Projection/protection: Weighting/waiting

Projection/protection

A recent extended interview between William Green, author of Richer, Wider, Happier, and Jason Zweig, annotator of the most helpful 2003 edition of Benjamin Graham's The Intelligent Investor, reminded me of Graham’s distinction between two kinds of investing disposition: projection and protection.

Projection is the attitude of the future-oriented growth investor, inclined to focus on the upside, to ask, What could go right here? The Scottish Mortgage investment trust being perhaps the best-known and - as of early 2022 - struggling example in the investment trust world.

Protection is motivated by a concern for the downside, concerned to ask prior to any commitment of capital: What could go wrong here? The Ruffer Investment Company, and Capital Gearing Trust being examples of this protective style.

Weighting/waiting

A further distinction came to mind when reflecting on this interview: the importance of weighting and waiting in making investment choices.

Investment success depends not just on deciding what to invest in, but how sizeable a portion of one’s portfolio should be committed to any one investment (weighting); and patience, for how long are you prepared to wait for the desired returns in each case?

The balance between projection and protection, and considerations of how heavy a weight and how long a wait you're prepared to entertain for each investment held are useful ways of framing capital allocation decisions.

2024 as 1974 revisited? UK political risk is being under-estimated

Edward Heath, Jeremy Thorpe, Harold Wilson: UK political party leaders in 1974

Since my youth I've been as interested in football as finance and politics. I measure my life in terms of World Cups and General Elections.

1974 marked the first year I became aware of both sport and political economy, and their respective effects on my feelings and finances. 

Harking back five decades is timely, not just because of the re-emergence of high, possibly double-digit, inflation in the UK in 2022, but also because aspects of the politics of the mid-1970s could return at the next UK General Election, most likely to be held in 2024, and the growing probability of this is not being factored into financial markets.

As of early April 2022, the Electoral Calculus site's translation of UK political opinion polls into parliamentary seats gives the Labour Party 303 seats, the Conservatives 257, the Scottish National Party 58, the Liberal Democrats 7.

Such an outcome, where it is impossible for the Conservatives to lead the Westminster government, is far likelier than most investors and bookmakers are currently pricing.

This is because the Conservatives must win at least 320 out of 650 seats to form a government. They will have no willing partners in a Coalition Government, other than a handful of Ulster Unionists, as happened after the 2017 General Election. The Liberal Democrats will not join a Conservative-led government, given their chastening experience after 2010. 

Conversely, even if Labour fall well short of the 326 seats required to form a majority on their own, their shared anti-Conservatism would form the basis of a potential 'arrangement' with the SNP to keep the Conservatives out of power.

Here's where things becoming exciting, interesting, sobering, worrying, depending on your political stance.

For so long as they are represented at Westminster over the next few years, it's difficult to imagine the SNP holding fewer than 50 seats. Given this, unless there is a large margin between the Labour and Conservative parties in England and Wales, it is very difficult for a UK-wide General Election to produce a stable, sustainable one-party majority government.

Three of the last four UK General Elections have produced a Coalition (2010), a minority government (2017), or a very small majority (2015).

Political uncertainty may be more structural in the UK than the exceptional outcome of the 2019 General Election has led many to believe. One thing financial markets dislike is political uncertainty as demonstrated by the relative weakness of the UK stock market from June 2016 until late 2019.

More speculatively, if a minority Labour government after 2024 requires not a full-blown coalition but rather a confidence and supply 'accommodation' with the SNP, and to some extent Liberal Democrats, then to shore up its precarious unity such an arrangement would unify for at least one parliamentary term around the following:

• A referendum on Scottish independence
• A reform of the electoral system, including boundary changes
• Votes for 16-17 year olds

If negotiating Britain's exit from the European Union was fraught, imagine how much longer and painful the separation of Scotland from the Union might be. 

Even if it didn't happen, the months, if not years, of uncertainty whilst the prospect of 'Scexit' was live would cloud the UK market's prospects.

