Bruce Stout: I’ve bought bargain bonds twice in 20 years, but won’t buy gilts now

Bruce Stout, who has managed Murray International (LSE:MYI) for nearly two decades, tells interactive investor’s collectives editor Kyle Caldwell, why he does not find the 5% yields on short-term UK government bonds (gilts) attractive. The global equity income trust predominately invests in shares, but has held small positions in fixed income in the past when there’s been bargain prices to take advantage of.

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Also in the interview Stout explains how Murray International’s portfolio has evolved over the past two decades, why he continues to have only a small amount of exposure to UK equities, and names reasons to be cheerful over the prospects for stock markets during the next 12 months. Stout will be retiring from fund management next June, passing the baton to colleagues Samantha Fitzpatrick and Martin Connaghan.

Murray International is one of interactive investor’s Super 60 investment ideas. It is currently under review given the recent announcement of Stout’s retirement.

Kyle Caldwell, collectives editor at interactive investor: Hello and welcome to our latest Insider Interview. Today in the studio I have with me Bruce Stout, fund manager of the Murray International Investment Trust. Bruce, great to see you again.

Bruce Stout, fund manager of the Murray International Investment Trust:Good to see you.

Kyle Caldwell:So, Bruce, you recently announced that you'll be retiring in June 2024. To start with, I was wondering if you could look back at your career and name the key lessons that you've learned over the years?

Bruce Stout:Well, I mean, I've been very lucky to work in fund management because it's an industry where every day you come in, something's different. Everything's always different. And that's a great challenge and it's a great opportunity as well. So when you look back on a period of 35 years or whatever, there are so many things that are completely different [compared] to what it was like in the past [and] to what it's like today. And you can learn some lessons maybe for the future. But it's just been a great privilege to work in this industry over such a long period of time.

Kyle Caldwell:So, you've been managing Murray International since 2004. So how has the portfolio evolved since then?

Bruce Stout: The portfolio has really changed for a trust that on a year-to-year basis tends to have pretty low turnover in terms of portfolio turnover. It's only when you look at it over the longer term, you see how much has actually changed and that's a function of opportunity, because if you roll back 25 years, it was actually very difficult to get decent dividend yield and decent dividend growth beyond the UK. I mean, there was nothing really in Asia, there was nothing really in Japan. Europe was patchy. America had pretty low yields even then. And so Murray International 25 years ago had 46% in the UK.

Now, in the last 20 years, the portfolio has become truly international. I mean, the UK weighting now is less than 5%, but that's not a function of not liking the UK necessarily. It's actually more a function of seeing better opportunities elsewhere that enable us to deliver the mandate, which is to grow the capital, grow the dividend and keep that yield above 4%. To allow us to do that through a fully diversified portfolio now of uncorrelated assets, when you've got a lot of money in one area of the world, when that market moves around, they all tend to move together sometimes, especially during periods of high emotion. So the trust looks very different from 20 years ago, but we would argue that it is actually in a much stronger position because of the diversification we can now get, which is a function of the way that markets have evolved as much as the way that we've sought to capitalise on these opportunities.

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Kyle Caldwell:Within the portfolio today, two key areas of focus, particularly given the high inflation backdrop, are looking for companies with pricing power and also [those that] have real assets. Could you name examples of companies that have both those characteristics?

Bruce Stout: One of the companies, and one thing that's not changed in Murray International, is that Grupo Aeroportuario del Sureste SAB de CV ADR (NYSE:ASR) has been in it for 23 years. Put in as a relatively small holding at IPO, it is the operator of airports in Mexico. Cancun and Cozumel are the big cash drivers for the company, but they've also now evolved to own airports in Colombia [and] Puerto Rico as well.

So, this is an example of real assets, real tangible assets, which are airports, runways, terminals. Very difficult to replicate because it's very difficult to get a licence to build another airport because of all the issues that are involved. And, quite frankly, they don't need another airport. But over the years, Cancun has gone from one terminal and one runway to four terminals and six runways, so you can see that the real asset has grown and grown and grown in value.

And in terms of pricing power, I'm not sure if it's pricing power or exploitation, but when you're airside in an airport and the temperature is 100 degrees, if you need a bottle of water, you'll pay for it. So, they have an incredible ability to push prices up and people will pay. And that's been the case for a long time. That's not a function of the inflationary environment we're in today. It's a function of their business model, and their business model has a lot of pricing power inherent in the commercial side of the revenue stream.

Kyle Caldwell:And what is your view on where inflation is heading? Over the next couple of years, should investors prepare themselves for the scenario of inflation being higher than the 2% that's targeted by central bankers?

Bruce Stout: I mean, that's a really difficult question because with Murray International, we're invested in 25 markets around the world. So inflation to us is inflation in all those markets and what's happening. There is a huge difference in the world today [over] what is happening in the developed world in terms of inflation and the developing world in terms of inflation. And there are certain things going on that we've never seen before.

People are obsessed with price inflation and the impact that things such as energy prices have on the CPI, or commodity prices have on the CPI. But in the developed world, we've not had real income growth for the best part of 15 years, and suddenly the labour market in many areas of the world, in the developed world, has most definitely changed. The participation rates have fallen since Covid.

Deglobalisation has meant the mobility of labour is significantly restricted now. And just look at the UK with Brexit, we just can't get people in to work in many of the industries where we desperately need people. And that means that labour has a much more powerful bargaining chip for wage growth. So, for central banks to obsess and focus on interest rates and focus on CPI while ignoring wage inflation is a serious error of judgement, because perhaps the labour market is completely unrecognisable to what it was before.

