VALUE OR GROWTH? A Tale Of Two Scottish Funds

There are two Scottish funds listed on the London Stock Exchange, which I would like to focus on in this article. They both have similar names, yet their investment strategies differ considerably. The first of these two funds, The Scottish Investment Trust, is a contrarian value fund. Whilst the second fund, the Scottish Mortgage Investment Trust, is a growth fund.

The Scottish Investment Trust (SCIN) is over 130 years old and was first established in Edinburgh in 1887. Since 2015, the fund has been managed by Alasdair McKinnon with a focus on blue chip dividend paying companies that are out of favour. McKinnon takes a contrarian view to investing avoiding sectors that are hot and investing in companies that are undervalued and where sentiment is poor. The rationale being that when sentiment turns, the value of the companies increase as investors begin to pile in. To be clear, contrarian and value investing don’t mean simply investing in any old company that is down and out and going through a turbulant period. It is important that the company has a margin of safety to ride out any difficult period thus protecting it from having to raise emergency cash and/or ceasing to remain a going concern. It is also equally important that the company has healthy cash flows and a decent track record of this. The amount of cash that a company generates from its operations is a crucial metric and sometimes overlooked. A low P/E (Price To Earnings) ratio is one thing and a significant metric in indicating whether or not a company is overvalued, yet it doesn’t tell the whole story. The level of cashflow generation indicates how much cash a company is generating and the more cash it generates, the more of a financial buffer it has, especially if it’s total operating margins are not very high. It is also important to monitor a company’s total liabilities and how manageable and sustainable they are.

As of 30th April 2020, the largest holdings in SCIN’s portfolio included large gold mining companies such as Barrick Gold and Newmont Mining, large pharmaceutical companies such as Roche, Pfizer and Gilead Sciences and other assorted value blue chips such as United Utilities, Japan Tobacco, BT and Chevron. The gold mining companies have been in the portfolio for sometime. Recently gold has performed very strongly and it’s likely to continue. McKinnon, like myself, is of the view that major fiat currencies run the risk of being debased. Since the last financial crisis in 2008, we have been living through a period of very low interest rates and easy money. The present COVID-19 crisis has only exacerbated this as central banks have reduced interest rates even more and printed unprecedented amounts of money to prop up national economies in the wake of this crisis. Add to this the staggering levels of global government, corporate and household debt and you have a rather fragile situation. McKinnon’s thesis for having exposure to gold is as a form of insurance against this extraordinary macro environment and the real future risks and consequences it carries. He is also no fool by investing only in the biggest and most geographically spread global mining companies with low production costs. Whilst it is true that gold may not currently be unloved, I would still consider it a contrarian investment as it represents, to a degree, a lack of faith and trust in central banks and governments. It is also considered unfashionable. I would argue that newer supply-capped digital cryptocurrencies such a Bitcoin are more fashionable and hotter than gold. Especially amongst younger investors who generally overlook gold and other precious metals as a store of value.

McKinnon deliberately stays away from sectors that are hot and fashionable such as the technology sector. SCIN has absolutely no exposure to FANG (Facebook, Amazon, Netflix, Google) stocks or any other hot tech/startup stocks. The closest thing to tech in the portfolio are it’s holdings in boring and undervalued blue chip communication service companies such as BT, China Mobile, Verizon and Deutsche Telekom. McKinnon believes that the tide will turn regarding the high valuation of many technology companies, as unlikely as this may currently seem, and that value stocks, for a long time overlooked and underperforming compared with their growth counterparts, will prevail in due course.

The Scottish Mortgage Investment Trust (SMT) is currently the most valuable investment trust by market capitalization listed on the London Stock Exchange. As of today, it has a total market cap in excess of £10bn and over the last decade has performed extremely well. The primary reason for its impressive performance has been it’s exposure to all the FANG companies plus a number of other tech investments that have recently done exceptionally well. For example, the fund has a substantial holding in Tesla, whose share price has more than doubled since the beginning of this year. Generally speaking, tech shares have done very well since the COVID-19 induced lockdown measures were put in place over the last few months and the share price of SMT is trading at all time highs.

SMT, like SCIN, is also a very old investment trust with a hundred year plus history having first been established in 1909. It is currently jointly managed by James Anderson and Tom Slater. Anderson has been managing the trust for 20 years with Slater joining him in 2015. Their focus is purely on growth and investing in companies of the future. SMT is everything that SCIN is not. SCIN adopts a Benjamin Graham style value investing strategy. SMT does not embrace this type of strategy and even questions it. This is highlighted in a series of interesting essays written by Anderson and published on the fund’s parent Ballie Gifford website entitled Graham Or Growth?. I highly recommend giving them a read as it provides one with unique insights into Anderson’s way of thinking and by extension the investment philosophy and strategies of SMT.

