Murray International Trust — Disciplined investment process

As shown in Exhibit 2 (LHS), in recent years UK equities have failed to keep pace with the world market (in sterling terms); this is partially due to domestic currency weakness following the UK’s European referendum in 2016. However, there are other reasons why investors may favour overseas equities, including higher growth opportunities and, compared to history, better prospects for dividend growth.

The broad-based equity sell-off in Q418, in response to tightening US monetary policy and an escalation in the US-China trade dispute, has led to more attractive company valuations. Although the US still looks relatively expensive (Exhibit 2, RHS), the Datastream World index is trading on a forward P/E multiple that is a 7% premium to its 10-year average; this is meaningfully lower than the c 20% premium before the Q418 stock market volatility. However, investors need to be vigilant: in an environment of macro uncertainties, slowing corporate earnings growth and the potential for further volatility in world markets, an increased focus on a company’s quality, earnings stability and valuation may be rewarded.

MYI is a well-established trust, launched in December 1907 and managed by Aberdeen Standard Investments. Since June 2004, the lead manager has been Bruce Stout, a member of Aberdeen Standard Investments’ global equity team; he has worked for the company (and its predecessors) since 1987 and has been directly involved with MYI since 1992. The manager aims to generate long-term capital growth (while preserving capital during periods of stock market weakness) and an above-average dividend yield from a globally diversified portfolio of equities and fixed income securities. There are no limits on geographic or sector exposure. Single holdings, at the time of investment, are limited to 15% of the portfolio and total gearing of up to 30% of NAV is permitted in normal market conditions (net gearing of 11.9% at end-February 2019).

The trust has a composite benchmark: 40% FTSE World UK and 60% FTSE World ex-UK indices; the high UK weighting is due to historical considerations, as in the past, other regions did not offer competitive dividend yields. (MYI’s UK exposure has declined from c 45% in 2004 to c 10% now.) Because of a change in the Financial Conduct Authority’s rules, whereby fund managers are required to explain their use of and adherence to benchmarks in the funds they manage, the board and the manager are considering if there is a more appropriate benchmark for MYI. This is deemed necessary due to the trust’s relative high exposure to emerging markets (more than 55% of the portfolio – held in both equities and fixed income securities). Given MYI’s focus on both capital- and income-derived returns, an inflation-based or absolute return (cash-plus) benchmark may be considered appropriate. Stout emphasises that whatever the trust’s benchmark is, he will continue to adhere to his index-agnostic investment process, seeking to both grow and preserve capital, while generating an above-average portfolio yield.

Reflecting on 2018, the manager says there were two key drivers to the global stock market: tighter US monetary policy and the rise of US protectionism, which particularly affected emerging markets, including their currencies, many of which are linked to the US dollar. The Federal Reserve has since adopted a more dovish approach, anticipating no interest rate hikes in 2019 and a slowdown in the reduction of its holdings in US Treasury bonds in response to stronger economic headwinds than previously anticipated. Stout says this change in stance is very positive for the interest rate cycles in the Asia Pacific and Latin American regions, where policy is much tighter than it would have been as a result of rising US interest rates and protectionism. The manager says that in selected emerging market countries, such as Indonesia and Mexico, levels of inflation are much lower than interest rates and if interest rates come down, it should be very positive for the performance of cyclical stocks, including consumer discretionary and financials.

In contrast, Stout is less enthusiastic about the prospects for developed markets, given the upcycle is now more than a decade old and there is increasing evidence of slowing economic growth, including in Europe and the US. However, the manager says that although the macro backdrop is interesting and can be influential, he continues to select stocks on a bottom-up basis, seeking companies that can consistently grow earnings and dividends. In general, he sees more attractive opportunities in emerging markets, where fundamentals are more ‘normal’ and there is a lack of headwinds such as excessive levels of debt, low consumer demand or a lack of policy flexibility. The manager believes that if developed economies slow, the impact on emerging market consumption will probably be modest, given most emerging market countries no longer have export-led economies.

Stout adheres to Aberdeen Standard Investments’ (ASI’s) house style, seeking high-quality companies that are trading on a reasonable valuation. Meeting company managements is a key feature of the investment process. The manager is able to invest in companies that are included on the ‘buy lists’ of any of ASI’s specialist regional fund management teams (UK, Europe, Asia Pacific ex-Japan, North America, Japan and emerging markets). As in-depth bottom-up stock selection rather than a consideration of macro factors is the key driver of MYI’s portfolio construction, individual share price performance rather than asset allocation should be the trust’s main value driver. There is a board requirement that MYI’s portfolio has between 45 and 150 holdings (there were 50 equities and 28 fixed interest investments at end-February 2019, which was in line with the prior year). The manager stresses that he invests without regard to benchmark allocations and is happy to invest across the market-cap spectrum. More than 55% of the portfolio is invested in Asia Pacific ex-Japan, Latin America and other emerging markets, as these are regions where Stout finds the best growth and value opportunities. His emphasis is on investing in defensive businesses where he has a high degree of confidence in a company’s ability to deliver earnings and dividend growth; essentially ‘buying good companies that are doing good things’. The process for selecting fixed income securities is the same as for equity investments, with the manager determining the relative value and prospects of each position. Initial equity investments are generally between 1.0% and 1.5% of the portfolio, while fixed income positions are generally smaller. To mitigate stock-specific risk, a holding will be trimmed within 30 days if it reaches 5% of the portfolio, and Stout is required to sell a holding within 30 days if it is no longer included in ASI’s regional ‘buy lists’. Portfolio turnover is very low, and many of the trust’s positions have been held for many years.

