Peter Spiller and Alastair Laing, Co-managers of Capital Gearing Trust plc.
Capital Gearing Trust plc (“CGT”) has returned 16% per annum since 1982, the year the current investment manager was appointed. Despite these relatively strong returns, the portfolio has rarely been consciously positioned for growth; rather the focus has been on capital preservation and the compound return has taken care of itself. CGT is managed as if it is the most precious pool of capital in the world, not least because it is the most precious pool of capital for us. Materially all our investible wealth is allocated to the strategy, the only true way to align the interests of agent and principal. Unlike most investment trusts our net asset value (“NAV”) and share price cannot meaningfully diverge, as the directors actively manage any premium or discount. There is no point preserving capital in the portfolio only to give it up through a discount to NAV.
CGT’s approach to capital preservation places heavy emphasis on patience and discipline, rather than employing hyperactive trading or relying on incomprehensible financial instruments. For much of the last 20 years CGT has been well served by the simplest of strategies, buying and holding long duration government bonds and largely eschewing consistently overpriced equity markets.
Sadly capital preservation in the current environment presents a very significant challenge. How should investors allocate their capital when both equity and bond markets are simultaneously overvalued? In our view the key is to adjust expectations and be prepared to wait for value to re-emerge. Our current ambitions stretch no further than keeping the real value of investor’s capital intact and waiting until compelling opportunities remerge. In practice this means a majority of the portfolio is invested in a range of short duration fixed income assets, offering a small but welcome real yield. Alongside these defensive assets sits a limited diversified portfolio of equities that is tilted towards actively managed UK small capitalisation stocks.
There are two good reasons to think that patience will be rewarded. Firstly there have been no historical examples of risk assets being sustained at current elevated valuation levels. Secondly, there appears to be a deep contradiction in investor assumptions that can be inferred from bond and equity prices. Global equity prices can only be justified if current record levels of corporate profitability are sustainable. This is at odds with very low long bond yields, which discount anaemic global economic conditions for decades to come. Anaemic economic conditions are not compatible with high corporate profitability; something is going to have to give. Historically bond prices have been the more reliable economic forecaster, however given huge central bank intervention in the financial markets nothing can be taken for granted. Only time will tell which group of investors will be left nursing the heaviest losses but it seems likely that medium term returns will widely disappoint investors in risk assets.
In the meantime our job is to try to ignore the extraneous noise and steward our precious pool of capital until asset prices once again suggests double-digit returns can be achieved without excessive risk. We look forward to that future opportunity but the journey from here to there will be a challenge. Our hope is that good things come to those that wait.