I was asked recently about the Murray International trust (MYI) and whether investors should stick with the fund as its long-term manager, Bruce Stout retires in 2024. While I actually quite like the current structure of the portfolio, its performance highlights the risks associated with relatively extreme positioning. The company’s annualised share price total return over the past decade was just 6.3% versus 11.9% for its reference index (The FTSE All World Total Return Index).
The bulk of the underperformance for the company, which exists in the Global Equity Income sector, is due to a long held underweight to North American equities on valuation grounds. Only 28% of the fund is currently invested in the region, compared to 61% for its reference index.
Compare this to Global Equity Income peer, JP Morgan Global Growth and Income (JGGI), which is one of the best performers in the entire investment trust universe over the past decade with annualised returns of almost 14%. That fund has clearly benefited from maintaining its exposure to US technology, which continues to be the driving force behind global market returns and has made it exceedingly difficult for active fund managers to beat their respective benchmarks due predominantly to the dominance of just a handful of large cap tech companies.
MYI and JGGI mark two very different approaches to portfolio construction, despite existing within the same sector, and while one has certainly been proven to be more effective over the past 10 years, as global managers have been rewarded for sticking relatively close to their benchmark allocations, there are no guarantees that this approach will lead to excess returns going forward. In fact, Murray’s performance over the past three years, with an annualised share price total return of 14%, well-ahead of the reference index, shows the potential upside that exists from taking on a more active investment approach.
Risks and rewards
Unfortunately, MYI’s long-term performance suggests that while the fundamental thinking may have been correct, the reality is that it can take a long time for a particular thesis to play out, during which time significant losses can mount up. In MYI’s case, its major point of difference was being underweight the US during a period of unprecedented outperformance, which has continued post pandemic.
This not only highlights the need to be open-minded as a manager (balancing short- versus long-term considerations), but also how crucial it is to be cognisant of the risk of extreme asset allocation bets so that when things go against you, the downside does not become catastrophic.
This is always a fine balance, and for the majority of active managers, the nature of returns over the past ten years has favoured those willing to forego conventional price discovery and concentration risk in favour of sticking with the crowd. However, with equity returns over the next ten years expected to be less than half that of the decade following the GFC, and fixed income now offering a real alternative, managers will likely need to be more active and take on more risk in the future, if they hope to move the dial on performance.
Finding the balance
One fund that I believe finds a good balance between managing the downside while also taking calculated risks is Alliance Trust (ATST). The fund is constructed through a ‘manager of managers’ approach with adviser, Willis Towers Watson (which has managed the fund since 2017), selecting between eight and 12 managers each of whom invests in a high conviction collection of stocks. Combined, these resemble the index at the sector level but with a high active share (around 80% at the end of 2022). This strategy has proved to be a successful one, delivering market beating returns over the past decade with an annualised share price total return of almost 12%.
The fund places a focus on diversification with balanced exposure to countries, sectors, and styles. While this has weighed on returns during the tech bull run, with the portfolio underweight several US mega caps including Apple and Tesla, its long-term performance shows that in general the managers have been able to balance this exposure, while maintaining continued diversification within the fund. The value of its broad asset base and relatively neutral style was highlighted during the 2022 bear market and ensuing value rotation, outperforming its benchmark and the majority of its peers, and this structure should continue to pay dividends (literally) going forward as equity dispersion increases.
As noted above, it’s difficult to imagine that investment returns in the 2020s will be as stable as the goldilocks period experienced following the GFC, where years of financial repression squashed volatility and drove up asset prices. Now, faced with a raft of structural factors that are expected to drive inflation and interest rates higher, including the ‘3 D’s’ of debt, demographics, and deglobalisation, investors will likely be faced with a much wider divergence of returns, placing more importance than ever on manager execution and fund diversification.
As US markets surge towards fresh all-time highs, and the valuation gap between the rest of the world widens to historical extremes, global managers are needing to make these choices now, on whether to ride the train of US exceptionalism into the sunset or shift away from US allocations that make up more than 60% of global benchmarks.
Whilst ATST aims to not take significant top-down bets relative to the benchmark, it does have some marginal style biases. Its greatest deviation comes from its underweight to the US and an overweight to the UK with the managers highlighting the gap in relative valuations, noting that these do not reflect the prospect of a structural rise in discount rates.
Returning full circle to the Murray question, its outlook clearly depends on the fortunes of the US to an even greater extent than that of ATST. While there’s certainly no guarantee that we’ll see a mean reversion in global valuations, the outlook for the fund is probably as good as it’s ever been. Unfortunately for long term investors, even if we do see a strong resurgence in UK shares, at least on a relative performance basis there remains a long way back due the scale of its bet against the US in recent years.
QD View – Mind the gap
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