31 October 2022 (pre-recorded 24 October 2022)
Below is a transcript of the episode, modified for your reading pleasure. Please check the corresponding audio before quoting in print, as it may contain small errors. Please remember we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at your time of listening. For more information on the people and ideas in the episode, see the links at the bottom of the post.
[INTRODUCTION]
Chris Salih (CS):
Hello and welcome to the Investing on the Go podcast. I’m Chris Salih, and today we’re joined by Jason Borbora-Sheen, manager of the Elite Rated Ninety One Global Income Opportunities fund. Jason, thank you for joining us once again.
Jason Borbora-Sheen (JBS):
Thanks Chris. Nice to see you today.
(CS):
And you. Let’s start, obviously [the] name of the fund, [so] let’s start with the world of income, which has changed quite considerably in the past few months. Could you, maybe talk, us through what’s happening in sort of the two big asset classes that you invest in, equities and bonds, and what’s changed, and the opportunity set and the dangers? Maybe just give us a once over on that.
(JBS):
[00:40] Sure. Okay. So, we think that, in any timeframe – meaningful timeframe – three factors drive both bond and equity markets. So, that’s a mix of growth and inflation, and in the way that policy – from a central bank or fiscal perspective – is reacting to that.
So, currently what we’ve seen is inflation remain higher and more persistent, as a reaction to that policy has been tightening – so, central banks have been either increasing interest rates, reducing balance sheets, or a mixture of the two – and as a consequence of that, there are further doubts about growth.
And, unfortunately for both bonds and equities, that’s been a very toxic mix. It meant that yields have moved up across asset classes, which add to, sort of, [on] first inspection might sound good, but obviously it means capital values have come down on the other side of that. And that’s been true both in equities and bonds, as I said. So, some of the numbers are quite eye watering. Treasuries this year – US government bonds – [are] down 15%. Lower-rated credits, as a consequence of that, [are] down nearly 20 [%].
Then taking us onto the equity space, global equities [are] down 25%. And, if we hone in on the UK, it’s a sort of interesting mix really. So, for most UK investors, they’ve had a big dampening effect coming from the massive depreciation of sterling, which is down 20% against the dollar year to date. And that’s meant that a lot of that loss that you would’ve witnessed in international equity markets were you, for example, based in the US, has been dampened. But I think that’s something that investors shouldn’t rely on too much. So, when you see global equities off 25%, but sterling is depreciated by 20[%], then naturally you are only off in a sort of single digits.
[02:17] But gilts are off nearly a third of their value this year, so 28% negative total return. And the FTSE has, I think, benefited from that mix of sterling depreciation and in international earnings. So, it’s down around 6%. But that’s left us, from an income perspective, in a pretty interesting space. So, yields on global equities have gone up to 2.5%; on high dividend equity indices now, they’re about 4.5%. So, some of the highest figures we’ve seen in a long time, and that’s the same also of government bond markets. So, you’re getting today on US treasuries over 4% and a similar amount in the UK.
(CS):
I mean, it’s quite a unique time. I mean some of the areas in the market that people perhaps thought wouldn’t fall as much as they have, actually have fallen. Could you maybe just go into a bit more [detail] in terms of the actual changes you’ve made in the portfolio to sort of counteract the environment we’re in, and perhaps tap into some of the opportunities as well?
(JBS):
[03:10] Sure. So, pretty big changes for us over the last 18 months, I’d say. Net equity has gone from a peak in 2021 of 60% [down] to today’s 30[%]. Actually, over the last few days that’s been increasing. So, we’ve gone up to closer the 35[%] net equity exposure. That’s been a sort of mixture of reducing down physical companies where we thought they’d become too expensive, but also using outright hedges. So, we use derivatives to take exposure down.
I think there also, we’ve got to say you know, we’ve been far from perfect, we have to say when we’ve got things wrong. And I think one of the things we’ve got wrong this year in particular, was owning more dividend growth orientated names. So, we focus on income equity at the core of the fund, but we also like those companies that can increase their dividend through time. And I think we had underestimated the extent to which those valuations on some of those companies had become stretched. So, part of the changes were selling out of those companies earlier in the year, but unfortunately, we’d seen some of the hit on performance from that.
