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Bruce Stout: why I de-geared out of ‘parabolic’ markets

Bruce Stout, manager of Murray International (MYI), a global equity income investment trust, discusses the ill effects of the financial crisis ten years ago and the 'economic vandalism' central banks have wrought in seeking to avoid a deflationary slump. With developed world stock markets looking very expensive, he explains in this video interview how he has positioned the fund in order to continue providing dividend growth to its shareholders. 

Can't watch right now? Read the transcript:

Gavin Lumsden: Hello, with me today is Bruce Stout, manager of Murray International, a £1.6 billion global equity income investment trust that he has run since 2004. Bruce, thanks for coming in today.

Now we have recently passed the 10-year anniversary of the financial crisis. You’ve been very critical of the way the Bank of England and other central banks have responded by printing huge amounts of money under quantitative easing [QE] policies. What do you think now though?

Bruce Stout: Well as far as we’re concerned it’s not gone very well. I think I’ve described it in the past as economic vandalism and I think that’s exactly what it is. Printing money to get you out of a deflationary trap.

GL: Because it stimulated asset prices and stock markets but done nothing …

BS: Done nothing for the real economy and it comes back to the issue of you can cut interest rates to zero but you can’t make people borrow. You can take a horse to water, you can’t make it drink and what we’ve had is the collapse in bond yields all around the world because of QE which means savers have no return on their capital and to get a return have taken riskier and riskier investment decisions into equity markets and bonds.

GL: That’s created demand though for the shares of your investment trust which yields nearly 4%, which obviously looks good against a quarter of a percent base rate.

BS: Yeh, I think probably when you look at a global equity yield you would look at it relative to a 10-year bond. And I suppose the issue there is a 10-year gilt yields only 1%. So yes, relative to that.

Of course the absolute yield is not what’s important here. It’s the ability to deliver that consistently over a period of time and to grow it because we do see a lot of companies today, clearly in the UK where they have 4 or 5% yields but the dividends have been uncovered for four or five years so they’re paying out far too much and not earning those dividends.

GL: So you’re looking for companies that have got strong balance sheets and will pay reliable dividends.

BS: Absolutely. So we look for a business – it doesn’t matter where it’s domiciled – but we’re looking for businesses throughout the world that have some sort of competitive advantage. You could call it a ‘moat’ if you like. As the business gets bigger, it gets stronger. That free cash flow they start to throw off can be reinvested in the business but can also be returned to us as shareholders in rising dividends.

GL: Now the portfolio is notably invested in emerging markets. Over half of the assets are invested in either the shares or bonds in emerging market countries. Can you explain why that is?

BS: Well it’s actually been like that for 15 years. And the reason for it is that in the United States for example we can find lots of very interesting companies, good businesses, well run, but they don’t really embrace the notion of returning cash to shareholders. They would rather use that precious free cash flow for short-term motives such as buying back stock and not reinvesting. That’s not particularly attractive for us.

Japan over the years has not been a particularly good hunting ground either. Yields are so low but then 10-year bond yields in Japan today are zero so why would a company need to pay a high dividend yield?

If you want quality dividend growth, that’s well covered by a balance sheet then you have to go to places like Asia and Latin America. But for an Indonesian company to pay 4% that’s well covered is perfectly in line with the yield structure in the country where a 10-year bond in Indonesia yields 7.5% so it doesn’t look out of kilter there.

GL: Now a few years ago the trust went through a difficult period when emerging markets were out of favour. Do you feel vindicated by the way emerging markets and Asia and Latin America have rallied? Last year your shares were up just over 50% because of that.

BS: I wouldn’t use the word ‘vindicated’. I think what happens there are periods during the history of a trust or the longevity of a trust when you will have a particularly strong period because of the exposures that you have. Between 2004 and 2013 we had a very, very strong period and the consumer staples in particular that were in the trust delivered lots of capital growth and income growth. But by the time we got to 2013/14, they were very expensive so we had to start to recycle the capital to look for cheaper alternatives without compromising on the quality.

And we didn’t really get an opportunity to do that until 2014/15. That’s when we saw a big sell-off in emerging market currencies and emerging market debt and that enabled us to de-gear the portfolio out of equities so we now have 21% in emerging market bonds.

GL: So let’s just clarify that. So gearing is the money that you borrow to invest on behalf of shareholders, so you’re investing more on their behalf. But unusually, or unlike some other investment trusts, you don’t invest that borrowed money into equities or shares, you’re investing it currently in emerging market bonds.

BS: At this particular period we are. So the gearing structure is that the debt can be three, four or five-year debt, but you can’t just pay it back. You’ve always got it there. So you have to be very careful what asset class you have it invested in.

So when we look at 2007, for example, the last time stock markets were very expensive, we were able to de-gear the trust by investing in UK gilts and US treasuries that yielded 5.5% when equities were only yielding 2.4%, which meant that going into the financial crisis at the end of 2007 we were only 88% geared into equities because we had 27% in bonds.

Today Murray International has its lowest gearing into equities, 91%, which means 20% is now in emerging market debt. That’s because stock markets have gone parabolic in the last two years and look very, very expensive.

GL: OK so you’re remaining defensive and diversified.

BS: Correct.

GL: Bruce, thanks very much.

BS: Thank you.

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