It is true that growth investing has greatly outperformed value investing since the last financial crisis more than a decade ago. At the very start of 2009 the Russell 1000 Growth Index (RLG) was around 360 points. Today it is almost 1820 points. In this time the RLG index has grown more than 500%. That is highly impressive. By comparison the Russell 1000 Value Index (RLV) was around 446 points on 1st January 2009. Back then the RLV index was higher than the RLG index. The same cannot be said today with the RLV index almost 1,105 points. The RLV index has grown less than 250% during this period. Whilst this is certainly not a poor return, it doesn’t hold a candle to the RLG index’s 500% plus return.

Regardless of which side of the fence I am on regarding value or growth investing, it cannot be denied that both Anderson and Slater are highly skilled and visionary managers with a highly impressive track record for picking winners. It is much harder to quantify growth stocks than value stocks via traditional metrics and methods of fundamental analysis. If one were to just use just those methods when investing, one would have passed on investing in Amazon, Alphabet or Tesla in the early stages of their listings in the public markets. It takes more than just the tried and tested strategies of the past to value these companies and Anderson’s essays make this very clear.

However, it is just simply not the case that all new and exciting tech companies are ‘crushing it’. There have already been some casualties. The one that springs most to my mind has been the downfall of workspace company WeWork. Before the issues of the company came to the fore, it had a valuation of $47bn even though it had vast amounts of debt. Today, it’s worth far less at around $3-4bn. One of the largest investors in the company is SoftBank whose Vision Fund took a massive hit. Fortunately, SMT and its parent company Baillie Gifford, never built up a stake in WeWork over the years, but it could have easily happened here.

The recent WeWork debacle is one of a number reasons that make me nervous about having too much exposure to SMT right now irrespective of its stellar performance. As much as I respect the vision and foresight of Anderson and Slater, I worry that their fund could come a cropper some time down the line if a number of the holdings in the SMT portfolio underwent similar write-offs in value like WeWork. One of the fund’s holdings, Tesla, is probably the most polarised and hyped publicly traded stock in the world today. I have a great respect for its founder Elon Musk, who is a highly driven and exponentially thinking visionary. There is no doubt in my mind that he is special. However, the company could very easily experience a similar WeWork style crisis. No matter how highly I rate Elon, the financial fundamentals of Tesla are fragile and the share price could dive spectacularly in the event of a major existential crisis. This would create a huge dent in the value of SMT, as its Tesla holding currently represents a chunky 10% of the entire portfolio. Together with Amazon (which also represents 10% of the total holdings), it is one of the largest holdings in the SMT portfolio.

McKinnon is very wary of the present high valuations of tech companies and has citied the WeWork situation as a clear and present danger. In a post from December 2019 entitled Peak Unicorn?, he refers to the overvaluation of these exciting multi-billion dollar valued unicorn story stocks as a ‘disruption’ bubble, which has been propped up by an environment of cheap money and will not end well.

The last ten years have been very good for growth and technology stocks, yet it remains to be seen whether the next ten years will be equally magnanimous.

 

By Nicholas Peart 

Published on 27th May 2020

(c)All Rights Reserved

 

CITED ARTICLES:

https://resoluteoptimism.bailliegifford.com/will-the-mean-revert/

Peak Unicorn?

 

Image: tripsavvy.com

 

Don’t Fight The Trend…

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But don’t be off your guard either.

A lot of the time, stocks are priced at a value quite debased from their fundamentals. Thus they are either overvalued or undervalued. This is true since markets are, for the most part, driven by sentiment. In the most extreme circumstances, total greed or fear takes over.

I have been rather baffled by the stock market rally over the last few weeks after having witnessed some of the most spectacular series of crashes over the brief one month period from the end of February towards the end of March. This rally far from reflects the economic reality on the ground. Many people have lost their jobs and are struggling financially. Yes, there have been huge stimulus packages to soften the blow, but these are artificial and only increase an already substantial debt load.

Yet markets can behave irrationally for a very long period of time. Far longer than one can stay solvent, to quote the economist John Maynard Keynes. Instead of trying to be right, sometimes it can pay to just go with the trend. That often quoted adage, the trend is your friend, is very true. Rather than fighting it, it can be less painful to simply ride with it in whichever direction it may blow.

But don’t get carried away. Always be on your guard. As the tide can abruptly change without warning.

