘No equity is worth buying. Everything is too expensive. We are compelled to be fully invested and have just 38 per cent in equities. The rest is in index-linked US treasury bills, UK T-bills, index-linked gilts, gold bullion and cash.’ The equity portfolio is overwhelmingly blue-chip, with a trans-Atlantic twist.

Angus points out that Personal Assets is not anti-equities. ‘In the mid-1990s the portfolio was 90 per cent equities. Our priority is wealth preservation, and right now equities are too dear. I can’t predict when it [the global equity shakeout] will happen or what will cause it. It could be another of president Trump’s stupid ideas. I have no idea. But we have to be ready for it. First, I expect increased market volatility and this will lead to an increased state of nervousness. The camel’s back is overloaded with worry. Something will come along: the final straw that breaks it.’

Heady premium

In early July PNL shares were quoted at a modest 0.8 per cent premium to net asset value, whereas RIT Capital Partners (RCP) commands a heady premium of 8.5 per cent. RCP, in which Lord (Jacob) Rothschild invests much of his family’s personal wealth, has an unusual asset mix. Equities, with a good exposure to US and Chinese technology stocks, account for more than 40 per cent of assets, and around 20 per cent is in private investments. One recently sold was Acorn, one of the world’s largest coff ee businesses.

Much of the balance is in hedge funds and other fund vehicles that are less familiar to most investors, such as distressed credit and relative value credit. RCP’s latest half-year report is due imminently.

Peter Spiller is manager of Capital Gearing (CGT), a trust with one of the best long-term records, which today sells on a premium of 1.6 per cent. In the aftermath of the 2008/09 crash it once exceeded 17 per cent. The market’s end-June slump, he says ‘is a mere flea bite compared to what is coming’. Spiller, whose mantra is safety and value, has for years predicted mayhem and severe inflation. ‘There is no precedent for today’s conditions,’ he says. ‘The only thing worth buying that holds real long-term value is US Tips [Treasury inflation-protected securities]. The amount of global debt is so high that one thing the US [and other indebted economies] cannot afford is recession. I’m pretty confident that in the short-term they will start printing [money] again.’ Quantitative easing has distorted the price of all financial assets, he says. This is now ending and the prosperity of the past seven years will come at a price.

Spiller makes no excuses for being only partly invested in equities during this remarkable bull phase. ‘All I can say is that we have produced 15 per cent compound returns for the past 36 years and the reason for this is that we don’t care about timing. We have been in index-linked [securities] for seven years; the important thing is to own them.’

Spiller says that in 1982, when he launched Capital Gearing, all monies went into equities as ‘everything was cheap, balance sheets were strong and inflation was high but falling. Everything is the opposite of today. It’s now all about preserving wealth.’

Spiller has identified some individual companies that he believes offer reasonable value, particularly a German company, Vonovia, which invests in Berlin residential property. ‘Values there are below replacement costs,’ he says. He has also bought a similar company in Sweden – Castellum, which owns properties in Gothenburg, Malmo and Stockholm. In the UK, he holds two property concerns: Grainger, one of the UK’s largest professional landlords, and Unite Group, which focuses on student accommodation, which he says ‘has a terrifi c record’.

In total, property now accounts for 14 per cent of CGT’s investments. Other corporate themes include ‘green’ equities. He owns Greencoat UK Wind and another renewable energy enterprise, Foresight Solar. The largest ‘risk asset’ cluster is ‘lots and lots of investment trusts’. In total, risk assets account for 40 per cent of the total. The balance is represented by Tips, other index-linked government securities and quasi-cash.

‘We bought trusts where we thought the discount would reduce or disappear and we have been quite active behind the scenes to make sure those things happened.’ However, Spiller adds: ‘We have done exceedingly well but there are now not a lot of opportunities for arbitraging the discounts. Many trusts are just not biddable.’

He worries that a market slump would lead to discounts widening again and doesn’t think private investors are aware of this danger.

‘I don’t want to see discounts widen again, and directors need to be reminded of their responsibilities. I regard trusts as terrific investment vehicles,’ he says, stressing that ‘any return to wide discounts would damage many investors and represent a major setback for the industry.’

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