Investment implications

Does this make the UK cheap for too many reasons, and potentially un-investable?

Not necessarily - the above scenarios might not happen, and even if they did, factors such as the likely fall in sterling would benefit many UK-listed stocks. That stated, I'm certainly a little sceptical when I hear UK fund managers describing the UK market as good value. It might well be cheap at first glance, but investors should always ask 'What is not being priced in?' when contemplating stock market valuations. 

My point is that the probability of a Labour-led UK government of some kind, particularly one likely to introduce constitutional reforms, let alone tax and regulatory policies inimical to financial markets, is far higher than both economic and political commentators realise.

As of early April 2022 the Electoral Calculus model gives a Labour majority a 39% chance and a Labour plurality a 26% chance. A Conservative majority is estimated at only 16% probability. It's hard to see the Conservative Party gaining popularity at a time of rapidly rising prices and taxes, and falling real living standards, between now and 2024.

So, if I get the opportunity to question any UK fund managers or company executives in 2022/23 I will be asking them to ponder the possibilities and prospects of a Labour-led government, if only to test if they're alive to its growing probability.

In 1974 there were two General Elections, followed by several years of political instability, notably over Scottish and Welsh devolution, and inflation peaking at over 20%. Just like Italy recently, England failed to qualify for two football World Cups in a row - 1974, and 1978. 

I'm not saying 2024-2028 will be an action replay of 1974-1978, but in both sport and political economy the possibilities of outcomes deemed unlikely but hugely consequential should be contemplated before not after they happen. 

Another one Bites the Dust: Jupiter Emerging and Frontier Income

To lose one investment trust from my portfolio to voluntary liquidation is unfortunate, but to lose a second one within a few months…so soon after Acorn Income…

The recent announcement of the proposed liquidation of the Jupiter Emerging and Frontier Income trust (JEFI) marks a disappointing end to an investment I’d made with high hopes at IPO in 2017.

With a long-term investment horizon, I remain firmly of the view that I should have a structural allocation of at least 10% to emerging markets,with a sizeable proportion of this focused outside of China, not least due to the heightened geo-political risks recent events have highlighted. This Jupiter trust, with an emphasis on high yield and up to 25% allocation to frontier markets, looked like an attractive means of generating income and growth.

One COVID-related dividend reduction period aside, the trust displayed a pleasing commitment to growing the dividend, with the current year seemingly poised to deliver 1.25p a quarter, a yield of around 5%.

Although JEFI's net asset value had not made great progress given many headwinds, not least COVID; over 3 years to March 18^th the NAV total return of 19.5% exceeded that one or two peers such as Blackrock Frontiers and Fundsmith Emerging, although was outpaced by the lower-yielding JP Morgan Emerging Markets Income Trust.

As recently as mid-February 2022 the JEFI share price traded just above the issue price of £1.00. But since then, the news in Ukraine - the trust had some Russian exposure – and the announcement of its imminent demise have hardly helped sentiment and the shares trade at around 90p as of 18^th March 2022, the discount still about 10%.

Given the probable offer of a cash exit at Net asset value it probably makes little sense to sell out now, and as with Acorn Income hold out to the bitter end. This is particularly the case as there might be some final dividend payment(s) and the emerging market alternatives are likely to be at least somewhat correlated to any near-term moves in the JEFI share price.

Where next for Emerging Markets Income?

So, what replacement investment should I make for this c. 3% of my portfolio?

I already hold Blackrock Frontiers. The aforementioned JP Morgan Emerging Markets Income trust has performed reasonably well in capital terms, but the dividend has been broadly flat for several years, and yields somewhat below 4%.

Given my inclination towards small cap value, I’m tempted to revisit a former holding, an ETF, the WisdomTree Emerging Markets Small Cap Dividend ETF.

I’d sold out of this a while ago due to concerns over its dividend visibility during COVID, but according to data on justETF, the COVID year dip in dividends from 45p to 40p a share in 2020 has begun to be corrected with a rise to 43p in 2021 and potentially 47-48p this year if the January 2022 half-year dividend of 24p is a guide. 

