Murray International Trust — Capital growth and above-average dividend yield

Exhibit 2 (LHS) shows the performance of UK and global equities (in sterling terms) over the last 10 years; investors in overseas companies have fared considerably better than those holding shares in UK firms over the period, partly as a result of sterling weakness. Since early 2016, equity investors have enjoyed above-average total returns driven by synchronised global economic growth, coupled with a rerating of share prices because of high levels of available liquidity encouraging investors to seek higher returns than those available from lower-yielding asset classes such as developed market government bonds and cash.

Looking at forward P/E valuations (Exhibit 2, RHS), following a period of rerating, the US looks particularly expensive compared with the rest of the world, and is trading at a 15% premium to its 10-year average. However, most other regional stock markets are also trading on a higher earnings valuation multiple than their historical averages, which implies that further share price appreciation is more likely to be driven by corporate earnings growth than another rerating.

In terms of economic growth, we highlight the International Monetary Fund’s forecasts for both advanced economies and emerging market and developing economies (Exhibit 3). Growth in the latter should continue to outpace economic expansion in developed markets due to factors such as a growing middle class, robust commodity prices and high levels of infrastructure spending.

Given the current macroeconomic environment, one may argue that the risks to global economic growth forecasts are to the downside. Issues that investors need to consider include the US’s protectionist policies and the retaliatory measures from its partners, which will have a negative effect on global trade. Another overriding issue within asset markets is the risk of a policy misstep as central banks gradually move to a more normalised monetary environment following their ultra-loose policies in response to the global financial crisis. The US is leading the charge, with the Federal Reserve Bank already raising its key Federal Funds interest rate eight times from 0.25% to 2.25%; in the UK, the Bank of England has raised rates twice to 0.75%; and the European Central Bank has announced it will taper its government bond purchases. The uncertain macroeconomic environment has already been reflected in equity markets so far this year, with increased volatility compared to the particularly benign levels in 2017. Given the backdrop of above-average valuations, risks to global growth and higher stock market volatility, investors may be better served focusing on high-quality, reasonably priced assets.

MYI was launched in Glasgow by chartered accountants Brown, Fleming & Murray as The Scottish Western Investment Company in December 1907, a period when the city had a thriving industrial and shipbuilding-based economy. Throughout its long history, the trust has had a continuing theme of growing income. Originally, the portfolio was invested in fixed income securities and had a meaningful exposure to US entities, such as railroads and tramway companies. MYI’s first direct investment in ordinary shares was in Union Pacific Railroad in 1910, although it was not until the early 1920s that equities made up a significant part of the portfolio. In 1959, The Scottish Western Investment Company merged with The Caledonian Trust Company, and was renamed Murray Western Investment Trust in 1979. In recognition of its global investment remit, the trust was renamed once more in 1984 as Murray International Trust; it is traded on the premium segment of the London Stock Exchange.

The trust is managed by Aberdeen Standard Investments (formerly Aberdeen and, before that, Murray Johnstone). The trust’s lead manager (since June 2004) is Bruce Stout, who is a member of Aberdeen Standard Investments’ global equity team and has worked for the company (and its predecessors) since 1987. Stout has held a number of roles within Aberdeen Standard Investments, including as an emerging markets fund manager, and has been directly involved with MYI since 1992. He aims to generate long-term capital growth (while preserving capital during periods of stock market weakness) and an above-average dividend yield from a globally diversified portfolio of equities and fixed income securities. From time to time, the trust may hold other equity-related securities such as depository receipts, preference shares or unlisted companies, and derivatives are permitted for efficient portfolio management.

MYI is benchmarked against a composite measure of 40% FTSE World UK and 60% FTSE World ex-UK indices. The high UK weighting is due to historical considerations, as in the past other regions did not have competitive dividend yields. When the manager assumed his current role in 2004, some 45% of MYI’s portfolio was invested in the UK, compared with 12% today. There are no limits regarding geographic or sector exposure, but a maximum 15%, at the time of investment, is allowed in a single holding. Total gearing of up to 30% is permitted in normal market conditions; net gearing was 11.8% at end-August 2018.