Elsewhere in the bond space, duration – which is our measure of sensitivity to interest rates; so, one year of duration means if interest rates go up by a hundred basis points [or 1%], you lose 1% of capital in the funds – so, that had come right down to less than one year, earlier in the year. But given we’ve seen that big move in a lot of bond markets, that’s actually increased now, to about two and a half years. So, interest rate sensitivity has picked up a little bit.
And then finally on the currency side, we hedge all our international exposure, so we don’t benefit from big sterling depreciation. We also then don’t get hurt by its significant moves to the upside [sterling rising against the dollar] which it feels like has been a long time since it’s occurred, but it does in the past.
(CS):
And just quickly for listeners on the currency side, I mean, has this year been a timely reminder of the importance of currency in the investing world?
(JBS):
[04:58] I think it’s been beneficial, if you have not hedged your sterling exposure, but I think you have to then look at it from the perspective of, well, what are the magnitude of moves that could occur? So yes, you’ve benefited if you decided not to hedge, or you benefited if you didn’t really think about it, and you just didn’t hedge.
But it should be a reminder that actually, if things move against you, that could be really quite painful. So, we are only active in our exposure. So, we have had long dollar exposure, which has helped performance, but we start from the point of being completely hedged, and it’s only active currencies on top of that. So, I think that will be important going forward.
(CS):
Let’s stay with currencies. I mean, I’ve noticed you’ve got a reasonable amount in emerging market local currency debt; bonds from Mexico and Indonesia are sort of among the top 10 bond holdings, for example. Could you tell us about your, sort of, favorite local currency over dollar-denominated debt even, and why these countries in particular, are attractive?
(JBS):
[05:54] Yeah, so I mean let’s start off with the asset class and its behavior. So, emerging market countries issuing debt in the same way as developed market governments do. The noticeable thing about that is typically, it either comes in a dollar format, ie. they’re issuing in currencies – and specifically the dollar – they themselves don’t print. So they’re, you know, denominated in their local currencies. But they’re issuing debt in dollars. The alternative is that they actually issue it in their own currency.
Now, the reason we like that sort of bond, is that we buy their local currency denominated bonds, and we hedge them back to the pound in this fund, and then you get a difference in behavior. So, dollar-denominated EM debt tends to trade a lot like equities. EM local currency debt can do, if you buy it in its traditional format, where you’re taking the fluctuations in the local currency of that issuing government.
[06:46] But actually, if you then hedge that currency risk out as we do, then you get a very differentiated performance profile. It actually behaves a lot more like a high quality, developed market bond. So, one of the things that we do, for example, South African bonds which mature in 2030, so fairly short maturity bonds, they yield 11%. We think that they potentially have capital upside, as well as that income story coming through, because they were earlier to raise rates.
A lot of these emerging market countries reacted in 2021, whereas [in] developed markets, central banks only started raising rates this year. So, inflation can actually start coming down earlier there, and you can actually see rate cuts come through. And the benefit of buying that low currency bond and hedging it ourselves is yes, there is a cost to hedging – cost is about 3% – but if we can earn then a total return of 8% from that bond, that to us feels pretty attractive over the next few years. So, it’s a differentiated approach to managing bond exposures, I think.
(CS):
And just turning back to equities, are there a couple of holdings that you are particularly sort of bullish on at the moment in the portfolio?
(JBS):
[07:46] I think the core to our process is we’re looking for three characteristics. So, we’re looking for a dividend yield. It doesn’t need to be the highest, but it does need to be above average. So, it’s got to be above that 2.5% I mentioned earlier on [inaudible], we want that to be reliable. So, we’re looking for a consistency of dividend and that, in the case of equities, it’s about the profitability of the company, it’s how leveraged it is, how historically it’s been able to manage dividend payments, particularly in times of stress. And then when testing the valuation case.