Although 'only' 3.5% or so yield at the current DGSE share price, the exposure to a wide range of small caps across several emerging markets offered by DGSE is attractive, and the DGSE share price has held up surprisingly well in the first quarter of 2022.

I’ve also noted the recent improvement in Latin American markets, so alongside a return to DGSE, a partial allocation of the Jupiter funds to the Blackrock Latin American trust - which has a 1.25% per quarter of NAV distribution policy - may help replicate the income yield from JEFI.

I just hope the board of JEFI acts swiftly and allows holders to exit at NAV as quickly as possible. There is no equivalent income-paying emerging markets fund available within the Jupiter stable, so the option of a dignified departure should be offered to JEFI shareholders, particularly those like me who invested right at the start of trust's regrettably short life.

The Thin Red Line in Investing

 "(...) it is by no means easy to draw the line between investment and speculation" (Philip Carret, The Art of Speculation,  1930, Ch. XVIII)

It can be equally difficult to draw the line between a morally defensible contrarian investment and an unethical exploitation of a troubled situation.

These points have been given renewed force by the February 2022 invasion of Ukraine by Russia, under the command of Vladimir Putin.

As the world's tentative recovery from the COVID pandemic is now confronted by the profoundly shocking spectacle of war in mainland Europe, well-known quotations like Nathan Rothschild's "Buy on the sound of cannons, sell on the sound of trumpets" seem utterly inappropriate.

Even if it were judged ethically appropriate to invest in Russia now, the removal of companies from London listings and the sanctioning of cash flows into and out of the Russian economy make it practically uninvestable.

However, once it became clear that an invasion was underway my investing red line was crossed, and small holdings in Polymetal and the Thornbridge Global Opportunites Fund (the latter holding 10% in Russia as of January 2022) were sold. 

Thus part of my planned 2042 value portfolio has already been disrupted, just after inception. 

Everyone's red line is differently placed, or perhaps non-existent, but some investments become too uncomfortable to hold with a clear conscience. Such is true of Russia for me in spring 2022.

I am fortunate to have the freedom required to ponder what to invest in instead. In the time it's taken me to write this post who knows how many in Ukraine will have lost their lives, let alone their liberties.

Inflation: Always and Everywhere a Social Phenomenon

There are currently at least two advantages to being a former academic sociologist in my early fifties: I'm just about old enough to remember the high and accelerating inflation of the mid 1970s, and I’m able to recognise the limitations of a purely economic theory of inflation.

Two things have prompted these musings on inflation. Firstly, encountering price increases on basic foodstuffs at one of the main discount supermarkets in the UK (500g bran flakes up from 46p to 49p, sardines from 31p to 35p), the daily reality of CPI inflation recorded at 5.5% in January 2022. See UK CPI data.

Secondly, reading a thoughtful essay on inflation, ‘The Perils of Yesterday’s Logic’, by Henry Maxey in the investment house Ruffer’s recently published Annual Review.

Maxey’s essay reminded me of Milton Friedman’s famous observation that “inflation is always and everywhere a monetary phenomenon”, (p181 in The Counter-Revolution in Monetary Theory).

Maxey also references a powerful intellectual counterargument to Friedman co-edited by couple of authors I read as an undergraduate, namely Fred Hirsch and John Goldthorpe’s 1978 collection of papers The Political Economy of Inflation.

The book was based on a 1977 conference at the University of Warwick where several non-economists brought wider social science insights to bear on a topic too important to be left to rival schools of economists.

Put simply, contra Friedman, inflation is always and everywhere a social phenomenon.

Maxey highlights Hirsch’s argument that inflation becomes pronounced when the status order of a society is in question: “containment of the latent distributional struggle without financial instability requires either sufficient authority or sufficient consensus, on the values or principles underlying the distribution of income and other aspects of welfare. If established authority weakens before a sufficient consensus or a new authority emerges, inflation results.” 