By Nicholas Peart

(c)All Rights Reserved 

 

Image: Peggy_Marco

It’s Only When The Tide Goes Out That You Discover Who’s Been Swimming Naked

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This is probably one of the wisest bits of advice related to the current market turmoil. And it was said by none other than one of the most successful investors of all time, the Sage of Omaha himself, Mr Warren Buffett.

What this present crisis has exposed are those companies that are worst prepared to handle a downtown. A company should always have sufficient emergency cash reserves or at least some margin of safety to protect it in the event of a slump such as the one we are currently experiencing.

The most prudent companies always have this margin of safety. On the other hand, the most ill prepared companies overleverage themselves and take on large piles of debt during the good times. Then when the bad times arrive and the tide goes out, they are the ones who are most vulnerable.

Right now boring old cash is king. Some of the most indebted companies are currently facing a genuine liquidity crisis and the very real possibility of going bust as their cashflows have virtually dried up. However, those companies who have set aside enough cash, have no or at least manageable levels of debt, and don’t have unsustainable overheads (or a low cash burn rate) will survive this downturn period the best and will bounce back the strongest when the markets do eventually recover.

I think this is something we can all learn when we make investment decisions, especially when we buy shares in companies during a bull market. It is always important when doing your own due diligence on a company to figure out how well it would fare when the tide changes. When the tide goes out, will it be sufficiently covered?

 

By Nicholas Peart

(c)All Rights Reserved 

 

Image: TimHill

MARKETS UPDATE: Thoughts On The Current Market Crash

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The last two months have been an exceptionally volatile period for global stock markets. The current COVID-19 pandemic has taken many by surprise and its consequences have had a clear affect on the markets during this period. For a long time, I thought that markets were overvalued and due for an eventual correction. The roots of my worries were based on the increasing levels of global debt since the last financial crisis of 2008 that have been fuelled by an unusually long period of low interest rates. With low interest rates money is cheap and cheap money has been the cause of the high valuations of many stocks and other assets such as property. All this concerned me. I knew it wasn’t sustainable and that eventually something would have to give. Yet little did I know that the catalyst for this current market crash would be a virus, which is now affecting citizens and the economies of every country on the planet.

I wrote an article back in 2017 and another one last year stating my fear that markets were overheating. Throughout all of 2019, I almost became resigned to the fact that we were in a ten year plus long bull market that seemed to show now signs of slowing down. Save for a sharp but very brief correction in equity markets from October to December 2018, the markets duly recovered and subsequently continued to hit new highs. Earlier this year, the NASDAQ index hit over 9,000 points and by mid February it had hit a new record of over 9,700 points. Back then I decided to view a longer term chart of the NASDAQ index and had discovered that back in March 2009, in the wake of all the wreckage of the last financial crisis, the NASDAQ index had collapsed to just under 1,300 points. In almost 11 years, the index had increased over 7 times in value. In the UK, only the FTSE 250 index comes close to matching the NASDAQ’s performance, but even the FTSE 250 has been no match. During that same time frame, the index went from under 6,000 points in March 2009 to a record high of almost 22,000 points in January this year. That represents an almost four fold increase in value. Impressive but still falling short of the NASDAQ’s run.

The reason for the NASDAQ’s epic performance is quite simply the unbelievable success of many of the biggest technology companies in the world, which are all listed on it’s exchange. The following NASDAQ listed companies: Amazon, Apple, Facebook, Alphabet, Netflix and Microsoft: have all been quite simply ‘crushing it’ throughout the last decade.

In the UK, the two principle stock market indexes are the FTSE 100 and the FTSE 250. Even though the UK doesn’t have anywhere near the kinds of innovative and exponential tech companies that come out of the US, the UK has a lot of thriving successful growth businesses and lots of these are listed on the FTSE 250. The FTSE 100, on the other hand, is made up more of long established big businesses with multi billion pound market capitalizations. Examples of such companies include Royal Dutch Shell, BP, Rio Tinto, HSBC, Unilever, Vodafone and British American Tobacco. These are big behemoth companies, which may lack the growth prospects of the smaller businesses listed in the FTSE 250. Yet what they lack in growth potential, they make up for by paying quite large dividends to their shareholders as their businesses generate a lot of cash. The FTSE 100 overall has, by comparison, not been a great performer. Even though from March 2009 until the January 2020, it went from less than 3800 points to almost 7700 points. Even though the index more than doubled during this period, it’s also worth bearing in mind that just before the turn of the new millenium, on December 10th 1999, the index was over 6700 points.