The board uses a series of key performance indicators to measure MYI’s success:

Stout offers a historical perspective to the current investment backdrop. He says that until 2008, there were macroeconomic relationships that could be used as roadmaps for investment, such as the relationship between bond yields and earnings yields, which had worked for around 50 years. The manager says the historical norm in the UK was that investors could earn a real (above-inflation) return on their bank deposits of 200bp. However, in 2008 there was a systemic global financial collapse, which wiped out yields on ‘risk-free’ assets. He believes this has serious implications for future economic growth. To bring about the illusion of financial stability, central banks embarked on an experimental policy of quantitative easing (QE) by massively expanding their balance sheets assets, and the resulting levels of debt are unlikely to be repaid, says Stout. He says that, for example, UK government debt has swollen from £1.0tn to £1.8tn over the past decade, and as a result, we are living in unprecedented times. Stout believes that while QE introduced a modicum of stability, the huge debt burden will be borne by future generations. A decade down the road from the global financial crisis sovereign balance sheets are still not being reduced, apart from in the US, and the manager says that debt loads in the UK, Europe and Japan continue to grow at the government, corporate and household levels. Stout says that there is a misguided belief that monetary policy can be normalised, ‘when no-one knows what normalised is any more’. He says that with abnormally low interest rates, there is no incentive for people to save, so how will economic investment be financed? As a result of the current backdrop he is very cautious on the prospects for developed market economies.

Regarding the UK, the manager notes the low level of economic growth, which is despite the largest financial stimulus ever. He is nervous about what will happen when there is a recession, as there are few fiscal or monetary tools left in the toolkit. The UK is a consumption-led economy and therefore cannot rely on exports for support. Within Europe, Stout comments that the banks have large debt burdens but cannot be allowed to fail, which is leading to ‘zombie’ institutions. He notes a general lack of growth outside of export-led Germany, which is dependent on a weak euro to sustain its competitive advantage. The manager is even more cautious on the economic prospects in Japan, commenting that it has ‘the worst demographic profile on the planet’, has the highest debt-to-GDP ratio of any nation that has not defaulted and suffers from endemic deflation. Stout says that within the US there is ‘an illusion of growth’ due to the impact of lower taxation, higher borrowing and debt-funded share repurchases. He notes that the current business cycle is the longest on record and the country is ‘living beyond its means’, as shown by the large spending required to fund its healthcare and social security programmes.

Given his cautious outlook on the economic prospects for developed economies, the manager believes it is important to focus on areas where there is real income growth and low credit penetration. He notes that emerging markets are no longer hostage to commodity prices, or reliant on a low-cost labour model and exports, but have real sustainable growth prospects helped by a growing workforce, higher levels of education and access to domestic capital for the first time. Stout says that the prevalence of younger demographic profiles in emerging economies is a critical driver of economic growth. He notes that household formation has a massive multiplier effect on consumption. There are many emerging market countries where housing is becoming affordable (unlike in the UK), including the state and rental sectors, meaning young people can afford to leave the family home, which provides a boost to economic growth. The manager notes that the Chinese consumer sector is now an important driver of global demand and in the next couple of years the Chinese economy will be the largest in the world. Stout says that the country experienced 15 years of export growth followed by 15 years of infrastructure spending, and while policy mistakes have been made, the economic progress is undeniable. He believes that if China has a competitive advantage in providing a product or service, the country will take market share. The manager says that there is pent-up domestic demand, which is less constrained by a credit overhang, unlike in developed economies.

Stout highlights MYI’s holding in Auckland International Airport as an example, given the company is a beneficiary of increasing demand from Chinese and other global tourists. It has long-term expansion plans, including building an additional runway, and adding more terminals, shops and hotels. Auckland International Airport’s increased profits are being returned to shareholders via higher dividend payments; its stock currently offers an attractive c 4% dividend yield.

The manager emphasises the focus on risk-adjusted returns. He acknowledges that he invests in some high-risk markets, and there can be periods of correlated volatility. Emerging markets are experiencing one of these times as a result of Trump’s protectionist policies. However, Stout says this is an abnormal period and will pass; he says that the US president will not be able to derail the economic growth opportunities in Asia Pacific and Latin America.

The manager follows Aberdeen Standard Investments’ house style of investing on a bottom-up basis in high-quality companies that are trading at a reasonable price. The quality of a company is assessed in terms of its management team, the business focus, strength of its balance sheet and its corporate governance track record. Aberdeen Standard Investments stresses the importance of meeting a company’s management team prior to making an investment. In terms of determining a firm’s valuation, the investment team considers key financial ratios, peer comparisons and an assessment of a company’s business prospects. Aberdeen Standard Investments employs a team-based approach to investing, and is unconstrained by index geographic and sector weightings. There is a key focus on risk management; Aberdeen Standard Investments’ portfolios are regularly monitored by an independent performance and risk team.

