Bonds are typically seen as the safest place to preserve one’s wealth, but with interest rates at record lows and inflation running high, equities may be the only place for investors to hide.
As inflation runs hot at more than 4% in the UK and 6% in the US, central banks could be forced to increase interest rates to combat further price increases.
Existing bond investors in this scenario would immediately see the value of their bonds decrease, and if central banks don’t raise interest rates, then bond investors receiving fixed coupons will continue to experience little or even negative real yields – the return in excess of expected future inflation.
Even if inflation turns out to be transitory, bond investors would still have experienced a material one-off haircut to their real yield.
Although equities are certainly more volatile than bonds over the short-run, Brunner Investment Trust manager Matthew Tillet explains why he thinks a diversified portfolio of stocks is actually less risky over the long-run.
He also explains why he’s not concerned by his worst performing stocks and why he is overweight healthcare stocks.
Performance of trust versus sector & benchmark over 5yrs
Source: FE Analytics
What is your investment process?
It’s a long-term, fundamentally driven investment process. We’re looking for three things: we want to invest in high quality companies that have decent growth potential and buy them at attractive valuations.
We think the combination of those three things together is the best way to achieve the objectives of the Brunner Trust: which is long-term growth in capital, outperformance of the benchmark and long-term growth in dividends and income.
How risky is the fund?
It is 100% equity, so in that sense it is riskier in the short term than a bond fund or money market fund. Although I would argue that over the long-term, a diversified portfolio of high-quality companies is actually one of the least risky options when you take purchasing power and inflation into account.
If you’re owning good-quality businesses that can keep pace with, or do better than, the nominal GDP growth of an economy, then over the long-term it’s going to protect you more than a bond, which just provides you a fixed coupon every year and doesn’t keep up with the level of inflation and overall growth in the economy.
We're investing 100% equities, so we're not going to be immune from volatility, but I think compared to some of the other equity funds out there we are relatively low risk because of our slightly more diversified approach.
What have been your best and worst calls over the past year?
Our best performers in the past 12 months have been holdings that combine an element of cyclicality, benefiting from the rebound recovery, but also with structural drivers as well. A good example of that is TSMC.
Semiconductors are a cyclical industry, but it's also got quite powerful structural drivers, some of which were accentuated by Covid and the need for many companies to accelerate their digital investments.
The worst areas have been some of the more defensive non-cyclical companies in sectors like healthcare and insurance, such as Munich Reinsurance.
It's not that surprising to me that those areas are coming up as the weaker performers. I'm not particularly concerned by it.
We're running a diversified portfolio so we're always going to have some cyclical companies and some defensive companies – and in a volatile period like we've seen over the past 18 months, there is going to be negatives on the attribution and there's also going to be positives as well, I expect that.
What is the most exciting area in your portfolio at the moment?
The healthcare sector is our largest absolute and relative weighting because from a quality perspective the healthcare sector has what we're looking for.
If you think about what you need to be successful with this industry – in all the sub-sectors within healthcare like pharmaceuticals or medical devices – they typically have high upfront investment requirements.
So you need to invest a lot in technology and research & development in order to just sustain your position, and certainly if you want to maintain market leadership. That tends to favour companies that already have well-established franchises in whatever sub sector that one is looking at.
Also, because it is a highly regulated industry where buyers of the products are sometimes driven by other factors – that again is a favourable characteristic because regulation makes the cost of business higher, which means it's harder for new competitors to enter as they have to deal with all those regulations, whereas existing companies tend to be better placed.
Then when you look at the longer-term secular tailwinds like the ageing populations around the world – which is an unstoppable force – it will lead to increased demand for healthcare products and services.
Do you use environmental, social and governance (ESG) in the portfolio?
It's always been part of what we do, and I'm not just sort of paying lip service to it here, it really is.
The reason for that is really quite simple: if you’re an investor that’s focused on the long-term and you are trying to understand the quality characteristics of businesses that one is investing in, then ESG is inextricably linked with both of those factors.
If there’s a company that's got a governance red flag, if you’re a hedge fund manager with a one-month time horizon, you’re not going to care about that. Similarly, if there’s a climate issue five or 10 years out, you’re not going to care about that either.
But if you’re looking at it from the perspective of thinking three-to-five years or more down the line, you are going to care about that issue because it is a risk factor that might materialise.
What do you what do you do outside of fund management?
My other form of brain exercise is chess which I’ve played my whole life. I also like walking, running and have taken up tennis again in the last year or so.
The other thing I like doing is cooking. I adopted a plant-based diet several years ago and I’ve been absolutely blown away by what you can do with it.