Investment Trust Portfolio: Shifting Dials
The dial changes through a series of questions. These include Russia’s invasion of Ukraine and China’s more robust foreign policy altering geopolitical calculations, with the pandemic crystallizing more immediately a number of trends and priorities for governments and peoples, and investors realizing that central banks have changed their minds and that inflation is no longer ‘transitional’. The latter in particular has implications for investors not only in terms of the balance and the nature of the diversification of their portfolios, but also the composition of their equity component. Investors should be positioned accordingly as interest rates rise more than initially expected
Rising inflation and interest rates
The “Preparing for Inflation” column (March 12, 2021) explained why ever-higher inflation was now part of the investment equation, contrary to expectations at the time, and how portfolios were positioned accordingly. Following a global economic crisis during the pandemic, the consensus was that deflation was the biggest threat. However, there were and are countervailing forces at work.
In the article, reference was made to the Quantitative Easing (QE) world of Alice in Wonderland, where economic reality and asset prices are distorted, and our long-term contrarian view. why governments had kept interest rates artificially low. Both policies had facilitated high borrowing and deficits as central banks eased on whether these policies would encourage subdued inflation, given that this would help erode high debt levels over time – the belief prevailing belief that inflation could be brought under control before it becomes a problem. Such policies also had the added benefit of hiding the real agenda in plain sight.
As a result, central banks have been “late on the curve”. Despite all the usual harbingers of rising inflation flashing red at the time (e.g. UK M4 and US M2 money supply figures) and clear evidence of pockets of significant inflation, policymakers did not have not reacted as they would have done in the past by raising interest rates. rapidly. The Federal Reserve indicated at the time that it was more relaxed about inflation rising above 2%, given expectations that inflation was not a problem. We are reminded again of Galbraith’s quip that the sole purpose of forecasting is to make astrology look respectable.
All that has now changed. The inflationary “genius” is out of the bottle. The problem with early rounds of QE was that printed money was largely absorbed by the financial system to restore bank balance sheets crippled during the financial crisis. This time, money printing reached the frontline economy and affected prices, and central banks became alarmed at the expected level of inflation. We no longer speak of inflation as “transitory”.
Along with replacing QE with quantitative tightening (QT), the Federal Reserve and markets are now pricing in an increased number of interest rate hikes – with some estimates suggesting UK rates will hit around 2.5% d end of the year. Markets are preoccupied with a recession or most likely “stagflation” – high inflation and little or no economic growth. The omens are worrying. Of the 16 cycles of tightening since the 1970s, certainly 12 ended in a recession.
And any market equivocation on the matter will come to better recognize the other long-term structural factors affecting inflation – some of which have been reinforced of late. Geopolitical risk is rarely absent, as the trade war and rhetoric between the United States and China have reminded us, but the invasion of Ukraine marks the advent of a new cold war in the defense of democracy – something we previously thought would require little investment. The West is once again realizing that the concept is fragile – it needs to be nurtured and protected – because many people don’t like it. Both hard and soft power budgets will increase.
The resulting hardening of alliances, along with the lessons of the pandemic, are helping to shorten corporate and energy supply chains. The “just in time” model is gradually being replaced by a “just in case” approach. Business cash reserves will increase to meet any crisis. It will also make it more difficult to find cheap labour. Indeed, wage inflation will be a key factor in this new inflationary landscape, also encouraged by the shortage of workers due to demographics and an understandable political program to better support low wages. All of this will negatively impact profitability unless prices rise.
Together, these factors will result in a persistent rise in inflation almost regardless of the economic backdrop. The markets are readjusting to this new environment. Portfolios must be appropriately constructed, relative to their mandate. The changes during the first quarter therefore continue with the theme of portfolio resilience given the expected volatility ahead.
The Growth portfolio completely sold its holdings in Montanaro European Small Enterprises (MTE), Montanaro UK Small Business (MTU), Global Healthcare Trust (WWH), Baillie Gifford US Growth Trust (United States) and JPMorgan Japan Smaller Growth & Income (JSGI). The money raised made it possible to complete JLEN Group of Environmental Assets (JLEN) and Finsbury Growth and Income (FGT)while Murray International Trust (MYI) and City of London (CTY) were presented.
The income portfolio reduced its stake in Herald (HRI)and sold its stakes in Smithson Investment Trust (SSON) and Edinburgh Worldwide (EWI). Ruffer Investment Company (RICA) and CQS Growth and Income from Natural Resources (CYN) have been added, while Bluefield Solar Income Fund (OSFI) has been presented. Otherwise, both portfolios sold their stake in Aberforth Split Level Income (ASIT) and introduced JPMorgan Global Growth & Income (JGGI).