Stout is a member of Aberdeen Standard Investments’ 10-strong global equities team, which is based in Edinburgh. He draws on the resources of five regional teams – pan-Europe, Asia Pacific ex-Japan, North America, Japan and emerging markets – and is able to invest in any company that is held in any of these teams’ regional portfolios. Every company held in a regional fund is visited at least twice a year, and findings are documented and shared across all of the investment teams. Stout’s emphasis is on investing in defensive businesses where he has a high degree of confidence in a company’s ability to deliver earnings and dividend growth. MYI’s portfolio typically contains around 50 equity holdings, across the market-cap spectrum. This provides sufficient diversification by sector and geography, which acts as a risk control, but is a small enough number to ensure that the manager is able to understand all positions fully. Stout says that the investment process is straightforward and he is essentially ‘buying good companies that are doing good things’. He maintains c 50 names on a watch list that may be considered for inclusion in MYI’s portfolio in the future. The trust also has the flexibility to invest in fixed income securities. The process for identifying, selecting and monitoring sovereign and corporate bonds is the same as for equity investments, with the total exposure, as well as the geographic and sector allocations, a function of the relative value and future prospects of each position. The weight of each holding in the portfolio does not reflect Stout’s level of conviction; he says that he has ‘no favourites’. Instead, the position size reflects how well an investment has performed since purchase. Initial equity investments are generally between 1.0% and 1.5% (while fixed income positions are generally smaller). Once a holding reaches 5% of the portfolio it will be trimmed within 30 days to ensure there is not an undue level of company-specific risk. The manager is also required to sell a holding within 30 days if it is no longer included in Aberdeen Standard Investments’ regional funds.

At end-August 2018, MYI’s top 10 positions made up 32.9% of the portfolio, which was a modestly lower concentration than 34.3% a year before; eight positions were common to both periods. The fund contained 51 equity and 28 fixed income holdings, compared to 50 and 27 respectively at end-August 2017. The trust’s breakdown by security type and geography is shown in Exhibit 4. There has been very little change in the structure of the portfolio over the last 12 months, reflecting the manager’s buy-and-hold investment approach. More than 40% of the portfolio is made up of Asia Pacific ex-Japan and Latin American and emerging markets equities, although Stout stresses that MYI is a global, not an emerging market, investment trust.

Commenting on the relatively low UK equity exposure in the portfolio, the manager notes that many of the larger dividend-paying UK companies have payout ratios above 100%, and Stout believes that a c 4% dividend yield on the UK market compared to a 1.3% UK gilt yield is unsustainable. He says that many UK investors have never experienced a cycle of dividend reductions, and if there is a dividend cut outside of the volatile commodity sector, the effect could snowball. The lack of dividend growth and of solid growth opportunities available in the UK explains the low exposure in MYI’s portfolio.

Within the bond holdings there is a mix of sovereign and corporate debt (mainly local currency, but also US dollar denominated), such as in Brazilian miner Vale and Mexican oil company Petróleos Mexicanos (Pemex). The manager explains that credit spreads have widened as a result of the US’s protectionist policies and MYI’s bond holdings are offering very good value. However, he considers that a c 15% fixed income exposure within the portfolio is sufficient given available opportunities in global equities.

The manager gives a historical perspective to MYI’s bond/equity exposure. He explains that in the run-up to the global financial crisis, UK gilt yields were c 5.5%, which compared to UK equity dividend yields of c 2.5%. As a result, he made a significant investment in both UK and US government bonds (all MYI’s investments are made on the basis of relative value). Fixed income exposure was more than 25% of MYI’s total portfolio, with 88% in equities (including gearing) at the end of 2007. Following the financial crisis in 2008, UK gilt yields fell to c 2.5% compared with a UK dividend yield of c 6.0%. As a result, the fund increased its exposure to equities to a 107% geared position by 2009, with c 8% in fixed income. The manager says that by summer of 2013 equities were looking expensive, but MYI’s fixed income exposure remained modest at 7% due to low bond yields. However, in H214 and 2015, emerging market currencies sold off sharply. The policy response was to raise interest rates, but this choked off economic growth and emerging market currencies fell even further, leading to inflation and even higher interest rates. Stout considered this an opportunity, with the best value to be found in local-currency emerging market debt. As at end-August 2018, MYI’s top 10 fixed income holdings included local currency sovereign debt in South Africa, Mexico, Indonesia and Uruguay, at coupons between c 5% and 7%.

