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Investment Trust Longevity in the Face of Conflict

21 April 2022 Sector Insights, Investment Styles, How to Invest Faith Glasgow

It’s not an easy time to be a cool-headed investor. Although the state of our finances in the UK pales into insignificance in comparison with the destruction and suffering being inflicted on the people of Ukraine by the Russian invasion, the fact is that the war and the price inflation it is stoking are giving many private investors sleepless nights.

Nor is it simply a question of concerns about the fate of volatile Russian funds or stocks, to which many UK investors have minimal exposure. The war has direct consequences for global stock markets, and major indices are very volatile as the news ebbs and flows.

To put that into perspective, the US S&P 500 index has fallen more than 7% so far this year (to 24 March), having recovered from a -13% low after the Russians attacked a Ukrainian military site near the Polish border earlier last month. The Nasdaq index of technology-focused companies was down 20% year to date after that attack; it has subsequently recovered to some extent, but remains 12% below its value at the start of the year. The MSCI World index is down 8% over that time, while the FTSE All-Share has done pretty well, having lost less than 3%.

Broker Interactive Investor (ii) is so far the only platform brave enough to publish data on the unpleasant consequences for customers’ portfolios. As at 14 March, the average SIPP portfolio held with ii had lost 12% in 2022. Those with a high proportion in global equities, and especially in the tech-focused stocks and funds that have done so well in recent years, will have taken a harder hit.

“The falls at the start of the year have been a consequence not only of the war, but also of the preceding rise in interest rates and the end of quantitative easing, among other factors that turned general sentiment negative from mid-January onwards,” comments Becky O’Connor, head of pensions and savings, Interactive Investor.

Moreover, on a short-term perspective, things are set to get worse, as rocketing fuel prices percolate through supply chains and push inflation up, potentially to above 8% by the end of the year. The Office for Budget Responsibility says it could take several years to return to previous low levels of inflation.1

So, it’s easy to feel pretty despondent about the state of your portfolio. However, global investment trust shareholders seeking comfort, can cheer themselves up by stepping back and taking a much longer view. It really brings home how robust these trusts have historically proved to be in troubled times.

After all, as Andrew McHattie, publisher of the Investment Trust Newsletter, points out, investment trusts have been around for more than 160 years, and have seen a fair number of international crises during that time.

“F&C Investment Trust started out in 1868 investing in emerging markets bonds. More than 130 years ago the names of trusts described their investment realms, including the African Gold Share Investment Trust, London Scottish American, Spanish Railways Trust and Investment, and the United States and South American Investment Trust,” he observes.

“So they have been outward-facing for a very long time, seeking the best returns from global innovations and accepting the attendant risks. Those have been managed well over time, and investment trusts have survived two world wars and much more besides.”

John Newlands, a long-standing investment trust expert and historian, gives some context to the experience of investment trust shareholders through those two huge global events. As he explains, the London Stock Exchange was closed for nine months at the outset of World War One, and trusts and boards just had to carry on as best they could, without a trading market.

“Portfolios were largely fixed interest at that time – and became more so as all US dollar securities were requisitioned by the government in return for War Loan issues,” he adds. “Most trusts had employees going off to the war, and some did not return.”

By the outbreak of World War Two, 30 years later, things had moved on apace: the UK government was better organised, and trading continued during much of the conflict.

Says Newlands, “There was a sharp uptick as the end of the war became more certain, and it caught many investors by surprise. I personally expect something like this to happen when the guns fall silent in Ukraine.”

In fact, the single most seismic shock of all for stock markets came in between the two, in the shape of the Wall Street Crash of 1929: this saw the US Dow Jones index lose a massive 89% of its value in less than three years.

Crucially, says Newlands, “not one of the older, long-established UK investment trusts with diversified portfolios and decent revenue reserves collapsed – Alliance Trust being a classic case in point. Even the best trusts suffered a sharp setback, naturally, but by as early as 1933, the signs of recovery were there and, in time, asset values would move to fresh peaks and beyond.” 

However, he adds, newer, less well-diversified funds, which had had little time to build up reserves and possibly had borrowed into rising markets as well, took a real hammering; some of them did not survive.

