Murray International Trust — Real income fund with diversified revenue stream

As shown in Exhibit 1 (left-hand side), share prices have recovered very strongly following the Q120 market sell-off; investors have been heartened by unprecedented fiscal and monetary support from central governments and the prospects of economic recovery helped by the roll-out of COVID-19 vaccines. However, there has been significant multiple expansion, as shown in the table below, which suggests that there may be a period of market consolidation as corporate earnings catch up with higher company valuations. The US market is looking particularly stretched, with the Datastream US index trading on a forward earnings multiple of 21.6x, which is close to its 23.8x 10-year high and a 27% premium to the average over this period. There is uncertainty about the path to a global economic recovery given different speeds of vaccine roll-outs across the world, risks of coronavirus variants and current supply chain issues, which are feeding into higher levels of inflation. With this growth and valuation backdrop in mind, investors may be well served by focusing on high-quality businesses that are trading on reasonable valuations.

When discussing the macroeconomic background, Stout says there are four important market themes for 2021. COVID-19 cases and vaccines – the manager says that one of the hardest questions to answer is what will happen to the pandemic. ‘It is a clinical issue as the disease is mutating and evolving, so either we will develop herd immunity, or we will have to learn to live with the virus’. Stout comments that despite the vaccine roll-out, the number of cases is rising as more people are being tested. Asia and emerging markets do not have the same access to vaccines as developed markets, although Japan is an exception among the latter as the take-up rate has been very slow ‘for a variety of reasons’.

A large amount of semiconductor testing is undertaken in Malaysia, which is experiencing another wave of COVID-19 cases, so lockdowns there are exacerbating the shortage of semiconductors in the global supply chain. The manager expects that once the vaccine roll-out accelerates, there should be an easing in supply chains and emerging market economic growth should follow the trajectory seen in many of the developed markets. He comments that this will be important in terms of Asian companies’ ability to pay higher dividends. Stout says that the vaccine roll-out is integral in terms of releasing pent-up demand, which he suggests will be very supportive for economic growth and corporate earnings. As a result, the manager is very positive on the outlook for dividend growth in 2022. He explains that Asian companies have strong balance sheets but have kept their pay-out ratios steady so lower income has meant lower dividend payments. The manager cites The Oversea-Chinese Banking Corporation in Singapore, which has a ‘fortress’ balance sheet but was squeezed by the regulators to cut its dividend. Stout explains that over the last 10–20 years there has been a change in attitude by Asian companies towards paying dividends. Following the Asian financial crisis, which started in July 1997 and was a result of corporate leverage, firms were very conservative. However, they are now more keen to return cash to shareholders, and given that the earnings of Asian companies are much stronger in 2021 compared with last year, the manager is confident about the outlook for dividend growth in the region.

Global growth and inflation – Stout wonders ‘what the economic growth profile once the pent-up demand surge is sated will be’. He highlights Europe following the global financial crisis, where the long-term GDP growth trajectory fell from 2.5% pa to 1.8% pa and then to 1.2% pa, which led to negative real income growth. The manager explains that the debt legacy curtailed domestic demand and there were restrictions on bank lending. He cites Italy, where he says that from the introduction of the euro to today, there has essentially been zero real economic growth over more than 20 years. Stout suggests there could be another downshift in economic growth in developed markets due to the increased debt burden as a result of coronavirus leading to a ‘nobody’s fault recession’. He says that fiscal policy has taken over from monetary policy and debt levels are huge in developed markets, so the manager sees better growth prospects in emerging markets, where he thinks there is a greater ability to see rising real incomes.

Central bank policy and bond yields – the manager believes that the idea that higher inflation is transitory and that supply disruptions will be quickly ironed out is ‘wishful thinking’. He cites rising house prices over a prolonged period and higher commodity prices, and suggests that fiscal policy needs to remain expansionary in developed markets until unemployment falls. The manager also points to higher wage inflation, which will be important to monitor. There had been very low inflation expectations, but in the UK, for example, with 10-year government bond yields at 1.2% and year-on-year inflation running at 3.2%, there is a 2.0% negative real yield; in such an environment, wage gains as low as in the low-single digit range look ‘unlikely’. Stout also highlights moves towards deglobalisation with the increased number of tariffs, along with product shortages, which are also inflationary. While policymakers want a certain level of inflation, the manager suggests that many of them do not have experience of operating in a period of high inflation, and do not understand how dangerous this is in terms of wealth erosion, referring to it as ‘financial repression’. Stout says that emerging market policymakers are pre-empting inflation risks by raising interest rates, suggesting ‘they are ahead of the curve compared with those in developed markets’.

