Peter Spiller: my trust bargain idea, and secrets to outperformance

Capital Gearing, the wealth preservation vehicle, has delivered positive returns in all but one year under Peter Spiller’s tenure - since 1982. In this video interview Spiller runs through how the trust has achieved that remarkable level of consistently. He also runs through portfolio activity, including naming an investment trust that is trading on an attractively wide discount.

Kyle Caldwell, collectives editor at interactive investor: Hello, today I'm joined by Peter Spiller, Fund Manager of the Capital Gearing (LSE:CGT) investment trust. So Peter, Capital Gearing is a wealth preservation vehicle that has delivered positive returns in all but one year under your tenure since 1982. So what's been the secret to that success? 

Peter Spiller, fund manager of Capital Gearing: Well, Kyle, the purpose of this trust has always been to not lose money, number one, but secondly to do better than the equity markets overtime. Now, that should not be possible if you read theory, but I think we've proved that it can be done, and it's all driven by asset allocation. 

So the principles of our asset allocation are very simple, that when prospective returns in an asset class are high and risk is low, then you want to lock those returns in for as long as possible, as high duration as possible. And the converse of this is true when returns are looking poor and risk is high, which I have to say largely describes the current situation. 

But back in ‘82 when I started, it was the most wonderful opportunity because the fees were low, inflation was high, but interest rates were high but falling. And the prospective returns in all asset classes actually were terrific, but equities are by far the longest duration asset. So if you want to lock in those returns, then equities are the way you do it. And back in those days we had 100% in equities.

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Just very quickly fast forward, I won’t go through every year, but fast forward to the end of the ‘90s. By then equities were looking dreadful that year, and high risk. But bonds still offered high real yields, 4 – 4.5%, that sort of thing. And so we had very few equities and a lot of bonds. And proper duration bonds, so we owned 30-year Bunds for instance at that time. 

And the truth of the matter is that actually once you've got a balance of equities and bonds, then you’ve got a chance at having negative correlating assets. And that's worked particularly well over the last decade and a half, with TIPS, who is one of the most reliable negative correlations in financial markets, is TIPS against UK equities. So that has been extremely helpful. 

Kyle: And what is the current exposure to equities and how does that compare to its level prior to the pandemic? 

Peter: Actually, I'll do it the other way around if that’s alright with you Kyle? So we were very lucky because at the end of 2019, beginning of 2020, a lot of private clients had bid the prices of renewable infrastructure particularly to very high levels, so the big premia. And we sold them all. So our total risk asset exposure fell from 45% down to about the low 30s as we went into February 2020, and we simply could not find attractive investments to get into at that stage. So we were very lucky, because when March ’20 came along, we had a lot of cash. And we bought in March when the market fell, so that was great, added to equities. But more particularly because equities recovered very quickly you recall, almost V-shaped in behaviour. But what didn't was property, and specialised property offered fantastic opportunities. So companies like Tritax Big Box (LSE:BBOX) for instance, which is in substantial part a credit portfolio, ie. long leases to creditworthy companies. And they fell to a huge discount, a 50% discount to their assets. 

So we bought a lot of that sort of thing. So that brought up risk asset exposure, right up to close to 50%. Naturally, we've been reducing it a little bit because we feel less confident that the potential returns remain as high as they were and risk is definitely rising. So currently we have probably about 18% in equities, but a further 26% or so in other kinds of equities, so a lot of that would be property, again this specialised property, which we think will be very efficient at dealing with inflation. And a fair whack of infrastructure and renewables, that sort of thing. 

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Kyle: So is infrastructure, renewables and property is where your finding the value opportunities at the moment? And I was wondering if you could name a couple of investment trusts that you invest in, in those areas? 

Peter: Oh well, we tend to invest in – they’re called investment trusts, that’s the structure of them, but they're not really investment trusts, they’re operating companies, aren’t they, in all cases? 

So one that I would pick out for instance, is Grainger (LSE:GRI). So Grainger is the biggest PRS [private rented sector] company in the UK. And it's not that we expect fast returns, but we believe that inflation will be problematic in the UK, but that rents overtime will at least match inflation. And with the pipeline of developments and gearing, it will probably produce decent real returns. Nothing exciting, but decent real returns. A solid rock to rest a portfolio on.

When it comes to investment trusts, there are still some great bargains out there. So one I would pick out would be North Atlantic Smaller Companies (LSE:NAS), run by Chris Mills. Fantastic record compared with any investment trust in the UK. But still trades on a 22/23% discount. It’s really been an amazing opportunity. We've held it for a very long time and continue to. 

Kyle: And are you finding in general, there are a few more investment trust discount opportunities at the moment, given there’s been a bit of a pick up in market volatility over the past couple months? 

Peter: Yes, not like the old days Kyle, I have to say. And I think that the key characteristic of investment trusts actually is that in the short term, you don't tend to get – or if you get short term dips, you don't tend to get huge opportunities in investment trusts, maybe they go 1 or 2%, 3% wider, but that's kind of it. And with most investment trusts there is considerable downside in the discount because in bear markets, proper bear market, ie., one which lasts for more than six weeks, then you do get sales of trusts at ever lower prices. I think it's because psychologically people relate the price, not to the asset value today, but what they expect it to be in a month’s time. And if every day you come in, then the market’s lower, then you start to discount those asset values by more. 

So I think there will be great opportunities, but as a general statement over the last 15 years, discounts have tightened enormously. And corporate governance is beginning to improve. So we are now seeing more ZDMs [zero discount models], like Capital Gearing, and those should be emphasised. Those ZDMs aren't just to reassurance that we won’t go to a large discount. remove the discount threat. But also because the issue on slightly higher asset values than it costs them to invest, or high premia that it costs them to invest and ditto in redemptions, they’re adding asset value all the time from that process. So Capital Gearing trust for instance essentially has no management fee at all in the last year because it's all been paid for by the redemption process and issuing process.

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Kyle: The rest of the portfolio is in defensive armoury. Could you run through the rationale behind your investments in inflation-linked bonds, which comprise around 30% of the portfolio? 

Peter: Yes. Well, first of all I think we're going to cover the prospects for inflation in a different video, but the first thing to say is what I’ve mentioned already, this extraordinary negative correlation which provides fantastic stability to portfolios going forward. But secondly, we do believe that inflation will be the big issue that faces investors trying to preserve the real value of their capital. And although we’ve moved a long way, so we've gone from 4.5% yields to -0.5% in TIPS at the long end, I still think there is much further to go. And the reason for that, just very quickly, is because of debt. So debt levels are so high that the only way to deal with them without massive defaults, which obviously involves a depression, is to have financial repression. That is to say, inflation rates that are significantly higher, well, certainly than they have been, they’re pretty high just at this particular moment, and interest rates that are well below those rates of inflation. So I expect negative real yields on TIPS to get much, much bigger, more negative, which will provide a very significant capital gain. So the UK, the comparative value is extraordinary the UK's, so the – there’s basically 2% difference in yield, UK at 2% more expensive.

Kyle: Peter, thank you for your time today.

Peter:  Not at all.