Murray International Trust — Big improvement in relative performance

In a world where we are relentlessly bombarded by headlines and short-term views, it is important to retain some perspective. As shown in Exhibit 1 (left-hand side), over the long term, investors have been rewarded by considering global rather than UK equities. However, given the very uncertain macroeconomic backdrop it would seem prudent to be extra vigilant when making investment decisions. Many market participants and corporate management teams do not have experience of operating in an environment of high inflation and rising interest rates, so share price volatility could persist for an extended period. Also, while valuation multiples have moderated, these may prove to be illusory if consensus earnings estimates prove to be too optimistic. A focus on both capital growth and income, seeking reasonably priced companies with robust fundamentals and pricing power that can be held for the long term, may be a sensible strategy to ride out the current storm.

Stout comments that this year has been a very difficult period for investors with inflation re-emerging and the war in Ukraine further negatively affecting global supply chains. He highlights that MYI aims to offer long-term capital growth above the UK Retail Price Index (RPI) (and capital preservation during market weakness), dividend growth above the UK RPI, a covered dividend and an above-average yield. The manager says that in the current environment it will be very difficult to generate above-inflation capital growth given the ultimate UK inflation rate is unknown, although he is very pleased that MYI’s income so far this year has exceeded expectations following on from a very tough 2020. Stout explains that the trust’s annual dividend has grown faster than the rate of UK inflation for 15 of the last 17 years, but with a much higher inflation rate this will be trickier now.

Highlighting the focus on capital preservation, the manager explains that MYI’s relative monthly performance in down markets is +0.76% (83 months), while in up markets it is -0.22% (151 months). Stout stresses that MYI’s portfolio is constructed on a bottom-up rather than a top-down basis, and he says it is important to determine the impact of inflation on investee companies’ businesses. Considering the macroeconomic backdrop, the manager comments that in developed markets such as the UK and the United States there is ‘an obsession with the outlook for short-term interest rates’. The manager suggests that central banks in these regions have been panicked into action in response to rapidly rising inflation and have been hiking rates at the fastest rate in many years. However, he says that economic activity is dependent on the long end of the yield curve and there has already been a significant backup in US and UK long-term bond yields. Stout opines that ‘no-one knows when inflation will peak and where long-term interest rates will end up’. He notes that other countries are nearing the end of their interest rate tightening cycles. In Brazil, the base rate has increased from 2.00% to 13.75% and inflation has moderated, while the manager suggests that the Mexican central bank has been raising interest rates and could start to ease monetary policy in the next few months. Stout comments that some parts of the world are countercyclical, and their central banks were pre-emptive in tightening interest rates in 2021.

Expanding on his perspectives, the manager stresses the importance of understanding long-term inflation. He says that there was inflation in the worldwide economy for the last 20 years, which the markets considered to be acceptable. Stout adds that enormous quantitative easing and the expansion of central banks’ balance sheets and the inflation of government debt was viewed by investors as a good thing, with the additional money printed invested in other assets such as equities, leading to an expansion in equity valuation multiples. The manager says that modest inflation expectations were based on the misguided assumption that interest rates would stay low forever and suggests that the current wage/price inflation is a product of the ‘financial largesse over the last 15 years’.

Stout considers that a 2.0% target inflation rate is ‘delusional’ and looking at past cycles, he notes that it tends to take five-to-six years to bring inflation under control. The manager points to a complete lack of quantitative tightening, even in 2018 when interest rates were rising, and suggests that if this were to happen now it would put upward pressure on longer-dated interest rates; hence, there is no evidence of a stomach for quantitative tightening when it could tip economies into recession. He adds that it is also ‘not a good time to pay more for mortgages when the cost of living is rising significantly’, and we are starting to see the impact of wage inflation on corporate margins. Stout comments that businesses in emerging markets are used to inflation, having experienced it many times before; central banks in these regions have been proactive in response to rising prices, while developed market companies are not used to dealing with extended periods of higher input costs. He adds that inflation distorts valuations, commenting that there has been a steady improvement in corporate margins over the last 15 years, but this could change, especially in labour-intensive industries and the ‘gig economy’. He opines that this has broader implications for credit quality and business financing, and while we are still early on in terms of an interest rate tightening cycle, ‘a lack of profits plus cash burn is a real problem for some companies’.

Turning his attention to China, the manager says that the government’s zero-COVID-19 strategy has dampened corporate earnings. However, activity is recovering and with core inflation consistently below target rates, he believes there is scope for further easing, leading to a recovery in corporate margins, which would be positive for the rest of Asia. Stout says that China remains a very important part of the global equation and it would be very difficult from a political perspective if there was no domestic growth in the country, so it seems fair to assume that the authorities would take active measures to ensure that this does not happen.

