Tech investors given fresh warning from Murray International's Bruce Stout

The trust has raised its dividend in each of the last 15 years, but 2018 has not been easy. Bruce Stout talks to Lindsay Vincent about predictions, FAANGs and trade wars.

Professionally, Bruce Stout is not in a happy place. No fund manager whose charge bumbles along in the fourth quartile of its peer group could be otherwise, especially one, such as Stout, with an impressive record of past outperformance.

Stout readily predicted that 2018 would be a testing year for his £1.4 billion Murray International, a global income trust that now offers a yield of some 4.5%, and so it has proved.

"I told shareholders (private client firms that hold stock for some of the trust's 25,000 investors) that if I got through the year without losing them money, and could raise the dividend, I'd be happy."

Dividend growth

The dividend has indeed grown, but as the shares have fallen from around £13 to £11 since January, Stout will be going some to show share price appreciation on the year. His view for 2019? "I'll be happy if we can again achieve real dividend growth, as we have for the past 15 years. Preservation of capital remains the key."

A September survey showed retail investors' confidence in the value of UK equities at its lowest level in 23 years and Stout's wider perspective of what lies ahead, let alone the severe global shakeout that has taken place this week, will not lift their mood. But contrarian investors - historically among the canniest – will not be discouraged.

Income trusts, by definition, get left behind when the focus is growth, and few investors need reminding that stock market values have grown at a record pace in the past decade. Further, some of Stout's defensive bets have been hammered. "British American Tobacco is down 24% – they don't normally behave like that – and PepsiCo went from $115 (£87) to $85 for no reason at all.

"We have seen the longest period of business expansion on record and many in asset management have never seen a recession or (until recently) interest rates go up. There seems to be a belief that these growth stocks will grow in perpetuity."

Stout managed technology funds in the late 1990s and reckons "what is happening now is similar to that period. These FAANGS (the US grouping of mega tech stocks) are up 28% on the year, and more people are not looking for active managers. People always go passive at the wrong time. They forget there are cycles. These companies have led the market up for five years, and passive investors will get all the downside when the cycle turns."

He weighs in on "people obsessed with "normal" interest rates – what is that?" Stout, an economics graduate, says in the 60-year period to the crash of 2008, the average real interest rate was 2%. "Since 2008 the normal rate has been zero. We know we can't go back to normalising rates, despite peoples' obsession." He also implies investor ignorance with regard the implications of monetary tightening.

"There have been 13 instances of tightening since 1958 and 10 of those caused a recession. The three that didn’t led (in the 1990s) to the Asia crisis, the Brazil crisis, and the Mexican crisis.

"Tightening monetary policy is not a science. They tighten it [to breaking point] and we have 10 examples of this." What is more, removing quantitative easing means a 'double liquidity hit'. He forecasts a setback in the US 'pretty soon'. "The business cycle is 10 years old and will turn down – that's why they're called cycles. Take the UK and Europe. Here we have 1.5% growth and except for Germany, Europe has not grown - Italy has not had growth in 20 years." He identifies 'currency management' as the spur to German expansion.

Stout accepts there was no alternative to quantitative easing (QE).

"It's in the title: Emergency Monetary Policy. It's a new concept to deal with. I am not criticising it, but to get rid of QE [without damage] is almost impossible. We'll be caught in a deflationary trap."

So where does this leave investors? "The biggest problem is that there will be no [real] growth. Huge debts have been built up in a drive for growth, but all that does is bring forward consumption. The developed world is all about consumption – it's 70% of economic activity. Now, with no wage growth, there is no potential for credit growth." He adds:

"So we need to go to those areas where the rates of consumption can still expand." He points to Brazil, China, India and Indonesia – "big centres of population with rising, real income growth. With young people – not like in Europe or Japan; 80% of Mexicans, for instance, are aged under 40."

The strength of the dollar and other concerns mean that emerging market currencies and equities are under pressure "but this weakness is not because of economic fundamentals", he says. Stout's emerging markets exposure helps explain why Murray International shares have slipped to a tiny discount to NAV. They moved to a premium in 2008, a margin that peaked at 14.7% in June 2013.

