Murray International Trust — Things looking good for MYI’s shareholders

As shown in Exhibit 1 (left-hand side) below, over the last decade, global stocks have performed considerably better than the UK market, including an above-average level of volatility in 2022. The uncertain backdrop has continued into 2023, as daily stock market moves appear to be driven by investors’ interpretation of US Federal Reserve comments regarding the direction and magnitude of interest rates. While year-on-year inflation data points have moderated, a tight labour force and rising wages could mean that interest rates remain higher for longer.

Although equity valuations have moderated (Exhibit 1, right-hand side), with the Datastream World Index now trading at a discount to its 10-year average on a forward P/E basis, caution is warranted. Unlike in emerging markets, developed market central banks and corporates are not used to dealing with sustained periods of high inflation. Hence, earnings estimates may prove to be too optimistic. If this is the case, then valuation multiples are less attractive than they appear.

Given that stock market volatility could continue, global investors may be best served by taking a longer-term perspective, seeking quality companies with good growth prospects, despite the uncertain economic backdrop, and that are trading on relatively undemanding valuations.

Stout believes that the most important thing to consider is the realistic expectations for MYI’s portfolio companies in terms of their earnings, dividends and valuations, given the changing economic dynamics during the last few quarters of rising inflation.

The manager highlights that US money supply has increased over the last 40 years, and accelerated during the global pandemic due to transfer payments. He comments that the Federal Reserve has printed money to bail out a series of crises, which has generated inflation in asset prices due to the sheer weight of money. Stout believes that if central banks are serious about bringing inflation down, the bond buyers of last resort are now gone, and bond yields are likely to remain higher than they have been over the last decade. He suggests that 4–5% annual equity total returns are more likely than the double-digit levels seen in several recent years, and valuation multiples should moderate (they compressed in 2022 as interest rates rose). The manager comments that with higher rates the asset bubble has been lanced, and he anticipates a raft of earnings estimate downgrades and earnings declines.

Stout cautions that rising interest rates and falling corporate profits led to three years of accelerating stock market losses between 2000 and 2002. He says that in the UK, investors are focusing on peak interest rates, but there is no evidence that inflation will return to the Bank of England’s 2% target. The manager comments that wages have started to rise due to the tight labour market, which is being exacerbated by a declining participation rate. He expects inflation to be more like 4–5% than 2%, explaining that as wages start to rise, it is difficult to bring overall inflation down. If inflation is higher for longer, Stout opines that equities will face competition for investors’ capital. He explains that emerging market central banks pre-empted inflation as they are used to dealing with rising prices, unlike in developed markets, and were raising interest rates in 2021. As an example, the Brazilian base rate has increased from 2.00% to 13.75% since 2021, and inflation has halved from c 12% in April 2022 to c 6% now, so interest rates could decline, which would be positive for growth and company valuations.

There are some small data discrepancies in Exhibit 2 due to rounding. However, in terms of MYI’s geographic exposure, over the 12 months to end-January 2023, there is a notably higher weighting in Europe ex-UK equities, which was broadly offset by lower allocations to Asia Pacific ex-Japan, UK and North American equities. Exposure to emerging market debt continues to decline.

MYI is required to hold between 45 and 150 positions; at end-January, there were 52 equities and 17 fixed income securities. The top 10 holdings made up 30.1% of the portfolio, which was modestly lower than 31.2% a year earlier; eight positions were common to both periods.

Stout highlights that the top 10 list is diversified by sector and geography, and there is a barbell approach between companies with high dividend yields, including SQM and Philip Morris, and those with lower yields but good dividend growth potential, such as Broadcom.

We discussed MYI’s H122 portfolio activity in our September 2022 review and in this report Fitzpatrick highlights the main H222 transactions. US major pharma company Merck & Co was added to the fund in August 2022; it is a global leader in immunology and generates strong levels of cash flow. Cancer medicine Keytruda is 35% of the company’s revenues and goes off patent in 2028. Hence, planning for the future, Merck is undertaking partnerships and selling its lower-growth businesses, such as women’s health. Gardasil (a widely used human papilloma virus vaccine) had capacity constraints, but these have now eased. The company’s animal health business is viewed as an attractive asset, which the manager suggests could be a valuable spin-off for Merck. It was added to MYI’s portfolio on share price weakness during a period when healthcare stocks were out of favour; since then Merck’s shares have appreciated considerably.