What is noticeable about this particular market crash is just how dramatic it’s been. Before the very beginnings of this market crash, when the markets closed on Friday 21st February, the NASDAQ was trading at over 9500 points, the S&P 500 was over 3,300 points, the FTSE 100 was over 7,400 points and the FTSE 250 was just a few points short of 21,800 points. By the time the markets closed just a few days ago on Monday 23rd March, the NASDAQ was below 6,900 points, the S&P 500 was a little higher than 2,200 points, the FTSE 100 had gone below 5000 points, and the FTSE 250 was trading slightly north of 13,000 points. In fact, just a few days previously on March 19th, the FTSE 250 had hit almost 12,800 points.

In the space of little over a month, the NASDAQ had fallen around 27%, the S&P 500 had lost around 33%, the FTSE 100 had shed 32% and the FTSE 250 had lost over 40% of it’s value. Since these lows from last Monday, markets have made some gains owing to stimulus from central banks, yet at the close on Friday yesterday, a good chunk of these gains were erased.

Going forward

The question now is, how will markets behave over the coming weeks and months? Will the lows hit last Monday be retested? It is always hard to predict the future, but I think they will be. The difference between this crisis and others is that this virus has been very disruptive. Since there is still currently no cure for the virus, the only measures to contain the virus have been for governments to impose lockdowns and restrict the movement of people. The most affected industries include the airline and travel industries. The airline industry in particular has been greatly affected as the number of flights have been severely diminished. It is likely that even the most established airline companies will struggle going forward without some form of a government bailout. With their cash flows from operations dramatically reduced, they will be drawing on their precious cash reserves to keep the lights on. But the truth is, with the restriction of movement, most industries will be affected. If a lot of the most affected companies struggle to remain a going concern they will go bust and as a consequence many people will lose their jobs. As an increasing number of people lose their jobs, they will have no income and likely also little to no cash savings to keep them going. There will be a frantic need to create liquidity to free up emergency cash. And this is why there has been a sell off of almost everything, even the most defensive of assets such as gold. When people are desperate for cash they will sell anything. This notion that cash is trash is a myth. In a difficult crisis such as this one, hard cash is king.

So going back to my earlier question; will markets continue to fall? I think they will as I don’t see lockdown measures easing any time soon. I also see an increasing number of people continue to lose their jobs and as a result an increasing need for emergency cash as more incomes dry up. In this situation, markets will continue to sell off. Shares that may seem like a bargain now will get even cheaper. I think the situation is serious enough to say that it is likely that some of the lows of the 2008-9 financial crisis will be tested. Yet do I think there are currently bargain shares to buy? Of course. But at the same time one should ask themselves the following; how much free cash do they currently have to invest? Not essential cash to survive, but cash they can either afford to lose or not have any need to draw upon for at least five years. If the latter than I would recommend periodically drip-buying a select number of quality companies (that are not over leveraged, that generate a lot of cash and have sufficient liquidity to be able to ride out this crisis and thus recover once its over), investment trusts or tracker funds over the coming weeks and months.

Cheap money 

It is likely that as the current crisis continues to bite, they will be a lot of government intervention to help citizens and business. One solution that has been doing the rounds is the idea of creating ‘helicopter money’ whereby central banks print money which is then given directly to households to help them and keep them solvent. In the USA, the current Trump government is planning on putting together a $2tn rescue package to aid businesses and households most affected. With interest rates at close to zero, the idea of printing staggering sums of money is a tempting one. As mentioned at the beginning of the article, since the 2008 financial crisis we have had a long period of low interest rates. And since the first shocks of the current crisis began to appear, both the Fed and Back of England reduced interest rates even further. As of now, the current Fed interest rate stands at 0% and the Back of England interest rate is 0.1%. With such rock bottom rates, the temptation to just keep printing money to infinity is very strong. As previous rounds of Quantitative Easing (QE) since the 2008 financial crisis have barely had an impact on triggering inflation, the current conventional wisdom is that even bigger rounds of money printing will also barely stoke inflation. Even the former head of the European Central Bank (ECB) Mario Draghi who back in 2012 vowed to do ‘whatever it takes’ to save the Euro, recently commented that interest rates will remain low for a very long time. Others also share this belief. But what if, out of nowhere, in the midst of all this money printing, a tsunami of inflation catches everybody off guard forcing central banks to abruptly increase interest rates to control it?

