It has been a dramatic turn of events for the US over the past month. Having long defied the recession bells, which have been ringing for the majority of the world’s developed markets, growth expectations in the US have dropped significantly as President Trump’s scattergun trade polices begin to torpedo the economy. Multiple large US banks have now cut their year ahead growth forecasts, and JP Morgan’s chief economist Bruce Kasman estimates there is around a 40% chance of a recession this year.
Far from worries about a recession, as recently as January, the main concern for the market had been the possibility that US policy makers had been too cautious in cutting interest rates. With growth still chugging along at almost 3%, treasury yields rose back towards cycle highs on fresh doubts around looser monetary policy, strong employment, and policy uncertainty surrounding the new government.
As it turns out, they were right to worry, although few could have predicted the extent in which the economic outlook has collapsed under the weight of Trump’s protectionist gambit. At its peak, the yield on the 10-year fell by over 60 basis points, with the stock market trailing close behind. The tech heavy NASDAQ remains in correction territory – a drop of over 10% – while the benchmark S&P500 is down 7% at the time of publishing. Beneath the surface we have seen more dramatic moves, with election trades such as Tesla down almost 50% from its recent peak, and AI poster child NVIDIA off 23%.
Of course, corrections of this size are part of a normal, functioning market and this weakness does need to be put in the context of the returns made over the last few years. However, with the US now accounting for over 70% of the MSCI All Countries World Index, the recent sell-off does highlight one of the challenges of today’s modern market structure: investor fortunes are overwhelmingly dictated by the US and the performance of just a handful of large cap tech companies.
For the most part, this has been a remarkably profitable endeavour with the S&P500 more than doubling over the last five years. However, with multiple expansion driving the bulk of these returns, the trade-off has been that we are now faced with a US market which, by some metrics has never been more expensive or highly concentrated. Needless to say, this is not a new concern, however, as evidenced by the recent price action, conditions have become significantly more perilous when coupled with an increasingly polarising and unpredictable policy backdrop.
In response, investors have begun to look elsewhere, and from February to March we saw a dramatic rotation, with the BofA’s closely watched monthly fund manager poll showing portfolio managers cutting allocations to US shares. This showed a record 40 percentage point drop, from a net 17% of managers being overweight US equities to a net 23% of managers moving underweight. Much of this capital has flown into Europe, and to a lesser extent, the UK, with allocations to European equities reaching a four year high.
For many investors, however, upping sticks and running to Europe is easier said than done, and historically, attempting to time market swings tends to end in tears. Positively, for those looking on with increasing trepidation at the current state of affairs in the US, there are a number of excellent options to ride this out. We would highlight four trusts that we know well.
Capital Gearing Trust
In fear of extreme market volatility, one option would be to turn to a trust that sets out to not to lose money. A trust that fits this bill is Capital Gearing.
The trust aims to preserve and grow shareholders’ wealth over time. It invests in a global portfolio of equities, bonds, and commodities and does not use gearing, short selling, or derivatives. It operates a discount control policy that keeps the discount fairly close to zero. A proportion of the allocation to equities takes the form of investments in other investment companies. Currently, the portfolio is positioned to protect against inflation. At the end of February, 36% of it was invested in index-linked bonds and 32% in what the manager calls ‘dry powder’ – things such as cash, short-term treasury bills, and short-term corporate bonds. From a currency standpoint, there is a strong bias (57%) to sterling and US dollars (28%).
Over the 12 months to the end of February, the NAV return was 5.8%, which compares well with inflation of 2.8%.
If you are prepared to take on a bit more risk, three options in the global sector that are either designed to have low volatility or who often end up with it because of their investment approach are AVI Global, Caledonia, and RIT Capital.
AVI Global
Although the returns of AVI Global (AGT) have more closely tracked the broader market over the last few years, the AGT team have made a conscious effort to shift the portfolio away from generic market risk, focusing instead on idiosyncratic catalysts and targeting companies whose shares stand at a discount to estimated underlying net asset value. It invests in quality assets held through unconventional structures that tend to attract discounts; these types of companies include holding companies, closed-end funds, and asset-backed special situations. Over the last two years, the company has demonstrated the value of its clear strategy and a high conviction approach, generating annualised NAV returns of almost 15% despite market factors which, as we have mentioned, have heavily favoured momentum trading and a small number of very large US technology companies.
Today, the increasingly uncertain economic back drop is expected to create a much wider dispersion of returns across markets. Not only will this create additional opportunities for the managers, but we believe it will also lead to more dramatic swings in benchmark returns, particularly given already-elevated multiples, increasing the appeal of assets that provide uncorrelated exposure to market benchmarks, such as AGT.
Caledonia Investment Trust
FTSE 250 company Caledonia Investment Trust (CLDN) has built up an impressive track record over the last 10 years, delivering an annualised NAV total return of over 15%. It has achieved this by sticking true to its investment philosophy, backing companies with strong market positions and fundamentals, for the long term. CLDN’S success has been built on its ability to invest only when it sees the best opportunities. As a self-managed trust, it is not constrained by a need to meet short-term performance objectives or comply with fixed-life fund cycles. Without external pressure, the managers can ignore the gyrations of fickle markets, exploiting secular growth rather than short-term cyclical opportunities.
RIT Capital Partners
RIT Capital Partners has a good long-term track record of avoiding the worst of market setbacks. It can also boast the highest 12-month NAV returns of the four trusts that we have discussed here. However, for shareholders, a widening discount has depressed what were decent long-term figures. Today, this might present an opportunity. The board is keen to see that discount narrow and, if the momentum of the previous 12 months continues, the trust should attract more interest.
As at the end of February, the portfolio was split 45% quoted equities, 33% private investments, and 24% uncorrelated strategies (mostly absolute return and credit funds). Its currency exposure is close to that of Capital Gearing.