Stout highlights some of the larger equity holdings in MYI’s portfolio. He has held a position in Grupo Aeroportuario del Sureste (ASUR) for around 20 years. ASUR is an international airport group with operations in Mexico, the US and Colombia and has benefited from weakness in the Mexican peso, which leads to increased demand for tourist locations such as Cancun and Cozumel. ASUR has grown from one to four terminals and has been increasing its runway capacity, and adding new shops, which are generating royalties and rental income. It offers a dividend yield of c 2%, which the manager believes will increase as the company’s capex wanes. This is an example of a firm providing a product or service that is in high demand and where the manager believes its competitive position will not be eroded as its business expands; Stout says ASUR holds a quasi-monopolistic position.

The manager has held a position in the world's largest dedicated independent semiconductor foundry, Taiwan Semiconductor Manufacturing Company (TSMC), for around 15 years. Historically, the company was not in a position to return a lot of cash to shareholders, due to the capital-intensive nature of its business. However, TSMC publicly stated that once it was generating higher levels of free cash flow it would be returned to shareholders. The company has followed through on its promises; the forecast TW$9 dividend for 2019 would represent a five-year compound annual growth of c 25%, and the shares are yielding c 3%. Stout says that this dividend progression is very impressive, especially for a technology company, and means that TSMC is not wasting money on mergers and acquisitions or share repurchases.

Elsewhere in the top 10 holdings list, the manager has a position in another Taiwanese company, Taiwan Mobile. He considers it a less exciting company than TSMC; however, it offers a c 5.5% dividend yield and regularly increases its annual distribution at a low single-digit rate. Stout says that Taiwan Mobile provides ballast in the portfolio to the holding in TSMC, with the two combined positions providing a c 4% dividend yield with double-digit dividend growth.

Daito Trust Construction is another multi-year holding. The company is suffering from a shortage of available workers due to competition from other construction companies ahead of the Tokyo 2020 Olympic Games. Stout will continue to hold a position in Daito Trust as the firm has regularly delivered positive results, while the company also offers a c 4% dividend yield, which is unusually high for a Japanese company.

Figures from Aberdeen Standard Investments highlight the manager’s long-term record of outperformance versus the composite benchmark. Stout has generated above-benchmark returns in every calendar year since he assumed the role of lead manager in 2004, with the exception of 2013, 2014 and 2015, which was a period of particular weakness in emerging markets.

In H118 (ending 30 June), MYI’s NAV and share price total returns of -8.0% and -7.5% respectively trailed the benchmark +2.2% total return. The trust’s meaningful exposures to Asia and emerging markets were the largest drags on performance. Although these regions have above-average growth potential, their stock markets sold off due to increased levels of investor risk aversion in response to the US’s protectionist policies. There were also negative currency effects; during the period, for example, the Brazilian real fell by 11% and the Indian rupee declined by 6% compared with sterling. Other reasons for MYI’s relative weakness in H118 were the continued strength of US and Chinese technology stocks, which are under-represented in the portfolio due to their low or zero yields, along with the trust’s exposure to the consumer goods sector, which was a relative underperformer.

MYI has generated solid absolute NAV and share price total returns of c 15% over the last three years, which is broadly in line with the benchmark. The trust has underperformed the composite index over one and five years, and more modestly over 10 years (Exhibit 6). This is a reflection of its conservative approach to capital growth and preservation, coupled with a focus on above-average income, which has meant that MYI has been unable to generate the same level of above-average total returns – largely driven by a handful of giant technology stocks – enjoyed by global equity investors in recent years. However, it should be noted that over the long term, investors in MYI have enjoyed significantly higher returns than if they had invested in a portfolio containing just UK equities, as evidenced by the trust’s outperformance of the FTSE World UK index over three, five and 10 years.

The trust’s relative performance over the last three years is highlighted in Exhibit 7. There was a strong period of outperformance in mid-2016 following the result of the UK’s European referendum, when sterling weakened meaningfully and there was widespread selling of risk assets. In contrast, there was a period of underperformance in November 2016, following the last US presidential election, as investors adopted a ‘risk-on’ mentality. These periods illustrate MYI’s defensive qualities, with its focus on both preserving and growing capital while delivering an attractive level of income to shareholders.