Market implications – the manager asks, ‘if there is inflation and monetisation of fiscal policy (printing money), how will bond yields not go up?’. He suggests this is only possible by monetary manipulation and financial repression, which is evident in Japan where banks and insurance companies have to hold a certain percentage of bonds in their portfolios regardless of the level of yields. Stout says this is the ‘slippery slope to financial repression’; bond yields have been declining for 40 years and there have been negative nominal yields in Europe for the last seven years.

The manager comments that investors are ‘obsessed with the 2013 taper tantrum’, which was a collective reactionary panic that triggered a spike in US treasury yields after investors learned that the Federal Reserve was slowly putting the brakes on its quantitative easing programme. This stance was eased following an equity market sell-off; hence in the United States, ‘there is no credibility in establishing a positive real yield’ opines Stout. However, if interest rates do not go up, he believes that inflation will take hold; he suggests that we could ‘see vast changes given that we have not come out of a pandemic before’. He adds that ‘emerging out of a war, it can take 10 years to rebuild an economy due to a lack of capacity, but that is not the case now’, while he considers that inflation in the labour market is a real problem.

Within the US stock market, the manager notes that passive flows now make up 52% of S&P 500 index trading volumes. There have been huge inflows over the last year, and the top five constituents now make up 24% of the S&P 500 index, while the top five NASDAQ index companies are an even more concentrated 41%. Contrasting this with emerging markets, he suggests that despite a huge surge in global trade, ‘investors seem to be disinterested in these regions, hence valuations here look very attractive on both an absolute and relative basis’.

The manager says that for MYI, it is very important to invest in companies where there is a high level of conviction that dividends will be paid. He says that the trust’s diversified portfolio ‘has been out of favour in recent years’ and with inflation risks rising, a focus on investing in real assets is advantageous. Stout believes that following a strategy of investing in thematic technology stocks is ‘dangerous’ and wonders how these businesses will respond in an inflationary environment, especially given that many corporate executives and market participants have not experienced such a backdrop before.

As shown in Exhibit 2, over the 12 months to end-August 2021 there was 4.6pp shift from bonds/cash into equities, with the largest total geographical weighting changes (equities and fixed income) being higher weightings to Europe ex-UK (+3.5pp) and North America (+2.9pp) and lower exposures to Latin America and emerging markets (-3.8pp) and Asia Pacific ex-Japan (1.3pp).

At the end of H121 (ending 30 June), MYI was invested in more than 20 countries, offering investors a geographically diversified portfolio. At end-August 2021, the trust held 75 positions: 52 equities and 23 fixed income (the board requires a total number between 45 and 150). The top 10 made up 29.8% of the fund, a modestly lower concentration compared with 30.3% a year earlier; seven positions were common to both periods. The active share was 93.4% (a measure of how a portfolio differs from an index – 0% is full replication and 100% is no commonality).

Starting off with the pharmaceutical area, Connaghan highlights MYI’s portfolio activity over the last few months. There are new positions in Bristol Myers Squibb (US) and Sanofi (France), which has a relatively new management team. Their share prices were reasonably valued as investors had concerns about the companies’ future pipelines and, in the case of Sanofi, the prior management team did not deliver on consensus expectations. These companies have been growing their dividends and are yielding above 3%. The managers are diversifying MYI’s pharma exposure away from Johnson & Johnson (US), Novartis (Switzerland – position sold, as better upside potential identified elsewhere in the industry) and Roche Holding (Switzerland).