The investment trusts sold during the quarter remain excellent companies, and those are all held in some of the other 10 actual investment trust portfolios managed on the www.johnbaronportfolios.co.uk website. The Growth and Income portfolios are two of the five website portfolios that reflect an investment journey, which gradually becomes diversified and defensive over time. The remaining five portfolios pursue a range of missions and therefore have greater latitude in their choice and weightings.
The changes largely represent a reduction in exposure to “growth” stocks (MTE, MTU, WWH, USA, JSGI, EWI, HRI, SSON) as higher interest rates will continue to push question their ratings, generally in favor of more defensive stocks. ‘value’ companies (CTY, MYI and JGGI) which are more profitable – both in the UK and abroad. The changes also see increased exposure to other assets, less correlated to equity markets, which stand to benefit from rising inflation (JLEN, CYN and BSIF) or which favor capital preservation (RICA) given the challenges ahead.
|Breakdown of the portfolio as of March 31, 2022|
|Growth portfolio||Income Portfolio|
|New City High Yield (NCYF)||4.5%||iShares Index Linked Gilts ETF (INXG)||5.0%|
|iShares Index Linked Gilts ETF (INXG)||2.5%||Henderson Diversified Income (HDIV)||2.5%|
|UK stocks||CQS New City High Yield (NCYF)||2.5%|
|Murray Income Trust (MUT)||5.0%||UK stocks|
|Edinburgh Investment Trust (EDIN)||4.5%||Dunedin Income Growth (DIG)||5.0%|
|City of London (CTY)||4.0%||Edinburgh Investment Trust (EDIN)||4.5%|
|Finsbury Growth and Income Trust (FGT)||4.0%||The Commercial Trust (MRC)||3.5%|
|The Commercial Trust (MRC)||3.0%||Invesco Perpetual UK Smaller Cos (IPU)||3.5%|
|Henderson Small Business (HSL)||3.0%||Montanaro UK Smaller Cos (MTU)||2.5%|
|Aberdeen UK Smaller Cos (SLS)||3.0%||International Equities|
|BlackRock Throgmorton Trust (THRG)||2.0%||Murray International Trust (MYI)||5.0%|
|International Equities||JPMorgan Global Growth & Income (JGGI)||3.5%|
|AVI Global Trust (AGT)||4.5%||Utilico Emerging Markets (EMU)||2.5%|
|JPMorgan Global Growth & Income (JGGI)||4.0%||Themes|
|Murray International (MYI)||3.0%||Ruffer Investment Company (RICA)||4.0%|
|Edinburgh Worldwide (EWI)||2.0%||Apax Global Alpha Ltd (APAX)||3.5%|
|Oryx International Growth Fund (OIG)||2.0%||Personal Property Trust (PNL)||3.5%|
|Herald (HRI)||4.0%||BB Healthcare Trust (BBH)||2.0%|
|Standard Life Private Equity Trust (SLPE)||3.5%||other assets|
|Personal Property Trust (PNL)||3.0%||BioPharma Credit Investments (BPCR)||5.5%|
|Bellevue Healthcare Trust (BBH)||3.0%||Property Standard Life Inc (SLI)||5.0%|
|Augmentum Fintech (AUGM)||2.5%||HICL Infrastructure Company (HICL)||4.5%|
|Apax Global Alpha Ltd (APAX)||2.5%||JLEN Group of Environmental Assets (JLEN)||4.5%|
|other assets||BlackRock World Mining (BRWM)||4.5%|
|Standard Life Property Income (SLI)||6.0%||CQS Natural Resources Growth & Inc (CYN)||4.5%|
|HICL Infrastructure Company (HICL)||5.0%||WisdomTree Physical Gold ETF £ (PHGP)||3.5%|
|BlackRock World Mining Trust (BRWM)||5.0%||Regional REIT (RGL)||2.5%|
|BioPharma Credit Investments (BPCR)||4.5%||International Public Partnerships (INPP)||2.5%|
|JLEN Group of Environmental Assets (JLEN)||4.5%||GCP Asset-Backed Income Fund (GABI)||2.5%|
|CQS Natural Resources Growth & Inc (CYN)||3.5%||Bluefield Solar Income Fund (OSFI)||2.5%|
|Holdings are rounded to the nearest 0.5%|
|January 1, 2009 – March 31, 2022|
|Since the beginning of the year (until March 31)|
|*MSCI PIMFA Growth and Income benchmarks are quoted (total return)|