As shown in Exhibit 8, in normal market conditions MYI typically trades close to NAV. The spike in the discount to 11.9% on 27 June 2016 followed the result of the Brexit vote. The trust is trading at a 1.8% discount to cum-income NAV. This compares to a range over the last 12 months of a 5.7% premium to a 3.1% discount. Over the last one, three, five and 10 years, MYI has traded at average premiums of 1.8%, 0.2%, 2.2% and 3.4% respectively. The board employs active share issuance and buyback programmes in response to widening premiums or discounts. It has authority, renewed annually, to repurchase up to 14.99% and allot up to 10% of shares in issue to manage a discount or premium.

MYI now has a more simplified capital structure. On 22 December 2017, the company redeemed its outstanding £150,000 of debenture stock at par plus a 1% premium and accrued interest up to 31 December 2017. This means the trust now has 128.1m ordinary shares in issue (with a further 0.4m held in treasury) and £185m in bank debt. On 1 June 2018, MYI announced a new five-year, £60m loan facility with the Royal Bank of Scotland (RBS) at an all-in rate of 2.325%, which was used to repay a maturing £60m loan with RBS. The trust’s remaining £125m of debt is with the same lender and is made up as follows: £15m at 1.467% (due 16 May 2019); £50m at 2.4975% (due 13 May 2020); and £60m at 1.714% (due 31 May 2022). Financial covenants dictate that MYI’s net assets must exceed £600m (currently c £1.5bn) and borrowings as a percentage of net assets may not exceed 40%; at end-August 2018, net gearing was 11.8%.

Historically, Aberdeen Standard Investments was paid an annual investment management fee of 0.5% of NAV, but with effect from 1 January 2016, there is a tiered fee structure, and there is no longer a performance fee. The management fee is based on the average net assets over the previous six quarters: 0.575% up to £1.2bn, 0.500% between £1.2bn and £1.4bn, and 0.425% above £1.4bn. No fee is charged on investments managed or advised by the Standard Life Aberdeen Group. The annual management fee is charged 30:70 to the revenue and capital accounts respectively. In FY17, MYI’s ongoing charge was 0.64%, which was 4bp lower than 0.68% in FY16 (0.69% in H118).

The board adopts a progressive dividend strategy, which means that in a year where there is a lower level of income received, distributions will be supplemented from reserves. Dividends are paid quarterly in February, May, August and November. In FY17, the total distribution was 50.0p per share, which was 5.3% higher year-on-year (versus a 3.6% rise in the UK retail price index); it was 1.04x covered by income. During the year, income was split as follows: 12.4% from UK equities; 58.6% from overseas equities; and 29.0% from overseas fixed income securities. At end-H118, revenue reserves were £72.3m, which is equivalent to c 1.1x the last annual dividend. Based on its current share price, MYI is offering a dividend yield of 4.5%.

MYI’s revenue stream is highly dependent on the strength or weakness of sterling. The board has considered the risks and rewards of hedging the trust’s currency exposure and has concluded that the risks of increased complexity and the high costs of hedging certain currencies would not be in the interests of shareholders.

Exhibit 9 shows the members of the AIC Global Equity Income sector – MYI is the largest trust by quite some margin. Its NAV total return is above average over three years, while trailing over the other periods shown. This is perhaps unsurprising given above-average equity returns in recent years, and the trust’s aim to both preserve as well as grow capital. MYI is trading at a lower-than-average discount and it has the second-lowest ongoing charge. Its net gearing is broadly average. The trust offers the second-highest dividend yield in the peer group, where the average is skewed by Blue Planet’s double-digit yield. If this fund is excluded, MYI’s dividend yield is the highest in the group and 1pp above average.

There are six directors on the board of MYI, all of whom are non-executive and independent of the manager. The chairman is Kevin Carter; he was appointed to the board on 23 April 2009 and assumed his current role on 28 April 2011. He was previously managing director and head of EMEA Pension Advisory Group at JP Morgan Securities. Carter’s other directorships include the Universities Superannuation Scheme; Lowland Investment Company; JP Morgan American Investment Trust; and Aspect Capital.

Following the retirement of James Best at the 26 April 2018 AGM, MYI’s senior independent director is Peter Dunscombe, who was appointed to the board on 29 April 2011. He is on the investment committees of Reed Elsevier Pension Fund, the Nuffield Foundation and St James’s Place, and is a director of HgCapital Trust and GCP Student Living.

Marcia Campbell (appointed on 27 April 2012) has a background in investment management, David Hardie (1 May 2014) has a legal background, and Alexandra Mackesy (1 May 2016) was formerly an Asian equity research analyst. The newest member of the board is Claire Binyon, who took up her appointment on 1 May 2018. She is a qualified chartered accountant with a background in corporate finance.