Who can doubt that the advanced economies of 2022 lack both authoritative leadership and widespread social consensus?

The level of prices, and their rate of growth depends on a complex ever-changing balance of forces on both the demand and supply sides of economic transactions, between producers and consumers, workers and employers, companies and regulators, politicians and electorates. This balance of forces is being profoundly disrupted in early 2022, with inflation one consequence (and itself a further source of disruption if persistent).

The acceleration or otherwise of inflation ultimately depends on the ability and willingness of people to pay for goods and services, and these are not simply determined by resource constraints, but are shaped by contestable definitions of social acceptability. Is it acceptable for companies to pass on cost increases? Will employees accept wage increases below the rate of inflation? Will consumers accept having to trade down as prices rise, or will they continue to accept higher prices to access favoured brands?

Hirsch’s notion of status order is well-chosen for it invokes Max Weber’s classic sociological definition of status as "the social estimation of honour".

Quantitative indicators such as the prices of goods and thereby the rate of inflation are the translation into numbers of social transactions where the numerical outcomes have processed through estimations of honour, decency and social and political acceptability. 

Prices embody both economic and social contracts.

The limits to inflation are set by how far people will tolerate the stretching of their definitions of what can be socially as well as financially afforded, and the extent to which what J.K. Galbraith termed ‘countervailing power’ can be mobilised and exerted against the pressures of rising prices.

This is why inflation is always and everywhere a social phenomenon.

In the meantime, I will enter supermarkets with renewed trepidation and reach for the few 1980s economic textbooks I didn’t throw out to remind me of ‘demand-pull’, ‘cost-push’, and other parts of the lost language of high inflation which are likely to prove useful in the days ahead.

The Start of a Twenty Year Investment 'Experiment'

Having turned 55 (and ‘retired’ from paid employment for some time) I will be taking my workplace pension later this month. As part of this package, a tax-free lump-sum is due, part of which will be spent on house refurbishment, the remainder invested.

A recent visit to an elderly relative in a retirement home brought home the need for me to have a large capital sum to draw down after I turn 75 to fund potential long-term care and health needs.

Recent investment experience, together with my eclectic outlook, has encouraged me to inflect this very long-term capital in the direction of the value style of investment.

My diverse (some would say incoherent) existing portfolio spans Chelverton UK Dividend and Edinburgh Worldwide, but arguably lacks both breadth and depth in its exposure to non-income paying investments in the value style.

The core of my portfolio will continue to be in dividend-paying shares and trusts/funds, but as I hope to live for another 30 years, I’m not abandoning long-term growth as an aspiration, but want to find growth in a value style.

The previous blog post highlighted the Palm Harbour Global Value Fund and the Kopernik Global All-Cap Fund as possible global value choices, and Asian value is to some extent covered by a long-standing holding in the Fidelity Asian Values trust. 

In completing this allocation to value investments in pursuit of growth (including a newly opened SIPP) the following funds have attracted my interest, and it’s notable that there’s a dearth of value-style investment trusts outside of equity income.

For UK Smaller Companies: The VT Teviot UK Smaller Companies fund has performed extremely well since launch despite the headwinds facing UK small cap value strategies: up 24% over 1 year to 1^st Feb 2022, in the sector top 5, along with other UK smaller value strategies, but unlike those Teviot was up 70% in the 3 years to 2022, in the sector top 5 with the leading growth-based UK smaller companies strategies over that longer time frame. 

One point to note: the fund charges a dilution levy of around 1% for purchases and sales - irritating, but I'm willing to pay it given my long time horizon.

For deep value: Arguably the deepest value, most contrarian UK All Companies fund or trust available is the Cape Wrath Focus Fund. 

After a rough 2019/early 2020 it performed strongly in 2021 and was the top performer in the IA UK All Companies sector in the 12 months to 1^st February 2022 (+35%).

For US small cap value: The VT De Lisle America Fund is one of very few actively managed small cap value funds, with its heavy weighting to US community banks perhaps well-placed given likely interest rate moves.