During H222, there were three complete disposals from the fund: Castrol India, which is disadvantaged by higher energy input costs; an América Móvil Mexican corporate bond, which had delivered strong capital growth and income over its five and a half year holding period; and a modest position in Indonesian cement producer Indocement Tunggal Prakarsa.

In FY22 (ending 31 December), MYI meaningfully outperformed the reference index. Its NAV and share price total returns of +8.8% and +20.6% respectively compared with the index’s -7.3% total return. At the stock level, the largest positive contributors to the trust’s relative performance were SQM (+1.8pp), Grupo Aeroportuario del Sureste (ASUR) (+1.7pp) and AbbVie (+1.0pp), while the largest detractors were GlobalWafers (-1.8pp), Taiwan Semiconductor Manufacturing Co (TSMC) (0.5pp) and Samsung Electronics (-0.4pp).

The trust’s best geographic contributors to absolute NAV performance in FY22 were Latin American equities (+38.0%), UK equities (+36.6%) and North American equities (+13.9%), while the worst was Africa and Middle East (just one stock, -20.0%). Sector performance was led by basic materials (+55.7%), energy (+41.4%) and healthcare (+24.2%), with technology (-22.1%), utilities (-19.2%) and telecoms (-5.5%) generating disappointing returns.

Looking at MYI’s 20-year track record to end-2022, data from abrdn show that the trust has generated average annual NAV total returns of +11.0% compared with +9.4% for the world market. MYI’s globally diversified approach has been beneficial as, over the period, the largest annual NAV total returns were from Latin American equities (+19.1%) and Asia Pacific ex-Japan equities (+14.9%). The performance of UK and Japanese equities have lagged with annual total returns of +3.7% and +5.3%, respectively. MYI’s NAV has outperformed the reference index since Q322 (Exhibit 7). As shown in Exhibit 6, its positive relative returns are gaining momentum, as the trust is ahead of the index over the last one, three and six months, and one and three years in both NAV and share price terms, while its NAV is broadly in line over the last five years.

Exhibit 8 shows the six largest companies in the AIC Global Equity Income sector; they employ a range of different strategies. MYI is the biggest fund and is differentiated by its c 45% exposure to emerging markets and its weighting in fixed income securities. The trust’s NAV total return is above average over the last 12 months, ranking second and lower than the mean over the other periods shown. MYI has second highest valuation in the selected peer group, where no funds are trading at a premium. It has the lowest ongoing charge and, in line with its peers, no performance fee is payable. The trust currently has the joint highest level of gearing and, along with another fund, the highest dividend yield, which is 80bp above the mean.

In FY22, MYI’s revenue of 60.1p per share was 16.3% higher than 51.7p per share in FY21, and is now higher than pre-COVID-19 levels. The board has proposed a final dividend of 20.0p per share, which would mean a 56.0p per share annual dividend in respect of FY22 (c 1.1x covered), which is a 1.8% increase compared with 55.0p per share in FY21. The trust now has an 18-year record of consecutive annual dividend increases. At end-FY22, MYI had £69.2m of revenue reserves, which is equivalent to c 1.0x the latest 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.

The managers were very pleased with the quality of the trust’s higher income in FY22, and that, once again, revenue could be added to reserves to be utilised in future years when income is lower. They are mindful that MYI’s income generation could be more difficult if bond yields are higher for longer than expected. However, the trust’s portfolio is more diversified now compared with 20 years ago. If there is a developed market recession and dividends come under pressure, MYI has a tailwind from its broad range of portfolio income.

MYI’s 1.6% discount to cum-income NAV compares with a range of a 2.1% 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 2.8%, 2.9% and 1.4%, respectively, while over the last decade MYI’s shares traded at an average 0.8% premium.

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 FY22, c 0.8m shares were repurchased and held in treasury, which was c 0.7% 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 45% 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. Its currency exposure is unhedged. Gearing of up to 30% of NAV is permitted (in normal market conditions).

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 with 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 the RBSI debt as it falls due over the coming years. MYI’s board is considering options for the loan that expires in May 2023. At 10 March 2023, net gearing was 8.8%.

Since 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 FY22, the trust’s ongoing charge was 0.52%, which was 7bp lower than 0.59% in FY21, helped by the lower tiered fee structure.

MYI is a conventional investment trust with one class of share; there are 125.0m ordinary shares in issue, with a further 4.4m shares held in treasury, and its average daily trading volume over the last 12 months is c 157k shares.

David Hardie will step down from the board on 31 December 2023, and will be replaced as chair by Virginia Holmes. Two new board appointments are expected in coming months.