Bruce Stout, Martin Connaghan and Samantha Fitzpatrick – all Investment Managers at Murray International Trust PLC – on their approach now that inflation is nearing its highest level in close to forty years.
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Inflation looks increasingly embedded, as wages rise
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Stock market leadership is concentrated in fewer and fewer companies
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We are responding with diversification, differentiation and a focus on real assets
UK Retail Price Inflation recently hit its highest level in close to forty years, with the Office for Budget Responsibility suggesting it may continue to climb for the first half of 2022. This is a challenging environment for companies facing rising input costs, but also for investors, who may find that the strategies that have served them well in recent years are notably less effective.
The inflation problem may also bring a market problem. Stock markets have showed considerable momentum, with 17 new highs for the S&P 500 this year. However, market leadership is increasingly concentrated in fewer and fewer companies, mostly a group of high growth technology names. These names are the most vulnerable to higher interest rates should inflation prove persistent.
At Murray International, we do not want to expose our investors to extremes. It is in this type of environment that an active, diversified approach comes into its own, allowing us to side-step the vulnerable ‘heated’ areas of the market, focusing instead on those companies that can continue to thrive in this environment.
Differentiated and diverse
Avoiding the concentration in the index is a key priority for the Trust. The MSCI World currently has over two-thirds of its value in North America and almost a quarter in technology. This lack of diversification is particularly problematic at a time when those areas appear highly valued and vulnerable to higher interest rates.
In contrast, the Murray International portfolio has a significant spread of over 25 different geographies represented. As an example, we have just 27% in the US, and a vastly higher weighting (28%) in Asia, where we see stronger growth emerging.
A greater priority is to find different businesses doing different activities. Our portfolio has semiconductor businesses, alongside pharmaceutical groups, chemical companies, mobile operators and consumer goods companies. These are companies with strong assets that can pass on rising input costs to their end customers.
A focus on real assets
The skills needed from a corporate management team in an inflationary environment are very different to that needed in a deflationary environment. For example, we see many companies cutting prices to maintain market share. In a deflationary environment, this might work, but it can erode margins quickly at a time when prices and wages are rising.
To protect against inflation, we have chosen to focus on real assets in Murray International, where there is intrinsic value. Those assets may be a 5G network in Indonesia, a gas pipeline in the US, or an airport in Mexico. These companies aren’t as impacted by higher wages because their asset base is a greater part of their valuation. They should avoid the squeeze of higher wages. Equally, their valuation is more transparent, based on assets they hold today, rather than the promise of growth tomorrow.
The Trust’s largest holding is Taiwan Semiconductor (TSMC). It takes significant capital and commitment to build semiconductor plants, but once they have been established, they are a powerful asset. Semiconductors are needed in more and more areas of life – from electric cars, to the “Internet of Things”, to Artificial Intelligence (AI) applications. TSMC has built significant manufacturing capacity, which gives it a technological and competitive edge.
The market continues to undervalue these assets across many sectors. While it will assign a high valuation to, for example, a cellular communications tower, it has not been willing to do the same with a 5G network. The market is not yet prepared to acknowledge the value in these areas because it has been narrowly focused on a handful of growth stocks. This is likely to change in the longer term.
A changing time
When we look at the market today, it seems many people still believe that the low inflation of the last couple of decades is going to last in perpetuity. They also continue to commit capital to the highly valued technology sector.
Those with longer memories have seen this type of problem before – and its consequences. Money follows the index and share price gains become self-fulfilling. It looks easy, until it reverses and the momentum that has driven shares higher works in reverse. The catalyst may be a rise in interest rates, but the global technology names are also facing significant regulatory and social pressures, while valuations are high.
It is often difficult to predict the catalyst for this reversal – it may be a policy mistake by central bankers or a persistent rise in inflation – but it always happens at some point. It is vital to manage the fund with these risks in mind.
This year’s climb for the largest global technology companies has started to look very extended. This part of the market is priced for perfection at a time when the economy may radically change direction. Our focus is on growing companies with solid assets, across a breadth of industries and geographies, believing this is the way to respond to inflation and increasingly narrow markets.
Companies selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance.
Important information
Risk factors you should consider prior to investing:
- The value of investments, and the income from them, can go down as well as up 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.
- Movements in exchange rates will impact on both the level of income received and the capital value of your investment.
- 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.
- With funds investing in bonds there is a risk that interest rate fluctuations could affect the capital value of investments. Where long term interest rates rise, the capital value of shares is likely to fall, and vice versa. In addition to the interest rate risk, bond investments are also exposed to credit risk reflecting the ability of the borrower (i.e. bond issuer) to meet its obligations (i.e. pay the interest on a bond and return the capital on the redemption date). The risk of this happening is usually higher with bonds classified as ‘subinvestment grade’. These may produce a higher level of income but at a higher risk than investments in ‘investment grade’ bonds. In turn, this may have an adverse impact on funds that invest in such bonds.
- 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.
- The Company invests in emerging markets which tend to be more volatile than mature markets and the value of your investment could move sharply up or down.
Other important information
Issued by Aberdeen Asset Managers Limited, registered in Scotland (No. 108419), 10 Queen’s Terrace, Aberdeen AB10 1XL. Authorised and regulated by the Financial Conduct Authority in the UK.
Find out more by at www.murray-intl.co.uk or by registering for updates. You can also follow us on social media here: Twitter and LinkedIn.
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