While a buoyant economic climate may encourage investors, high valuations and geopolitical uncertainty warrant caution.
Nevertheless, there are ways to navigate uncertainty.
- The economic and political order is changing, at the same time as technology is disrupting existing businesses.
- Stock market valuations leave little room for error
- Finding businesses with resilient business models, run in a sustainable way should give greater predictability
On the face of it, there is much for investors to be happy about in the current climate. Global economic growth is moving higher, fuelled by tax cuts in the US and the increasing strength of China. Investor confidence remains buoyant and markets continue to achieve new highs. However, all this exuberance should give investors pause for thought.
January’s meeting of global economic and political leaders in Davos highlighted the fragility of the existing trade and economic order. Global leadership is shifting and trade relationships are being redrawn. Technology is having an increasing influence, disrupting businesses and changing the way people and companies interact. These changes have potentially far-reaching implications for companies, as they adjust to this new world. Not all will thrive in this new environment.
At the same time, stock market valuations leave little room for error. Prices have moved up a long way and on a variety of metrics, look expensive. Although there is no immediate catalyst for markets to fall – interest rate rises are likely to be gradual and moderate – as investors, we need to ensure that we are prepared for a changing environment.
As we see it, there are a number of ways to manage this shift. The first is to find high quality, resilient companies that can withstand long-term changes. This means looking beyond the next quarter’s earnings, or shorter-term difficulties to a company’s longer-term prospects and sustainability.
This sustainability takes a number of forms. First it is the sustainability of the business itself. Quite simply, can it continue to sell its products into the future? At the moment, this means looking for those companies that are not likely to be buffeted by the current political environment. For example, having globally diversified revenues, including revenues from growing markets provides some defence against the political uncertainty in the UK. Equally, companies on the right side of technological change will prove more resilient.
It also means holding companies in a variety of business areas to ensure that we are not over-exposed to one particular area. These are uncertain times. For example, at the moment we have around 15% of the portfolio in overseas companies. In this, we strive to find those sectors that are not well-represented in the UK, such as technology names, to build diversity into the portfolio.
The businesses in which we invest must also operate in a sustainable way. This means not taking on excessive debt, being prudent in their acquisition strategy and using capital effectively. In judging this, we look at metrics such as return on assets, and operating margin. We believe these are more accurate indicators of inherent business strength than sales growth or operating margin.
It also means durability of dividends. We like companies that have the cash flow and stability to grow their dividends over time. At the moment, there is a wider problem in markets, whereby companies are continuing to increase dividends without the earnings to back them up. We want to ensure that companies are growing dividends from earnings. On the trust, we have built up dividend reserves and now have the equivalent of around 80% of the annual dividend. This is helpful in ensuring consistency of income for our shareholders.
Increasingly, we find this sustainability and quality further down the market capitalisation spectrum. This year, that has included investing in mid-cap companies such as property groups Asana and Big Yellow, plus Manx Telecom and Croda. Within the property groups, we find more companies that are ‘all weather’ among the mid-caps, less exposed to the individual property cycles of, say, London or the retail sector. There is also better dividend growth in the mid-caps.
In this environment, we also want to ensure that companies take governance seriously. Managing a company responsibly and sustainably is becoming more important for shareholders, and as such, is more influential for share price returns. This is part of our analysis for all companies in the trust. We do it as an investment team, rather than outsourcing it to proxy providers – that way we can focus on what we consider to be most important.
Finally, just as we would not overpay for the investments in our portfolio, keeping our costs low on the trust is important. At 0.25%, we now have the lowest non-index marginal rate of any investment trust.
Overall, although the economic environment is benign, a lot of good news is already priced into stock markets today. On a lot of measures markets look expensive relative to their long-term averages. There are also still worries over Brexit, over changing patterns of trade, over an increasingly interventionist industrial policy. All of these factors may influence share prices in the short-term. However, we believe that the strongest companies can still thrive in this environment. They just have to be chosen with care.
The Murray Income trust aims for high and growing income with capital growth, by investing in a diverse portfolio of companies with the potential for earnings and dividend growth. We focus first on quality, then price, measuring a company’s potential on the strength of its management team, its cash flow and balance sheet. We strive to build a diversified portfolio that will be resilient in all market conditions.
Risk factors you should consider prior to investing:
• The value of investments and the income from them can fall and investors may get back less than the amount invested.
• Past performance is not a guide to future results.
• Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.
• The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company's assets will result in a magnified movement in the NAV.
• The Company may accumulate investment positions which represent more than normal trading volumes which may make it difficult to realise investments and may lead to volatility in the market price of the Company's shares.
• The Company may charge expenses to capital which may erode the capital value of the investment.
• Derivatives may be used, subject to restrictions set out for the Company, in order to manage risk and generate income. The market in derivatives can be volatile and there is a higher than average risk of loss.
• There is no guarantee that the market price of the Company's shares will fully reflect their underlying Net Asset Value.
• As with all stock exchange investments the value of the Company's shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.
• Certain trusts may seek to invest in higher yielding securities such as bonds, which are subject to credit risk, market price risk and interest rate risk. Unlike income from a single bond, the level of income from an investment trust is not fixed and may fluctuate.
• Yields are estimated figures and may fluctuate, there are no guarantees that future dividends will match or exceed historic dividends and certain investors may be subject to further tax on dividends.
Other important information:
Issued by Aberdeen Asset Managers Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Registered Office: 10 Queen’s Terrace, Aberdeen AB10 1YG. Registered in Scotland No. 108419. An investment trust should be considered only as part of a balanced portfolio. Under no circumstances should this information be considered as an offer or solicitation to deal in investments.
Find out more at www.murray-income.co.uk