Conversely, in the emerging world, interest rates were put up a year before they were in the developed world. They've seen inflation many times before in the likes of Latin America and parts of Asia. If we look at inflation today in Chile, Brazil or Mexico, it's back to mid-single digits, sometimes low-single digits, and it had been up in double digits. So, they've already controlled inflation there. In fact, they've already started to cut interest rates. Brazil cut this year, and Chile has cut this year. And so they're in a much, much better position because they understand the inflation that they've got in the developed world. It looks as if the central banks don't actually understand the type of inflation that is affecting the economies today.

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Kyle Caldwell:So, Murray International predominantly invests in equities, but there's also some exposure to bonds. I wanted to ask you why you don't have exposure to UK government bonds, gilts? It's been a popular area this year for private investors given that, you know, they can pick up yields of around 5% on short-term debt.

Bruce Stout: We have only bought bonds in any kind of material size twice in the last 20 years, and that was when we adjudged them to be at absolute bargain prices. Once was in 2007 when 10-year gilts and 10-year treasuries were yielding 5.5%, but at that time equities were yielding 2.5%. And the other time was in 2014-15 when emerging debt looked incredibly attractive.

But if we look at gilts today, if you look at gilts over the last 70 years, then gilts have tended to trade with a 200 basis point real-risk premium to the inflation rate. So, if the inflation rate was 3%, bond yields would be 5%. So, we look at a 10-year gilt today at 4.5% and say, is that really accurately priced for whatever the inflation environment? It's very difficult to say. If inflation is much stickier than people think and it's here to stay at 4% or 5%, then maybe a gilt should be 6% or 7%. That would be fair value. To get it to be really attractive it might have to be higher.

Now, of course, people would counter that and say if it's 7%, the UK economy would crumble. Well, that's a different issue. That's an issue of debt. It's an issue of where we are in terms of borrowing both at the consumer level and at the state level. But to get bonds attractive for us, they have to be really sold off to the point where people have revulsion towards the asset class.

And for what you've just said, that's most definitely not the case in the gilt market today. The final thing I'd say about bonds, particularly in the developed world, is that the market's not priced bonds for the last 15 years, governments have priced bonds for 15 years because quantitative easing means there is a buyer of last resort, and that buyer for that has been the government.

The governments are no longer involved in quantitative easing because they can't anymore. It's just too much, they've done too much. So, if there is quantitative tightening, as they say, then the government will no longer be the buyer and the market price-setter of bonds, the market will have to set the price for bonds. And if the market wants a risk premium over the rate of inflation, then we'll have to wait to see what that actually is because we're not there yet.

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Kyle Caldwell:You mentioned earlier that you've got around 5% of the portfolio in UK equities, but that's not a reflection [of] you thinking there's not value opportunities in that market. It's more a reflection of the fact that you can find better opportunities elsewhere. But given that the valuations are so cheap at the moment for the UK equity market, is it an area that you've been looking at a bit more closely recently?

Bruce Stout:It's something that we hear constantly from the sort of consensus view that the UK is cheap. Is it cheap or is it a value trap? Are the companies better positioned today than they were five years ago, or 10 years ago, to grow their earnings and grow the dividends? The only way you can make that judgement is to actually look at each individual company and say, you know, 10 years ago it had a big market with Europe and it had perhaps all kinds of distribution in different parts of the world. Is that better today or worse today after Brexit? So, you have to do it on an industry-by-industry basis.

There has been fundamental change in many industries in the UK in the last five or 10 years and the issue of labour and wage inflation is not going to go away in the UK for some considerable time because the demographics of the UK are not good. There's too many elderly people like me now going through the system and we need young people in the workforce in order to perform the service sector, getin the tourist sector, various sectors of the economy, where we just can't get staff. So, there may be structural wage inflation for some time. So, maybe the UK isn't as cheap as everybody says because maybe the growth prospects for the individual businesses are not as good as they think they are.

Kyle Caldwell: And finally, Bruce, I was wondering if you could name one reason to be fearful and one reason to be cheerful for the prospects for stock markets over the next 12 months?

Bruce Stout: Sometimes in fund management, people are always fearful. There's always reasons to be fearful. I think, we have catastrophes and we have all kinds of dislocations every single year in this business. And in fact, this year it's only six short months since the US banking system was under significant pressure, and that all seems to have been swept under the carpet. So there's always reasons to be to be fearful.

I think because we focus on quality businesses, we don't like companies with lots of leverage. So we try and keep the process that we have always adopted, which is a cautious approach because we always start from a viewpoint of, we don't want to lose our shareholders money. Then you want to make money. So there's nothing really for us to be that fearful of. But there's plenty of uncertainty and problems, there always will be.

In terms of reasons to be optimistic, it’s been a really tough period post-Covid, where there have been all kinds of dislocations in the world in supply chains and movement of labour, as we've mentioned, and price inflation caused by various things in parts of the world, particularly in Asia and in emerging markets, that seem to now be mitigating.

And we seem to be back to sort of levels of inflation that we've seen before, which means that there's real scope for interest rate cuts in some of these areas and the long-term drivers of things such as rising real income, youthful populations, good savings, less debt, they're all still intact. So, there's real scope for earnings growth and dividend growth in businesses that are exposed there. And that makes us reasonably comfortable with the outlook for these parts of the world.

Kyle Caldwell:Bruce, thank you for your time today.

Bruce Stout:Thanks very much.

Kyle Caldwell:That's it for this episode of our Insider Interview. You can check out the rest of the series on our YouTube channel where you can like, comment and subscribe. Hopefully, I'll see you again.