In addition to Novartis, in recent months there are other complete disposals. Bayer was sold as Roundup is continuing to weigh on the company (Roundup is a weedkiller and there are accusations that it causes cancer; it was acquired as part of the takeover of US-based Monsanto in June 2018). The managers are also concerned about Bayer’s product pipeline and patents. Connaghan suggests the company’s management is not allocating capital efficiently as it is being distracted by the ongoing Roundup issues. The holding in Swire Pacific was sold, with the proceeds used to fund the position in China Vanke and to increase MYI’s holding in China Resources Land. Intel has exited the portfolio as the managers are concerned it is falling behind its competitors such as GlobalWafers and Taiwan Semiconductor Manufacturing Company. There have been delays in releasing its 7nm chips and has had to outsource production. Connaghan says Intel’s strength is designing rather than manufacturing; he believes the company would be more efficient if it operated a fab-light or fabless business model. The company has a very strong balance sheet and high levels of technological intellectual property, but the manager suggests Intel has been spending too much capital on fabs. He comments that ‘MYI made a lot of money in a short space of time in this stock’. Within the fixed income portion of the portfolio the position in Alfa 6.875% 25/03/44 bond (Mexican real estate) was sold due to an unattractive valuation.

MYI has a new holding in Chinese real estate company China Vanke, which is engaged in developing, managing and selling properties. This sector, when you take into account the knock-on effect to the wider economy, generates between 25% and 30% of economic output in the country. The Chinese authorities are tightening regulation of the real estate sector; under the ‘Three Red Lines’ policy companies are scored as green, orange, yellow or red based on their cash-to-short-term debt ratio, net gearing ratio and liability-to-asset ratio. China Vanke passes these tests, but around half of the 66 major developers in the country were not at one point. Connaghan points to the company’s inexpensive valuation, trading on a mid-single digit forward P/E multiple and offering a 5.7% yield with a growing dividend. While China Vanke has a lower growth rate due to reduced leverage, the manager says its growth is now of a higher quality. The company is taking market share as its weaker competitors are having to dispose of some of their assets. Connaghan believes China Vanke’s management team is ‘on the front foot’ and is diversifying the company’s operations. The firm is ‘one of the best quality operators in a tough industry’, he adds. However, readers should note that the unfolding events at major property company Evergrande Group could have an adverse effect on investor sentiment towards Chinese real estate firms.

In H121, MYI’s NAV and share price total returns of +8.7% and +7.3% respectively did not keep pace with the reference index’s +11.4% total return. In terms of geographic contribution, the best absolute total returns came from the fund’s North American and Latin American equities (+13.4% and +11.1% respectively), while emerging market bonds detracted from MYI’s performance (-1.4%). In sector terms, the trust generated the best returns from its holdings in energy (+17.8%), basic materials (+17.0%), technology (+13.6%) and industrial (+11.3%) stocks. Two sectors declined in value: utilities (-6.9%) and real estate (-3.6%).

Exhibit 6 highlights MYI’s relative performance, its NAV is ahead of the reference index over the last one and 12 months, while lagging over the other periods shown. Compared with the broad UK market, the trust has performed somewhat better illustrating the potential benefits of investing overseas, when UK shares are underperforming.

Stout comments the ‘reference index is irrelevant to shareholders as they want real income growth’. He says MYI is a ‘proper income fund’ and dividends should be fully covered. As a result, there are no holdings in the large-cap US technology companies, which have performed very well in recent years, as they do not deliver the required level of income. The manager adds that ‘the choice of the current reference index keeps things simple but does not reflect what MYI Is aiming to achieve’. It has more than 25k individual investors who favour the managers’ strong investment discipline and contrarian views.

MYI is the largest fund in the AIC Global Equity Income sector by a large margin. The seven funds follow a variety of investment strategies; for example, MYI is differentiated by a higher-than-average emerging market exposure. Its NAV total return is broadly average over the last 12 months, ranking third, but below the mean over three, five and 10 years, ranking sixth in each period. The trust’s discount is above average in a group where two funds are trading at a premium and one has a noticeably wide discount (its largest position at c 14% is a stake in Majedie Asset Management). MYI has a competitive ongoing charge, ranking second, and no performance fee is payable and it has the highest level of gearing. The trust ranks first in terms of its dividend yield, which is 1.5pp above the average.

