The case for capital preservation trusts
Previous columns have highlighted in some detail why markets will continue to climb the wall of worry and yet also the importance of increasing diversification as an investor’s risk-adjusted investment journey unfolds, especially as financial goals draw near. To this end, the portfolios employ various ‘alternative’ assets including bonds, precious metals, commodities, infrastructure and commercial property. Also included are capital preservation trusts which are sometimes the unsung heroes in this category given their track record and consistency of returns over the various cycles. This reduced volatility is particularly helpful as a source of firepower when markets succumb to the inevitable wobble.
Keep on climbing
These rising markets have been increasingly irking the sceptics. There has in particular been much talk as to ‘all-time highs’, and warnings that stocks have never been so expensive. Such thinking is somewhat convoluted. Previous highs must be breached if markets are to progress, just as good walks consist of an increasing number of steps. The reasons for my turning more positive on equities in early 2023, and remaining so, have been well-rehearsed in these columns at the time and since – most recently ‘Retaining faith in equities’ (21 June 2024). However, the graph from Montanaro Asset Management caught my eye as it reminds us that markets often climb walls of worry – the current example is no exception.
The Global Economic Policy Uncertainty index captures the frequency of its 21 major country members when their newspapers mention terms such as economy, policy and uncertainty. Given sentiment influences the direction and gradients of markets, it is perhaps as useful an indicator as to the extent of ‘worry’ as any and neatly climaxes at key moments of concern (such as the Russian Debt crisis, the Eurozone crisis and Covid), at which points the S&P500 usually has a brief wobble. Yet, as one would expect, the graph goes on to confirm the market continues to reward those investors who can take a medium to long-term view. The current extent of divergence between the market and index is worthy of note.
And whatever one’s views of Trump, his victory is further fuelling the market’s rise. Having been named ‘Time Person of the Year’, he celebrated by ringing the bell at the NYSE last week to shouts of “USA! USA! USA!” from a Wall Street chorus as the market moved higher. When in office, he plans to reduce corporate taxes by a quarter for businesses manufacturing in America (thus removing the uncertainty of the Democrats possibly raising them), meaningfully cut regulation and the size of the state, and quicken the pace of government bureaucracy. This is straight out of the bag of President Milei in Argentina, whose popularity is holding firm. There is little for the market to dislike.
Yet it is at such times of euphoria that those investors requiring a degree of defensiveness should be ensuring the extent of their portfolio’s diversification is fit for purpose. The litmus test perhaps is not only that it meets their perceived risk profile, but that they can sleep at night when the next market wobble appears. Selling equities after a market correction and then trying to time the re-entry is a fool’s game – time in the market is better than market timing! Markets can move very abruptly in both directions. Various analyses show that missing the best 5 or 10 days over a five- or ten-year period can meaningfully erode the overall gain for that period.
Better to be comfortable with a portfolio’s construction and capitalise on any setbacks by using the other assets (including cash) as reserves with which to invest, even if this construction borders on the more defensive. It is no accident that the portfolios tend to be modestly underweight equities relative their benchmarks. Yet, although reducing portfolio risk by increasing exposure to uncorrelated assets has proved effective over time, because such assets do not move in tandem as a bloc or with equities over the same period, some may have fallen in price in recent times and therefore not be best placed to act as a reserve when firepower is needed. Renewable energy and infrastructure are currently examples.
This is where capital preservation companies tend to shine. Because of their focus on inflation when generating returns, the mix and nature of investments held (particularly index-linked bonds) tend to generate less volatility when it comes to asset values and therefore share prices. This is reassuring as it affords some confidence that these companies will be well placed to assist when the next market setback occurs. It is no coincidence that such companies constitute one of the larger positions among our lower-risk portfolios.
Portfolio holdings
Indeed, the portfolios have been increasing their exposure to capital preservation companies of late, encouraged by their record of usually keeping pace with broader indices in recent decades – no mean feat given their remits and dispositions. Below are the holdings:
Ruffer Investment Company (RICA) maintains a low weighting to equities with the balance invested in ‘safe haven’ assets such as conventional short-dated and index-linked bonds, gold, and derivative protection and alternative strategies such as exposure to the Japanese yen. We concur with the company’s view on inflation:“Our structural view that the world has entered a new regime of higher and more volatile inflation remains unchanged … we have reached the end of cheap energy, cheap goods, cheap labour and cheap capital – all of which have been powerful disinflationary forces in the last couple of decades.” Meanwhile, RICA has commendably kept pace with the FTSE All-Share index since its inception in 2004.
Capital Gearing Trust (CGT) similarly has a good track record – recent figures showing it has increased its NAV at an annualised rate of 8.3% since 2000, while exhibiting low volatility. Again, this is an impressive record. It adopts a slightly more ‘traditional’ approach than RICA in rarely employing any derivative protection strategies. Portfolio composition consists of equities (usually investment trusts, where discounts look attractive) at c.35%, index-linked bonds c.30%, conventional government bonds (usually short-dated) c.20%, corporate bonds c.11%, gold and cash c.4%. The company pursues a disciplined discount-control mechanism which ensures the share prices seldom trails the NAV by any margin.
Personal Assets Trust (PNL) again pursues a more conventional asset allocation but has a greater exposure to US inflation-linked bonds (TIPS) and gold (c.12% of assets). It states: “In our view, the equity market fails to reflect the rise in the cost of capital in recent years or the risks from the economy slowing. We are keen to increase the allocation to equities when we feel prospective returns are good. It is essential to avoid being sucked into a long-running bull market at what may prove to be close to the top … the Company holds substantial ‘dry powder’ that we expect to add to existing and new equity holdings when the opportunity arises.” Again, the company has managed to keep in touch with the FTSE All-Share over time.
Disclaimer: The information contained in this article does not constitute investment advice or a personal recommendation and it is not an invitation or inducement to engage in investment activity You should seek independent financial advice as to the suitability of any investment decision. Past performance is not a guide to future performance. The value of investment company shares, and the income from them, can fall as well as rise. You may not get back the full amount invested and, in some cases, nothing at all.
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