Meet the fund manager

Name: Bruce StoutAge: 59Position: Senior investment manager, Aberdeen Standard. Manager, Murray International.Education: Strathclyde University. Economics.The past: Joined GEC, feasibility studies for telecom opportunities in China. Entered fund management 1987 through Murray Johnstone, now part of Aberdeen Standard.Home: Edinburgh. Plays football: "You’re never too old."Finances: In-house funds.

Deflationary trap

Stout's long-term view is that "we can't see how the developed world gets out of this deflationary trap. But I can see how emerging markets can. Just take one fact from China. Ten years ago, few ever left the place, but 100 million travelled abroad last year – Auckland airport, for example, is loaded with Chinese visitors." He adds: "Where in the west do we have retail growth projections to match those of India?"

The other cloud hanging over world trade comes from trade wars. Stout pours scorn on president Trump's ignorance of commercial realities. "Trade wars have happened in the past and nobody wins. You just get lower growth and higher inflation. Import substitution is an out-of-date model from the 1950s that just doesn't work.

"Protectionism is doomed to failure and it is totally illogical. The dollar has been rising because interest rates are going up and the economy is on a sugar rush from tax cuts. If the dollar is rising because of this, how can other countries be called currency manipulators? Yet this is the agenda coming out of the White House, on social media, at 2am in the morning.

"The long-term winner from all this is China. China will have the same government in 10 or 15 years. They're not worried about issues such as mid-term elections or policies that could go a different way."

China's huge debts and the folly of 'shadow banking' – whereby bank and institutional loans are advanced off-balance sheet, and beyond regulatory supervision – is seen by the west as the sword of Damocles threatening financial stability. But Stout thinks otherwise.

"Shadow banking is a beast that can change – it's manageable. China can change emphasis very quickly – it can change policies fast. If they want to clean it up, don't bet against them doing it. They have the tools to do it. Here, in the west, there are no tools left. "And that must make you pessimistic about the developed world, and its ageing populations. Where is the growth going to come from?"

Right now, the strength of the dollar, trade war threats, and political upheavals have caused a malaise in emerging markets. But, for contrarian investors, this is a strong signal to wade in. Buy in gloom, sell in boom, is an investment mantra with more wisdom than most others.

Developing markets, by value, account for some 40% of Murray International's 50-strong equity portfolio, with Asia Pacific responsible for 25%. Developed economies account for 40% and key holdings include so-called 'bond proxies' such as Philip Morris and Total.

Exotic holdings

Fixed interest securities, split between emerging markets, Asia Pacific and a toehold in South Africa, are vital for income and represent some 15% of assets. Perhaps the most exotic holding is a Dominican Republic dollar-denominated government bond.

Stout owns just two equities in Japan, but one of them, Daito Trust Constructions, is nonetheless one of his largest single holdings. He is not averse to Japan but finds it a country ‘where it is hard to get growth and a dividend yield'.

Other top 10 holdings include ASUR, a leading company in Mexico that is also listed on Wall Street. The firm owns nine airports in Mexico, including that in the tourist mecca of Cancun. "The only risk to growth is a hurricane; the weaker the peso the better for incoming tourist numbers."

One of the more intriguing investments is Quimica Y Minera, an important Chilean enterprise whose main products include iodine and potash. But the most alluring mineral to come from the company's production facilities in the Atacama Desert is lithium, the key element in digital and other batteries. It also has medical uses. "The yield is 4% and dividend growth is good," says Stout.

Taiwan Semiconductors is a longstanding holding and one, as Stout points out, with a "stunning five-year record of dividend growth. It makes chips for just about everybody." Like some others, Stout is at odds with Taiwan's status as an emerging market. "If Taiwan is an emerging market, then many in Europe should be classified as frontier markets."

He blames Morgan Stanley, whose MSCI indices are the yardstick for investment management. "This [dumb] decision means a lot of people can't buy the stock."

Stout feels the growing US practice of share buybacks is equally dumb. As well as inflating values, which is fine and dandy for executives' share option schemes, many firms are borrowing to fund the buybacks.

He offers a telling fact. "Net debt to equity in the US, ex the financial sector, has risen from 48% in 2013 in the US to 62%. In Asia, net corporate debt to equity is just 17%."

A further fact is that poor performance explains the gradual disappearance of the trust's premium to net asset value. Sure, sunshine follows rain but if Stout's predictions are on the money, investors can still take comfort from a decent and rising yield until the global economic malaise passes.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.