The FY20 annual dividend of 54.5p per share (0.85x covered) was a 1.9% increase compared with 53.5p in FY19 and above the level of UK inflation (Retail Prices Index +1.2%). So far in FY21, two interim dividends of 12.0p per share have been declared (both in line with the prior year). The board has indicated the FY21 annual dividend will at least match the 54.5p per share paid in FY20 and follows 16 years of consecutive annual growth. Over the last 20 years, dividend cover has ranged from 0.80x (in FY03) to 1.19x (in FY11). At end H121, MYI had revenue reserves of £58.2m, which is equivalent to c 0.8x the last annual dividend. Starting in 2021, the manager is now able to 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 a 5.1% dividend yield.

Over the last three years, MYI has generally traded in a range of a 5% premium to a 5% discount to cum-income NAV (Exhibit 10). Its shares are currently trading at a 7.3% discount, which compares with a range of a 4.0% premium to an 8.2% discount over the last 12 months. Over the last one, three, five and 10 years the trust has traded at average valuations of a 1.8% discount, a 0.8% discount, a 0.0% discount and a 2.1% premium respectively. Stout explains than in general, investment trust discounts have widened. Some have thin trading volumes and ‘global funds are not so much in favour; investors are preferring more specialist funds’ he suggests.

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 H121, a modest 69.7k shares were repurchased (Exhibit 11) as the board is committed to using money wisely and will not aggressively chase shares when trading volumes are modest.

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 Stout believes these regions offer the prospect of higher economic growth alongside relatively attractive company valuations.

MYI’s performance is now 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 new 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 15% 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 8 October 2021, net gearing was 12.6%.

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 economic, social and governance (ESG) credentials. Company valuations are assessed across a variety of relevant measures including earnings yields, free cash flow yields and dividend yields. The manager targets a double-digit annual total return from MYI’s holdings, selecting 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 40–60 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 the global coverage list.

Although ESG and climate-related factors are not the overriding criteria in relation to Stout’s 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 manager can draw on the resources of abrdn’s ESG equity analysts and central ESG investment team 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 in 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.

On 12 April 2021, MYI’s board announced it had agreed terms to extend part of the trust’s long-term borrowings through the issuance of a £50m 10-year senior unsecured loan note at an all-in annualised interest rate of 2.24%. The proceeds were used to repay a £50m revolving credit facility with The Royal Bank of Scotland International (RBSI), which expired 13 May 2021. Under the terms of the loan note agreement there is also an additional £150m facility available for drawdown for a five-year period, which will be used to repay MYI’s existing RBSI debt as it falls due over the coming years. The trust has total borrowings of c £200m, which represented net gearing of 12.6% at 8 October 2021.

MYI has a tiered management fee structure: 0.500% of NAV up to £1.2bn and 0.425% of NAV above this level. It is split 30:70 between the revenue and capital accounts respectively. In H121, the trust’s ongoing charge was 0.60%, which was 8bp lower than 0.68% in FY20, helped by an increase in net assets and lower administrative costs.

MYI is a conventional investment trust with one class of share; there are 128.0m ordinary shares in issue, with a further 1.5m shares held in treasury, and its average daily trading volume over the last 12 months is c 184k shares.

MYI has had a formal succession plan in place for many years and the board has a diverse range of skills and experience. On 13 April 2021, it was announced that Nicholas Melhuish was appointed as an independent non-executive director with effect from 1 May 2021. He joined Corpus Christi College, Oxford as a fellow and bursar in 2018 following a career in portfolio management including as head of global equities at Amundi. Melhuish is a non-executive director of JPMorgan Claverhouse Investment Trust, a trustee of the Trusthouse Charitable Foundation and a director and trustee of The London Clinic.

Following the conclusion of MYI’s AGM on 23 April 2021, Kevin Carter and Marcia Campbell retired from the board and Simon Fraser was appointed as chairman. However, on 10 August 2021 it was announced that Fraser had died following a short illness. David Hardie has agreed to chair MYI on an interim basis, while Alexandra Mackesy has taken on his role as senior independent director. The board will be undertaking a search for additional non-executive directors to bring the count back up to six, from the current four.