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The reason Brunner IT is sticking by quality as the market begins to turn

16 August 2018

Brunner Investment Trust’s Lucy MacDonald explains why she is sticking by quality stocks as the conditions in place since the global financial crisis start to change.

By Rob Langston,

News editor, FE Trustnet

With valuations at more expensive levels and central banks begin to withdraw liquidity from the financial system, Brunner Investment Trust’s Lucy MacDonald said she is standing by her quality stocks.

MacDonald, chief investment officer for global equities at Allianz Global Investors, said the changing market backdrop is likely to mean that the strong returns witnessed more recently are harder to come by.

“Our overall view is that we are entering a period where we think overall capital returns will be flatter and a bit more volatility will begin to creep into the market after a period of exceptionally high returns and very low volatility," she said.

“We think that because we are getting to peak liquidly following the quantitative easing, from the fourth quarter this year liquidity will being to be drained out as it turns into a withdrawal."

Indeed, interest rates in the US have already gone up about six times and are closer to more normal levels, she noted.

MacDonald also said that growth was likely to tail off as 2019 approaches with the market adjusting to changes in both monetary and fiscal policy and the expectation of lower profits.

She explained: “I would say it would be impossible for growth to be as fast next year as it is this year. We’re seeing 10 per cent growth in earnings this year and it’s not going to be continuing that trend.”

Indeed, as the recent Bank of America Merrill Lynch Global Fund Manager Survey noted, 12 per cent of asset allocators don’t think corporate earnings will improve by 10 per cent or more over the next year, a sharp decline since the start of the year.

 
Source: BofA Merrill Lynch Global Fund Manager Survey

“Also, valuations are at a relatively high level,” MacDonald said. “If you’re looking at book value equity markets are looking at the high end, on a P/E [price-to-earnings] basis they look more moderate and that’s because we’ve seen such a level of withdrawal of equity through share buybacks.”

“All of that suggests it’s going to be harder work for equity markets to drive strong returns.”


 

After a relatively benign 2017 characterised by low volatility and the absence of too many market-moving events, this year has seen greater instability in markets posing a fresh challenge for investors.

The hard stance taken by US president Donald Trump on trade negotiations with key allies and global rivals alike have made markets less predictable after a year in which there had been strong, correlated growth among most major economies.

Performance of VIX YTD

 

Source: FE Analytics

“Volatility had a very sharp rise in February when there was a bit of an inflation scare and that seems to have faded again, but we think it is likely to continue to have some more increasing frequency of volatility.”

MacDonald said the withdrawal of quantitative easing is likely to add to further bouts of volatility as liquidity exits the financial system.

However, this is unlikely to pose a challenge for MacDonald and Brunner Investment Trust, which she said will benefit from its focus on quality.

“We’ve been through many different environments [as a team], I’ve been investing for 30 years now and sort of seen everything. So, it doesn’t feel excessively challenging,” she explained.

“As far as an environment for making absolute returns, I think it is more challenging but what we’re really interested in is staying on top of that.”

The manager added: "We feel - as active managers - we should continue to thrive and that’s because we think the investment policy will really add value.

“In a period where you have limitless liquidity then quality is not a feature which is valued but as we move into this [new, post-QE] environment we think it’s reviewed and we think it’s already starting to come true.”

Indeed, MacDonald said quality stocks tend to perform better towards the end of the cycle and as such has continued to position the portfolio accordingly.

While acknowledging that it has become more difficult to invest as valuations have continued to soar, the higher levels of volatility in markets this year have helped to create some specific opportunities.

The adoption of a new benchmark last year for Brunner Investment Trust has also opened up a wider range of companies to choose from, allowing greater overseas investment.

She explained: “We’ve deliberately been taking more overseas exposure because that will diversify our source of income and give access to more growth opportunities.

“Now when you look at [the trust] it is a third US, third UK and a third overseas. Really, it’s where the stocks happen to be and fit the criteria we’re looking for.”


 

Within the portfolio, MacDonald said she has taken some profit out of momentum names such as iconic beauty brand Estee Lauder, pharmaceutical company AbbVie, emerging market giant Tencent and technology firm Microsoft.

Those profits have been reinvested in the financials sector which the manager believes could benefit from a rising rate environment, including new position Charles Schwabb, the US stockbroker.

The UK portion of the portfolio – overseen by Matthew Tillet – has been buoyed by corporate activity including the takeover of media business UBM by peer Informa and NEX Group by US firm CME.

However, the manager said she has also continued to reduce the number of holdings within the portfolio from around 80 names one year ago towards 70 currently although she is aiming to end at around 60 stocks.

“All of the portfolios we run [at Allianz] are concentrated and we feel that Brunner can have a few more names because it needs the income,” she said.

Additionally, the renegotiation of costly debentures held by the trust has also benefited Brunner as the trust has seen its discount to net asset value [NAV} come in from past levels.

The investment company’s discount currently stands at 10.14 per cent, below its three-year average level of 12.91 per cent, according to data from the Association of Investment Companies (AIC).

Discount/Premium of trust over 5yrs

 

Source: FE Analytics

“It went out to 20 per cent and then a combination of performance and what we’ve been doing to the trust has brought it in,” said the manager.

“It is in a range of around 10 per cent, which obviously we think is very good value and what we need to do is continue to drive performance and demand over time and that should continue to narrow the discount.”

Over the past year, the trust has delivered a total return of 10.74 per cent compared with a 15.12 per cent gain for the average IT Global trust.

Since MacDonald was appointed manager to the trust on 27 June 2005, the trust has delivered a 253.8 per cent total return compared with 251.6 per cent for the average peer.

Brunner has ongoing charges of 0.72 per cent, is 8 per cent geared, has a yield of 2.3 per cent.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.