MYI’s board requires that the fund has between 45 and 150 positions; at end-July 2022, there were 54 equities and 19 fixed income securities. The top 10 holdings made up 29.5% of the portfolio, which was broadly in line with 30.0% a year earlier; six positions were common to both periods (Exhibit 2).

ASUR is MYI’s largest holding and is an operator of 16 airports in central and Latin America. The managers stuck with this position during a very difficult COVID-19 affected 2020 as they have faith in how the company has dealt with periods of industry weakness in the past. Its management put cash away for a rainy day and there is a net-cash position on ASUR’s balance sheet. The company has long-term concession agreements with established regulatory frameworks and has consistent and balanced growth between international and domestic traffic, and there is a clear runway on the company’s capex plans for both 2022 and 2023. Around two-thirds of ASUR’s revenues are regulated fees, including airline and passenger fees. However, according to the managers, there are real growth opportunities in its retail, food and beverage, banking and FX, car rental, parking and ground transportation operations. ‘More passengers spending more money and a captive audience offers the company real pricing power in an inflationary environment’ say the managers.

A stock that has performed particularly well in MYI’s portfolio is top 10 holding SQM, which is a Chile-based lithium and plant nutrient company; its stock has more than doubled this year. Around one-third of its revenues are derived from lithium, where there is a global shortage due to high demand from electric vehicle manufacturers for example. Another third of SQM’s revenues is from potassium, which is used in the manufacture of fertilisers. There is also a global shortage of potash- and potassium-based fertilisers due to the war in Ukraine, which has led to significant price increases. The managers considered it prudent to take profits in MYI’s fertiliser exposure, so they reduced the SQM position and sold the Nutrien holding (see below).

Exhibit 3 shows MYI’s geographic exposure. Over the 12 months to end-July 2022, the largest changes were a 3.9pp higher weighting to Europe ex-UK and lower allocations to Asia Pacific ex-Japan (-2.7pp) and North America (-2.5pp).

Fitzpatrick explains that MYI’s portfolio activity in H122 was higher than normal as market volatility led to more attractive opportunities. Siemens entered the portfolio in February 2022 and is a diversified German multi-industrial company that is benefiting from the trends of increased automation and electrification. Its shares trade at a discount due to the firm’s conglomerate structure, which provided the managers with a favourable entry point. Danone was purchased in April 2022 to further diversify MYI’s consumer staples exposure. The company is a major global player in the dairy and water categories and has a new management team, which offers a turnaround opportunity. Investors are sceptical about this occurring, which allowed the managers to initiate a position at an opportune price. BE Semiconductor was added to the portfolio in February 2022 and was funded by reducing MYI’s semiconductor exposure in TSMC and GlobalWafers. The company has a leading position in advanced packaging within the semiconductor industry and its customers include industry heavyweights Intel and TSMC. While the BE Semiconductor position has not performed well since purchase, the managers are confident about the company’s long-term growth prospects helped by the digital and cloud infrastructure build out and the growth in 5G networks, artificial intelligence, data centres and electric vehicles, among others. They believe that BE Semiconductor is a well-managed business that brings ‘something a little bit different’ to the portfolio. The Woodside Energy position is a result of BHP selling its petroleum portfolio to the company in exchange for Woodside Energy shares, as BHP is focusing on its cleaner gas assets and strengthening its balance sheet. MYI’s holding was switched from UK- to Australia-listed shares due to lower liquidity in Woodside’s UK listing.

Complete disposals in the fund were all on valuation grounds. PepsiCo was trading on a 20-year high earnings multiple, with an unattractive dividend yield and cost pressures were weighing on its margins. Nutrien’s shares had performed well on the back of rising potash prices, while Schlumberger’s shares had done relatively well within the energy sector; this was a relatively small position and there is a trend of an increasing number of orders heading towards the alternative energy rather than the oilfield services sector. MYI had a holding in an Indian corporate bond that was trading above par so was used as a source of cash in March 2022 to add to the positions in Zurich Insurance group and Nordea.

In H122 (ending 30 June), MYI’s NAV and share price total returns of +3.8% and +9.5% respectively were considerably better than the reference index’s -10.5% total return. By geography, the best performing regions were UK equities +27.2% (2.8% of end-H122 NAV), Latin American equities +24.1% (11.9%) and North American equities +13.6% (25.1%), while the worst performing were European equities -5.4% (22.6%) and Asian equities -5.1% (27.1%).

There was a wide range of sector returns in H122, with the best performing being basic materials +36.3% (7.5%), energy +32.0% (9.6%) and healthcare +19.8% (11.5%), and the worst performing by far were technology -24.0% (14.1%) and utilities -21.9% (1.1%).