McHattie makes the point that some dividends were reduced or suspended by UK trusts as a consequence of the 1929 crash. In contrast, these days investment trusts “have the considerable advantage of well-established revenue reserves to smooth dividends and to maintain them during difficult periods”. He believes the crisis in Ukraine seems unlikely to have any general impact on dividends across the industry.

More recently, the devastating terrorist attacks of 11 September 2001 have had the most painful and protracted impact on markets worldwide. Annabel Brodie-Smith, communications director at the Association of Investment Companies, says, “If you had invested £100 in the average investment company at the beginning of 2001, by the end of September your investment would have been worth just £74. By the end of 2004, the Iraq War had begun and that same investment would have recovered to £82, but would still be 18% below its original value.”

However, investors who pulled out of the market during that time and failed to catch the wave as it rebounded, would have lost out. “Two years later, markets had bounced back and your investment would be worth £131,” continues Brodie-Smith.

“Fast-forward to today and your original £100 investment would be worth £572 – a return of nearly six times your original investment in a period of just over 21 years.” Moreover, that period includes not just the 9/11 attacks, but the 2008 Global Financial Crisis and the recent Covid pandemic.

Since 1945 there have been several other regional conflicts, including the Falklands War and two Gulf Wars, which, while devastating for those directly involved, on the whole have proved to be relatively short-lived setbacks for the closed-ended sector’s performance.

For example, AIC data indicates that an investment of £100 at the beginning of 1982 in the average investment company, would have been worth £97 by the end of April during the Falklands War, but by the end of the year it would have recovered to £136.

Similarly, although a £100 investment would have fallen to just £83 in the six months following the start of the first Gulf War in August 1990, within a year it was back in positive territory at £103.

As Brodie-Smith observes, “Of course, investment companies’ share prices will suffer in the eye of the storm, but when markets recover, they bounce back strongly.”

Investment trusts do have important structural advantages in terms of resilience: for instance their listed company status and closed-ended structure mean managers can take a long-term view, without fear of having to buy or sell portfolio holdings in response to shareholder pressure, because demand/supply inequities play out through share price movements on the stock market. (In contrast, open-ended fund managers have to create or cancel units on a daily basis, depending on the flows of money into or out of the fund).

Trusts also have the facility to hold back up to 15% of income received from portfolio companies, so they have a reserve to draw on that enables them to maintain their dividends in lean years.

But the bottom line is that in the long term, equity valuations are not terribly vulnerable to catastrophic events such as war or terrorist attacks. US wealth manager Barry Ritholtz wrote recently in Bloomberg Businessweek, “What drives equity prices are increased corporate revenue and profit, and the typical geopolitical event isn’t big enough to change those very much.”2

Thus, few investment trusts are really struggling as a direct result of the war in Ukraine. McHattie points to JPMorgan Russian Securities, “which has seen its net asset value fall sharply and its shares drop from over 700p in early February to around 80p now”.

He adds, “Barings Emerging EMEA Opportunities, which had nearly 28% of assets in Russia at the end of January, has also fallen, but the vast majority of trusts – particularly those with energy holdings – have been well positioned to protect investors’ assets.”

So what should investors do? Newlands underlines the familiar but important point that panicking and selling when crisis hits, tends to be a very bad idea. “Not only will you be disposing of your shares at a depressed ‘bid’ (selling) price, but you’ll be repurchasing, even in the absence of any market movements, at a higher ‘offer’ price, usually plus stamp duty and broker’s commission as well. So the round trip has a cost to it.”

Moreover, there is a very real danger of missing a key recovery surge when sentiment recovers. Newlands points to the 1973/74 bear market following the Middle Eastern oil crisis. “The then leading UK indicator, the FT30 Index, shot forward by more than 90%. Investors who had lost faith and moved into cash were kicking themselves for years afterwards,” he says.

He recommends that anyone concerned about potential geopolitical or economic risks, should take steps to “place their portfolios on a firm basis in the first place” through broad diversification across styles, regions and assets, and drip-feeding into the market. “This might mean slightly lower projected future values for their financial returns, but a far better night’s sleep when the next crisis strikes,” he advises.

Faith Glasgow is a freelance journalist and former Editor of Money Observer



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