David Kimberley
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Updated 20 May 2022
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Disclaimer

This is not substantive investment research or a research recommendation, as it does not constitute substantive research or analysis. This material should be considered as general market commentary.

Last week we spoke with Gervais Williams for the first episode of our new podcast (you can listen here). The focal point of that discussion was a book Gervais wrote several years ago on the subject of deglobalization.

Although that’s a topic which is likely to conjure up images of Donald Trump yelling about China, a large part of Gervais’s book deals with the deregulation of debt and the easy money policies that have lasted now for over a decade.

One of the interesting points made is that the corporate world has adopted the overleveraged approach which banks had taken prior to the Financial Crisis. Whereas banks were forced to change their ways after the crisis, companies have arguably been incentivized to do the opposite. Corporate risk taking has enhanced returns for investors and the ability to borrow at rates close to zero meant debt could build up and continually be rolled over.

In this environment, buying an index fund makes sense. Firms can access easy cash and bolster returns with cheap debt. The problem is these periods also create extremely fragile companies. Good times make companies complacent anyway, but if you add to that easy access to capital, then it means the downside risk they face when a retrenchment occurs is much greater.

If we are entering a period of retrenchment, and it’s still not clear that we are, buying an index fund becomes a lot less compelling. The dynamic described above could lead to higher downside risk for firms that default. It may also mean we enter a period of stagflation, during which buying an index tracker doesn’t yield satisfactory returns.

Jonathan Ruffer captured these concerns when he wrote last month that, “forty years of a bull market, where for decades ‘buying the dip’ has been a sure-fire idea, is clashing against circumstances and events which may break this benign and predictable investment pattern.”

The good news for readers is that investment trusts seem better placed than others to deal with these prospective problems. Beyond simply taking an active approach to the market, many trusts look relatively well placed to deal with the macroeconomic headwinds that may be on the horizon.

Indeed, in a year that has produced little to be optimistic about thus far, the Ruffer Investment Company (RICA) has delivered NAV returns of just over 4%. Dividend stalwart City of London (CTY) has produced NAV returns of close to 2% over the same period, more impressive than it sounds given just how hard hit markets have been so far in 2022.

There is also some historical precedent for other trusts, like Brunner (BUT) or F&C Investment Trust (FCIT). Both have survived the Great Depression, World Wars, and 1970s hyperinflation. Past performance is not an indicator of future returns but it is somewhat reassuring to know that many trusts have managed to survive severe economic downturns and continued generating returns for shareholders.

Past performance is not a reliable indicator of future results

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