MYI’s performance has improved over the last year as investors have moved away from their multi-year preference for growth stocks due to rising interest rates. Its NAV and share price are ahead of the reference index over one, six and 12 months. Illustrating the potential benefits of investing overseas, the trust has outperformed the broad UK market over almost all the periods shown in Exhibit 6 in both NAV and share price terms. Stout believes that MYI’s current reference index keeps things simple but does not reflect what the trust is trying to achieve in terms of long-term capital growth, while preserving capital during periods of stock market weakness, and an above-average dividend yield with real income growth. The manager points to MYI’s more than 25k individual investors who like the team’s investment approach and often contrarian views.

MYI is by far the largest of the seven funds in the AIC global equity income sector. They follow a range of different investment mandates; for example, MYI is differentiated by its c 50% exposure to emerging markets and currently has a single-digit percentage weight in fixed-income securities. The trust’s more-defensive portfolio has performed relatively well so far in 2022 as investor appetite for growth stocks has waned in an environment of rising interest rates. As a result, MYI’s NAV total return ranks first over the last 12 months, a not insubstantial 11.8pp above the peer-group average and 4.2pp higher than the second-ranked fund. The trust’s NAV total return is above average over the last three years, ranking fifth, but trails over five and 10 years ranking sixth over both periods. MYI’s discount is below average in a group where only one fund is trading at a premium and one has a noticeably wide discount. The trust has a competitive ongoing charge, ranking second (no performance fee is payable) and it has the highest level of gearing. MYI is the second-highest yielding fund, which is 0.5pp above the mean.

MYI’s H122 income of £45.5m was a meaningful 23.2% increase year-on-year as the trust’s receipts are recovering from the COVID-19 induced weakness. The board has announced that the FY22 annual dividend will at least match the 55.0p per share (0.94x covered) FY21 distribution, although MYI’s annual dividend has increased for the last 17 consecutive years. At end-H122, the trust had £63.3m of revenue reserves, which is equivalent to c 0.9x the last annual payment. Since 2021, the managers can write covered put and call options on underlying portfolio investments and employ stock lending to generate a modestly higher level of income. Based on its current share price, MYI offers an attractive 4.5% dividend yield.

With the improving income profile, Stout suggests that the trust is on track for a covered divided. He says that the largest dividend improvements have come from banks, insurance and energy companies. However, firms can come under political pressure if their dividend growth is considered to be too high, especially given the rising cost of living; hence, companies are also returning cash to shareholders via share repurchases, which is not MYI’s preferred option. There have also been a couple of dividend cuts in the portfolio including Taiwanese semiconductor company GlobalWafers, where a deal to buy German-based Siltronic fell through due to a lack of approval by the German regulators meaning GlobalWafers now has higher internal funding requirements.

Over the course of 2022 to-date, MYI’s discount has been in a narrowing trend (Exhibit 10), which may be reflecting the trust’s improved relative performance. The 5.1% discount to cum-income NAV compares with a range of a 0.0% premium to a 9.3% discount over the last 12 months. Over the last one, three and five years the trust’s average discounts are 4.8%, 2.2% and 1.0% respectively.

Renewed annually, the board has the authority to issue up to 10% and repurchase up to 14.99% of MYI’s issued share capital. Aiming to reduce volatility in the trust’s valuation and make a small positive contribution to the NAV, the board repurchases shares if they trade at a persistent discount to ex-income NAV, while issuing shares if they trade at a persistent premium to cum-income NAV. During H122, a modest c 0.5m shares were repurchased and held in treasury, which was c 0.4% of MYI’s share base.

Launched in December 1907, MYI is one of the oldest UK investment trusts; it is listed on the Main Market of the London Stock Exchange. Bruce Stout, a senior investment director in abrdn’s global equity team, has been the trust’s lead manager since 2004, although he has been directly involved with MYI since 1992. He works closely with investment directors Martin Connaghan and Samantha Fitzpatrick. The team 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. Around 50% of the fund is invested in emerging markets as the managers believe these regions offer the prospect of higher economic growth alongside relatively attractive company valuations.

MYI’s performance is measured against an all-world reference index; before 27 April 2020 it was benchmarked against a composite measure (40% UK and 60% world ex-UK). The trust’s investment objective was also changed on this date, aiming to achieve an above-average dividend yield, with long-term growth in dividends and capital ahead of inflation, by investing principally in global equities (MYI’s prior aim was to achieve a total return greater than its benchmark by investing predominantly in equities worldwide). The board believes the different wording gives shareholders a clearer picture of what the trust is trying to deliver.

There are no geographic or sector limits on portfolio construction, but at the time of investment, a maximum 5% of the fund is permitted in a single security, although in practice this percentage is much lower. From time to time, the trust may invest in equity-related securities such as depositary receipts, preference shares or unlisted companies and derivatives are permitted for efficient portfolio management. Gearing of up to 30% of NAV is permitted (in normal market conditions); at 16 September 2022, net gearing was 11.7%.

