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James Carthew: the challenge for Murray International investors

14 September 2020

It's just as well holders of Bruce Stout's global equity income trust are paid to wait with a high dividend yield as its positioning has been wrong in recent years.

Murray International (MYI ) is the largest of the global equity income trusts with a market value of £1.2bn, and the highest yielding at 5.5% compared to its AIC Global Equity Income sector average of 4.3%. 

However, its long-term returns are a long way behind those of rivals. Over 10 years, MYI has returned 6.7% a year, on average. Over a year, its return on net assets is almost 20% behind that of JPMorgan Global Growth and Income (JPGI ), for example. The shares stand on a 6% discount, wider than the 2% average of its six-strong peer group.

There is a material difference in the investment approaches of MYI and JPGI, however. MYI follows a traditional equity income style of seeking out companies with higher-than-average yields. JPGI invests in higher growth but lower yielding shares and makes up any shortfall in its revenue account by distributing capital.

Bruce Stout, longstanding manager of MYI, talked to investors and analysts recently following the publication of MYI’s interim report, which covered the first six months of 2020. Stout and MYI are trying to navigate many competing forces and the scale of this task should not be underestimated. 

These include: 

  • how best to manage an income fund;
  • value versus growth;
  • the depth and duration of the dividend recession;
  • inflation versus deflation;
  • and where best to invest your capital?

The first of these questions is encapsulated in the divergence in performance between MYI and JPGI. It is a topic that I have discussed here a few times and I won’t go into it again now except to say that it probably boils down to your views on value-style investing versus growth-style investing.

MYI is managed with a ‘growth at a reasonable price’ (GARP) style not a value approach. However, the requirement that companies should have attractive levels of dividend yield means there is a high overlap with value indices.

Value traps (companies that look cheap superficially but face insurmountable problems and are probably heading for oblivion) are proliferating as new technology makes whole industries obsolete. Covid-19 has probably accelerated that trend. The GARP approach and Aberdeen Standard’s overall emphasis on quality do mean that there is nothing in MYI’s portfolio that looks to me like an obvious value trap, unless you subscribe to the view that all oil companies fall into this category.

The portfolio’s exposure to the energy and basic materials sectors, while not excessive has been unhelpful recently. MYI’s underperformance is more about what it doesn’t own, however. The yield requirement excludes much of the technology and healthcare sectors, including the narrow group of companies that have been driving markets higher.

One of the side-effects of the Covid crisis has been much lower interest rates. These boost the valuations of growth companies valued on discounted cash flow models. They also weigh on investors’ expectations about the profitability of banks, which make up a substantial part of value indices. 

However, MYI looks to have an underweight exposure to banks in any case with none in the top 10 holdings and the largest bank holding being Oversea-Chinese Bank (headquartered in Singapore) and the next largest Brazil’s Banco Bradesco.

MYI’s Latin American equity exposure is still relatively high at 12.8% of the portfolio at the end of July. This has been a big drag on returns as Latin American markets have been held back by the region’s poor record of tackling the coronavirus.

Over the first six months of the year, dividend cuts and suspensions reduced MYI’s income by 14% year-on-year. Across the market, dividends are expected to fall by more than this so this perhaps evidence of MYI’s quality bias. 

Stout believes a dividend recession can have a more persistent effect on markets than an earnings downturn. In the latter case, investors tend to anticipate a profits recovery well in advance. However, once companies have cut their dividends, the fund manager’s experience suggests that they can take four or five years to restore to previous levels. This presents a real headwind for equity income managers.

Stout expects an uptick in inflation once the initial deflationary impact of lockdowns passes. Expansionist monetary policies and deglobalisatio and protectionism will play a part in that. He doesn’t think governments will return to austerity or try to raise interest rates. Companies with pricing power will cope best in this environment and he is factoring this into his stock selection.

MYI’s asset allocation is driven by Stout’s stock selection decisions but I think asset allocation has ended up having a significant role in MYI’s underperformance. Overweighting emerging markets and underweighting the US has been unhelpful. However, given that valuations are much higher in the US than they are in emerging markets and growth prospects for emerging markets are better, I wonder whether this stance may pay off eventually?

I am struggling to see an immediate catalyst for a renaissance in the fortunes of what was for many years a powerhouse in the sector. That does not mean that we should write it off. If you think it will come right at some point over the next couple of years, the trust’s yield pays you to wait.

James Carthew is a director at Marten & Co. The views expressed in this article are his and do not constitute investment advice.

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