MYI’s portfolio breakdown is shown in Exhibit 3. Over the 12 months to end-February 2019, there have been modest changes in exposure, with the largest moves being a 2.8pp higher allocation to North America and decreased exposure to the UK (-1.6pp).

Stout says he is comfortable with the trust’s level of fixed income securities, which at 16.2% is towards the lower end of the 15–20% five-year historical range. MYI’s top 10 concentration was 31.4% at end-February 2019 (Exhibit 1), which was modestly lower than 32.8% a year earlier; eight positions were common to both periods, highlighting the fund’s low turnover.

During FY18 (ended 31 December), there were four new positions initiated:

The four stocks sold in FY18 were Mexican beverage company Femsa (investing for future growth rather than growing its dividend), Italian steel pipe manufacturer Tenaris (very long-term holding, but a competitive market) and small positions in European companies Casino and Engie (concerns about economic growth in the region and the sustainability of dividend growth).

In FY18, MYI’s NAV and share price total returns of -7.5% and -6.8% respectively trailed the benchmark’s -5.2% total return. Individual stock contributions were led by US exchange company CME group (+0.8pp) and Malaysia’s Public Bank and US telecom company Verizon (both +0.4pp), while the largest detractors were tobacco firms British American Tobacco and the US’s Philip Morris (-1.4pp and -0.9pp respectively), along with Chilean lithium producer Química y Minera (-1.2pp). However, of the overall 110bp portfolio underperformance (before costs), 90bp was due to asset allocation, with just 20bp due to stock selection.

Over the last three and 10 years, MYI has generated double-digit average annual total returns in both NAV and share price terms (Exhibit 4, RHS). On a relative basis, the trust has outperformed its composite benchmark in share price terms over three years, while lagging over one, five and 10 years (Exhibit 5). Its NAV has underperformed over these periods. MYI’s defensive qualities are shown in Exhibit 6, as it meaningfully outperformed its composite benchmark in the Q418 global stock market correction.

Following a de-rating during 2018 when MYI’s discount to NAV widened to 5.4%, its shares are once again trading at a premium. The current 3.0% premium to cum-income NAV compares with the 0.6% to 3.3% range of average premiums over the last one, three, five and 10 years.

Subject to annual renewal, MYI has authority to repurchase up to 14.99% and allot shares up to 10% of issued share capital to manage a persistent significant discount to ex-income NAV or a premium to cum-income NAV. The board believes it is in shareholders’ best interests to reduce the volatility in the trust’s discount or premium, while repurchasing shares at a discount and allotting them at a premium is modestly accretive to NAV. During FY18, 0.4m shares (0.3% of the share base) were allotted, raising £4.3m, while so far in FY19 0.7m shares (0.5% of the share base) have been allotted, raising £8.1m.

MYI is a conventional investment trust with one class of share; there are 128.8m ordinary shares in issue. The trust has £185m in debt, including a £60m, five-year facility with the Royal Bank of Scotland International (RBSI) at an all-in rate of 2.328%, which was taken out on 31 May 2018. MYI also has a £15m loan with RBSI that is due to mature in May 2019; the board is reviewing options to replace this facility. Total gearing of up to 30% is permitted in normal market conditions; net gearing was 11.9% at end-February 2019.

The trust has recently revised its management fee. With effect from 1 January 2019, 0.500% will be charged on net assets up to £1.2bn, with 0.425% of NAV above this level (previously 0.575% up to £1.2bn, 0.500% between £1.2bn and £1.4bn, and 0.425% above £1.4bn). The management fee is split 30% and 70% between the revenue and capital accounts respectively. In FY18, MYI’s ongoing charge was 0.69%, 5bp higher than 0.64% in FY17.

MYI pays quarterly dividends in August, November, February and May. The board employs a progressive dividend policy, meaning in years when the trust’s income is lower distributions will be supplemented from reserves. MYI’s revenue stream is affected by the strength or weakness of sterling; however, due to the complexities and costs associated with currency hedging, the board believes hedging would not be in shareholders’ best interests.

The FY18 proposed total dividend of 51.5p per share (0.96x covered) is 3.0% higher year-on-year, and while this increase is modestly lower than the 3.7% average annual compound growth rate over the last five years, it is higher than the rate of UK inflation over the period. At end-FY18, MYI had £73.6m in revenue reserves, which is c 1.1x the FY18 dividend payment. Based on its current share price, MYI is offering a dividend yield of 4.4%.

MYI is by far the largest trust in the AIC Global Equity Income sector (Exhibit 8). Its NAV total returns are above the mean over one and three years, ranking third out of seven funds in each period, while they are below average over five and 10 years. However, Stout is keen to stress that he does not consider how the peer group is performing; his sole focus is on MYI’s shareholders and delivering on the trust’s strategy of long-term capital growth (and capital preservation during periods of market weakness), while offering an above-average dividend yield.

MYI is one of the four peers trading at a premium; it has a competitive ongoing charge and an above-average level of gearing. Excluding Blue Planet’s double-digit dividend yield, MYI offers the highest yield in the sector, which is 0.7pp above the 3.6% (ex-Blue Planet) average.

There are six directors on the board of MYI, all of whom are non-executive and independent of the manager: Kevin Carter (appointed to the board on 23 April 2009, chairman since 28 April 2011); Peter Dunscombe (appointed on 29 April 2011, senior independent director since 26 April 2018); Marcia Campbell (appointed on 27 April 2012); David Hardie (appointed on 1 May 2014); Alexandra Mackesy (appointed on 1 May 2016); and Claire Binyon (appointed on 1 May 2018).

The board is planning for the future, as Dunscombe will retire at the 2020 AGM, with Hardie becoming the new senior independent director, while chairman Carter will retire at the 2021 AGM.