Stocks are selected on a bottom-up basis, so sector, regional and country allocations are a result of these decisions. abrdn employs a long-term approach, focusing on companies that its research analysts identify as high quality. Firms are considered on five key factors: the durability of its business model and its economic moat; the attractiveness of the industry in which it operates; the strength of its financials; the capability of its management team; and an assessment of its ESG credentials. Company valuations are assessed across a variety of relevant measures including earnings yields, free cash flow yields and dividend yields. The managers select companies that have the most attractive quality and valuation characteristics, while offering the best expected risk-adjusted returns. abrdn uses a global coverage list that is constructed by each of the specialist regional analyst teams (UK, Europe, Asia Pacific ex-Japan, North America, Japan and emerging markets) containing all companies with buy-and-hold recommendations, which provides the trust’s investment universe.

For MYI’s fixed-income holdings, the process for selecting and monitoring both sovereign and corporate bonds follows the same methodology used for equity investment. Portfolio geographic and sector exposures are a function of each security’s relative valuation and prospects. Within the portfolio there are typically 60–80 companies across the market-cap spectrum ranging from position sizes of between c 1% and c 5%. Equity holdings are generally initiated at around 1.0% to 1.5% of the fund, while initial fixed income positions tend to be smaller. If a holding reaches 5% of the portfolio, it is trimmed within 30 days and the manager will sell a holding within 30 days if it is no longer rated buy or hold on abrdn’s global coverage list, subject to the timing of dividend payments.

Although ESG and climate-related factors are not the overriding criteria in relation to the managers’ portfolio decisions, they do form a very important part of the investment process and have done so for more than 30 years for three key reasons:

The managers can draw on the resources of abrdn’s ESG equity analysts and central ESG investment team (more than 20 experienced specialists) who collaborate to generate a deep understanding of the ESG risks and opportunities associated with each company analysed.

Climate change risks are vast and becoming increasingly financially material for many of abrdn’s investments not only in the high-emitting sectors, such as energy, utilities and transportation, but also along the supply chain, for providers of finance and those reliant on agricultural outputs and water. Companies that successfully manage climate change risks are expected to perform better over the long term.

A systematic and globally applied approach to evaluating stocks allows abrdn to compare companies consistently on their ESG credentials, both regionally and against their peer group. Findings from research and company meetings are captured in formal research notes. All firms analysed are allocated an ESG rating between 1 and 5, where 1 is best in class; 2, leader; 3, average; 4, below average; and 5, laggard. Once abrdn invests in a company, it is committed to helping that firm maintain or raise its ESG standards further. Regular engagement is seen as a necessary fulfilment of its duty as a responsible steward of clients’ assets and provides an opportunity to share examples of best practice seen in other companies.

MYI has total borrowings of £200m with The Royal Bank of Scotland International (RBSI): a £50m 10-year senior unsecured loan note at an all-in annualised interest rate of 2.240% expiring on 31 May 2031 and three unsecured fixed-rate term loans (£60m at 2.830% expiring on 31 May 2037, £60m at 2.328% expiring on 31 May 2023 and £30m at 2.250% expiring on 16 May 2024). The trust also has a £150m facility available for drawdown, which the board intends to use to repay MYI’s RBSI debt as it falls due over the coming years. At 16 September 2022, net gearing was 11.7%.

From 1 January 2022, MYI has a reduced tiered fee structure of 0.5% of NAV up to £500m and 0.4% of NAV above this level (previously 0.5% of NAV up to £1.2bn and 0.425% of NAV above £1.2bn). It is split 30:70 between the revenue and capital accounts respectively. In H122, the trust’s ongoing charge was 0.55%, which was 4bp lower than 0.59% in FY21. The board remains focused on controlling costs, so the lower management fee should help to contribute to a further reduction in the ongoing charge in the future.

MYI is a conventional investment trust with one class of share; there are 125.3m ordinary shares in issue, with a further 4.1m shares held in treasury, and its average daily trading volume over the last 12 months is c 175k shares.

On 22 June 2022, the board announced the appointment of Virginia Holmes as an independent non-executive director with immediate effect. As the former CEO of AXA Investment Management, she brings significant senior asset management expertise and experience to MYI’s board. Holmes is currently chair of trustees at the Unilever Pension Fund, senior independent director at Syncona and European Opportunities Trust and chair of the remuneration committee at Intermediate Capital Group. She was previously chair of USS Investment Management and of BA Pension Trustees, a founder director of the Investor Forum, non-executive director of Standard Life Investments and chair of the investment committee at Alberta Investment Management Corporation.