In gold and silver we trust

If you have read some of my other articles you will see that I have always been a big fan of precious metals. And this is especially true now in our current economic climate where uber-low interest rates and cheap money have been reigning supreme. A consequence of more than a decade of low interest rates has been that total levels of government, corporate and household debts have increased dramatically. To exacerbate an already fragile economic situation, the current crisis has triggered central banks of major economies to drop interest rates to zero. On top of this, humongous rescue packages are being created to aid affected households and businesses. Although this may create short term relief, it will further accelerate already staggering levels of global debt, which have already been allowed to get out of control for too long. Taking on debt is fine when interest rates are low, but what happens if all of a sudden interest rates increase? I say this, because as I previously mentioned, not many people are taking into account the very real threat of inflation, which may finally be awakened out of its slumber in a big way as a consequence of larger than normal levels of money printing. When interest rates increase to control this inflation, suddenly all this cheap money floating around will seize to be cheap and all this gigantic debt will become more expensive to service.

I can’t help but think that all this will be nothing but beneficial towards the prices of gold and silver. Over the last several months, gold has been slowly increasing in value. It recently hit $1,700 an ounce and is currently hovering in the $1,600s. In my view, I think any dips in the gold price should be taken advantage of. It is unavoidable that there will be dips in the gold price as households scramble to free up cash, but over the coming months and years I think gold will do very well.

I am equally keen on silver. It is less scarce than gold and is more sensitive to industrial demand, but compared to gold it is currently extremely under-priced. For many years the silver to gold ratio (SGR) oscillated between around 20 and 100, and it was an incredibly rare moment if it ever went above 100. Over the last two weeks, this ratio broke the 100 ceiling and spiked to over 125 at one point. As I type, the ratio is 112. A consequence of this further distancing between the gold and silver price has caused some to say that silver is done and has lost its appeal as a store of value. Yet I disagree strongly. If anything, I think this is an incredibly good buying opportunity to have exposure to silver as I can foresee it playing catch up to gold in an epic way.

 

By Nicholas Peart

29th March 2020

(c)All Rights Reserved   

 

Image: OpenClipart-Vectors

 

The Markets Of Warwick Triangle

 

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Warwick Triangle

 

Around the Berea Road Station in central Durban and the flyover passes marking the beginning of the N3 highway is a fascinating dishelved mess of markets known as the Warwick Triangle. These markets are so raw and alive they make the infamous Tepito Mercado in Mexico City look like Portobello Road market in Notting Hill. One day I decided to go on a tour of this part of town with a local guide from the tour firm Markets Of Warwick.

 

The Bead Market

This market has been temporarily relocated onto the narrow sidewalk of one of the busy flyover passes. Walking here was a challenge and trying desperately to be on your guard – even with a guide!

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The Bead Market

 

The Impepho Market

Entering this market was like walking through a post war bombed out Barbican or Westway. Here traditional Zulu women sell impepho and bowling size balls of red and white limes mined from iNdwedwe, north of the city.

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The Impepho Market

 

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Impepho

 

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White lime

 

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Red lime

 

The Brook Street Market

This market sells mainly textiles…

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Brook Street Market

 

The Berea Station Market

This is the place to go for pirate DVDs, CDs, shoes and designer clobber at rock bottom prices as well as traditional Zulu King Shaka spears and shields…

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Berea Station market

 

The Early Morning Market

This market is known as the Mother Market and has now been going for 100 years. This is the place to go for fruit and vegetables as well as spices. The quality of the fruit and veg is better than what you’d find in Pick n Pay and Checkers and at a fraction of the price. The spices here are cheaper than those in nearby Victoria market…

 

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Inside the Early Morning Market

 

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Abundant veg 

 

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Spices at rock bottom prices

 

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Early Morning Market trader

 

Bovine Head Cooking Market

I think if I took Morrissey here he’d have a stroke. This is not a place for animal rights activists. Yet Francis Bacon would be captivated. This place is raw and visceral. The severed heads and other body parts of cows and goats lie openly in green rubbish bins and black rubbish sacks – life here is cheaper than table salt.

 

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Inside the Bovine Head Cooking Market

 

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Super gourmet food I just can’t wait to dive into

 

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Too much

 

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Look away

 

The Herb Market

My guide explicitly tells me not to take photos of the herbs as I’d be ‘diminishing their potency’ – the last thing I want to do is incur the wrath of the traditional Zulu people so I only manage one cheeky photo from the entrance. As well as traditional herbs and plant extracts, one can find small used whiskey bottles now experiencing a new lease of life carrying the contents of different animal fats including those extracted from the Big Five.

 

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The entrance to the herb market

 

by Nicholas Peart

23rd June 2016

(all rights reserved)