For Japanese value: The Nippon Active Value Fund is a London-listed investment trust and one of a genre of activist vehicles targeting many cash-rich Japanese companies as the corporate governance culture in Japan becomes more shareholder-friendly. In early 2022 it has so far avoided the heavy sell-off in Japanese smaller company growth trusts such as Shin Nippon and JP Morgan.

The start of the 20 year experiment

To start this two-decade long investment journey, and with a global value tracker, as well as two growth trusts I already hold, as comparisons, here below are the prices as of 02/02/2022 and latest available price-earnings ratios, from Morningstar [date of PE in brackets]

Health and technology permitting, I aim to track the progress of this ‘growth in the value style’ part of my portfolio regularly in these posts until I turn 75 in 2042.

Will 'value' outperform growth over the next two decades?

Palm Harbour Global Value Fund EUR 13.55 PE 7.01 [31^st Oct]

Kopernik Global All Cap AG £1.6855 PE 6.68 [31^st Dec]

De Lisle America B £5.7542 PE 9.07 [31^st Dec]

Cape Wrath Focus A £1.4591 PE 6.22 [31^st Jan]

Teviot UK Smaller Companies £1.8223 PE 10.48 [31^st Dec]

Nippon Active Value £1.31 PE 14.6 [31^st Dec from trust Factsheet]

Edinburgh Worldwide £2.305 PE 71.34 [31^st Oct]

Scottish Mortgage £11.055 PE 34.36 [31^st Oct]

XTrackers MSCI World Value Factor XDEV £29.13 PE 9.61 [31^st Dec]

The Value Rotation: In Search of Global Value Funds

It hasn’t been easy for value investors for most of the last decade.

However, since Christmas 2021 with the MSCI World Growth index down nearly 11% in a month, and previous high performing technology-heavy growth funds like Scottish Mortgage and Edinburgh Worldwide off some 30 to 40% from their peaks of a few months ago, recent declarations of the irrelevance or death of value investing seem premature.

It’s particularly poignant to mark the potential revival of value investing in the week which confirmed the absorption of the value-investing based Scottish Investment Trust into the management of the JP Morgan Global Growth and Income Trust (the review prompting this was referenced in a previous blog post).

Ironically, in the month to January 21st 2022 the Scottish Investment Trust was the top performing trust in the UK-based Global investment trust sector, with a Net Asset Value increase of 5.1% starkly contrasting with Scottish Mortgage’s fall of 13.8%.

More broadly, funds managed in the value style such as Schroder Global Recovery and MI Thornbridge Global Opportunities sit near the top of the global fund sector performance league tables over one to twelve months, as do funds specialising in previously out of favour sectors associated with value investing such as energy and finance.

Where next?

With interest rates starting to rise, inflation seemingly more durable than envisaged and more increases in both likely in 2022, could the long-anticipated rotation from growth investments to value investments not only be underway, but starting to become firmly rooted?

The honest answer is, “It’s impossible to be certain”, but it’s likely that the more the macroeconomic and political environments deviate from the low inflation and low interest rate climate of the 2010s, the more will the best performing funds and investments of the next few years differ from those that have performed best in the last few years.

With this in mind, how should a private investor like myself, hoping to live for another three decades, react? 

The question assumes greater significance for me in early 2022 as having just turned 55 (!) and elected to access my work pension, I will be in the fortunate position of having some capital to deploy [assuming urgently needed house refurbishments don’t consume all of it], with the specific purpose of creating a capital backstop for possible later life health and personal care costs 20-30 years from now.

If at least part of such a long-term growth portfolio should be allocated towards ‘value’ investments, what are the options?

UK Value?

It’s not just because they’re talking up the investments they manage that UK fund managers continue to highlight the absolute and relative cheapness of the UK stock market. As a recent discussion by the JO Hambro UK Equity Income fund highlights, by the end of 2021 the UK market had rarely been cheaper.

The potential for a re-rating of the UK market is seen in the strong performance of UK value-based trusts and funds such as Temple Bar and Aurora in early 2022.