So, the core of the portfolio, I think, is about owning companies which aren’t too expensive, have reliable dividends. An example of that I’d say, is Johnson & Johnson; not the highest yielder in the world, you know, 2.6 or 2.7%, but 60 consecutive years of dividend increases, which gives us a lot of faith in the resilience of the company, if we see tougher times ahead economically.
That doesn’t mean we only own these very, very stable names. We can own other less consistent dividend payers, if there’s enough in the valuation that makes us think that the total return on the stock, as well as the income, is going to be compelling. So, an example of that is probably the likes of Daimler, the truck company. So, not a traditional sort of dividends payer necessarily, but has really, we think, changed its business model. So, they’re much more conservative with the way they manage their order book, as opposed to before, where there were big fluctuations with demand. This has been a much more conservative approach and they’ve got a commitment towards paying out the dividend. And that sort of change in behaviour means we’re compelled to have a smaller weight in that sort of name, relative to Johnson & Johnson, but still take some exposure to it, nonetheless.
(CS):
Okay. Just a couple quick questions. Firstly, you talked about the fixed income side of things. Are you in the short duration camp? Are you thinking rates won’t get to sort of, 5[%], 6% in the UK? What’s your sort of view on that?
(JBS):
[09:33] So, we’ve increased duration from the very low point of the year, which was less than one year of duration in total exposure. We’ve actually gone up to about two and a half [years]. And that to us, is sort of more where we would think, on average, we would be.
So, I think we’re through the worst, maybe from, a capital loss perspective on government bond markets, but not yet facing big upside. I think in order to get conviction on that – then this is true of all developed government bonds – we need to see growth data fall off. So, whilst growth data is not compelling at the moment, it certainly isn’t recessionary, at least in the US yet.
As we see that coming through, I think that’s when the case for government bonds stacks up a bit more. The UK’s a slightly idiosyncratic case currently. I think what we need there, because the valuation in the bond market is a tick for me on gilts, but we need to see more fundamentally, orthodoxy come through on the fiscal side, and on the central bank side. And there are hints that we’re getting towards that. I think we just need confirmation of that, and then we’d be more compelled to add there.
(CS):
I mean, let’s tie [it] all in at the end then. maybe just give us your outlook for income investing over the next 12 to 18 months. So, are we in a sort of transitory period, is it favourable? Are you sort of wary? Maybe just talk about that. I mean, is it just a case of things are getting harder?
(JBS):
I think we are wary, it’s fair to describe us in that sense. So, our net equity is towards the low end of its range. Our duration is still low but has come off the lows, or the very lowest. And currency exposure is small, but we are modestly long the dollar. And that all is because we think that that mix of growth, inflation and policy isn’t improving sufficiently; that, despite the fact we’ve seen some correction of valuations, it’s not outright compelling.
Let’s focus for a moment strictly on income investing; in a long-term sense, it works very well, because if you look across asset classes, income explains the majority of total returns. And so, we think, investors who tend to focus on capital gains, miss the opportunity that comes from income. So instead of saying, I’m going to buy a share today [at] 10 pounds and sell it in 10 years’ time for 20 [pounds], we are saying, well, let’s buy one for 10 pounds today and see if we can get a pound of income per year over the next 10 [years]. So, that’s our focus in the long-term.
I think relatively then, it’s quite compelling today, because income has seen yields rise; you’ve seen high dividend yield indices now offer 4.5% dividends; you’ve got government bonds offering 4%. So, that does look better than what we see on a lot of sort of growth-type companies. But in absolute terms, do we think that there are hard times ahead? I would say yes, because that potential for recession in order to tame inflation, is high. And so, I think we need to go through that, take some further pain, but ultimately then, that makes the outlook pretty compelling for us.
(CS):
Jason, once again, thank you very much for your time today.
(JBS):
Thanks very much. Thanks for your time.
(CS):
And if you’d like to learn more about the Ninety One Global Income Opportunities fund, please visit fundcalibre.com. And while you’re there, remember to subscribe to the ‘Investing on the Go’ podcast.
(Outro)
Please remember, we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at the time of listening. Elite Ratings are based on FundCalibre’s research methodology and are the opinion of FundCalibre’s research team only.