However, for my own purposes given I already hold a some UK value investments, such as Chelverton UK Dividend and Aberforth Split Level Income, I’m not rushing to add to my UK exposure.

I also have some longer-term concerns about the UK political backdrop. 

The travails of the Conservative Party currently look deep-seated, and it’s probable that in 2023/24 the stock market will wake up to the risks of a Labour-led government and/or the Scottish independence referendum that might be the price of SNP support for a minority Labour administration. The difficulties of Brexit are minor compared to the potential complexities and uncertainties of Scotland voting to break away from the Union. A tail risk of this kind merits caution before assuming a large UK weighting.

Where to find global value?

As noted in the previous blog post discussing the demise of the Scottish Investment trust, there are surprisingly few, if any, value-based global investment trusts.

The AVI Global Trust might be considered as such, although it eschews the one-dimensional value label, and sees itself as a 'third way' combining growth and value styles. 

Taking AVI Global on its own investment merits, the access to a broad range of holding companies (such as EXOR, Pershing Square and Christian Dior) and special situations is attractive, so it’s a strong candidate for part of this long-term growth portion of my portfolio.

What I’d really like to invest in is a global small cap value proposition.

However, attempting to find one is problematic. Most small cap value ETFs are regionally specific, centred on the USA or Europe especially.

Likewise, there are a number of regionally focused small cap value funds and trusts, notably De Lisle America, Fidelity Asian Values, Nippon Active Value.

Thus far, only two actively managed global value funds have caught my attention and seem available to a UK retail investor (via the AJ Bell platform).

Global small and mid cap value

The Kopernik Global All-Cap Equity Fund is managed by experienced US-based value investor Dave Iben. 

As of December 2021, Morningstar’s portfolio analysis gives its portfolio a price-earnings ratio of 6.68, surely one of the cheapest portfolios available.

That said, the focus on energy, materials and emerging markets, notably Russia, may deter many and performance has been volatile: falling more than 10% short of both its benchmark and peer-group in 2017 and 2019, but significantly outperforming in 2020 and 2021.

I am tempted, albeit for a small portion of my funds.

The latest quarterly webcast for the Kopernik fund (20^th January 2022) is available here.

Palm Harbour Global Value Fund

The fund that intrigues me the most is also one of the smallest and least well-known.

The Palm Harbour Global Value Fund was launched in 2019 and cities the usual value investing names (Buffett, Graham, Klarman) as inspiration.  Seeded by, and closely related to the COBAS asset management firm established by the Spanish value investor Francisco García Paramés, as of January 20^th 2022, the Palm Harbour fund had gained 39% since launch.

Morningstar’s portfolio analysis gives its portfolio a price-earnings ratio of 7.60.

With holdings such as International Game Technology, an Italian-American lottery company, and Ginebra San Miguel, a Filipino gin producer, the fund is nothing if not distinctive and idiosyncratic. It is in Morningstar’s Global Small/mid-cap sector with 55% of the holdings categorised as small cap and 17% micro-cap by Morningstar.

Only 15% of the fund’s holdings are domiciled in North America, 63% in Europe, and a sprinkling in Japan and Asia.

So, at last, a genuinely global small cap value fund!

There are some concerns: the fund had a very poor early 2020; it is only valued once a week, on a Wednesday; there is just one named fund manager, Peter Smith; and at just under five million euros in size its long-term sustainability might be a worry.

However, if you’re going to invest in actively managed funds rather than trackers or ETFs (a debate for another time…) then funds like this that differ markedly from the benchmarks and provide access to holdings otherwise out of reach are likelier to add something to one’s portfolio.

Having had a fruitful E-mail exchange with the fund (itself a useful albeit not clinching indicator for a prospective investor) the Palm Harbour Global Value Fund is likely to be part of my later life growth portfolio.

One lesson of early 2022 is that capital growth is not always best served by self-defined growth funds – there remains a place for investments in the value style. Value funds can grow in value.