Capital Gearing Trust p.l.c (CGT) Earnings Call Transcript & Summary

Hello, and thank you all for joining today's interim results presentation for Capital Gearing Trust. My name is Katie Forbes, and I am Head of Investor Relations, CGT, and I'm joined here by my colleagues Chris Clothier, [indiscernible] and Emma Moriarty, Portfolio Manager. Before we get started, I just want to quickly call out the disclaimer. So please note that the value of investments can go up and down, and nothing we say today should be taken as investment advice. Prior today's presentation will provide a quick overview of the Trust itself, before moving on to the fund performance, and then Emma will close off with a macro outlook update. To quickly summarize our results, Capital Gearing Trust have achieved a net asset value total return of 2.4%. This compares to the change of the consumer price index of 0.9%. The share price total turn over the period have been at 3.1%. I'm happy to report that all parts of the portfolio contributed positively, and Chris will go into more detail on this during the presentation. At the end of the presentation, we'll then move on to Q&A, so please continue to submit your questions throughout. Without further ado, I will now hand you over to Chris.

Thanks, Katie. Good morning. Thank you so much for joining us. So we'll start off just with a very quick overview as to what Capital Gearing Trust is about. The company's objective is to preserve and then grow shareholders real wealth over time. And the objectives are stated in that order intentionally. So our primary objective is to preserve well. And we are a London listed investment trust listed on the FTSE 250. And one thing that is slightly unique about the trust is that it has a discount control mechanism. And what that means is that the share price of the company and its net asset value should track each other very, very closely. And we do that by the company going into the market and buying back shares when the company is trading on a discount and issuing shares when it's trading on a premium. I should add that the fund is a very low cost, and we have a management fee of 40 basis points and an ongoing charges figure of less than 0.5%. So who are we? CGS Management is the Manager of Capital Gearing Trust. We're a small boutique based here in London, and we comprised 13 people at a dock. What do we do at CGS management? We do 2 things. We run conservative multi-asset funds, of which Capital Gearing Trust is our flagship, but we also have an open-ended sister fund to Capital Gearing Trust called CG Absolute Return that's domiciled in Ireland and is in UCITS structure. And then the other thing that we do is we manage index-linked bond funds, which invest in index-linked bonds issued by high-quality governments around the world. And you can see a list of those funds on this page. Just turning to our track record. So we began managing Capital Gearing Trust in 1982, our founder, Peter Spiller, started managing it then. And he has been managing it for 42 years, which makes him I think probably the longest-serving fund manager in London. And as you can see, the track record has been very decent. So if you were lucky enough or why is enough to have invested GBP 10,000 in April 1982, when you started, you would have a little over GBP 2.6 million today. And if you had reinvested all of your dividends. But most importantly, the thing that speaks to the point about being a capital preservation vehicle is that we've done that without taking large levels of risk and that there have only been 2 years when the total return has been negative over that 42-year period. So I'm just going to touch really quickly on our investment process. So what are we trying to do? We're trying to preserve our shareholders wealth and then grow it at inflation -- at a higher rate than inflation over the long term. We define preserving capital is not losing money over a 12-month period. And we're trying to generate inflation plus 3 or 4 over the long term. I'm sure enough, we have done rather better than that since our inception. We thereby try to keep things simple. So we don't use derivatives. We don't use gearing. We just invested in a mixture of cash, bonds, equities and commodities. How do we go about doing it? Well, we're focused on asset allocation rather than individual stock selection. We are very value oriented. And then we have 2 specialties. The first is that we try and exploit discount opportunities in the investment trust market and use that as a source of generating alpha in the jargon, and that's to say just a little bit of extra return that we would get from the underlying asset markets themselves. And we also make extensive use of indexing bonds in our portfolio construction. Of course, as a fund that's able to invest in almost anything and go anywhere around the world, you need to have some guideposts as to how you go about doing things. And that's what we're setting out here on this chart. And so roughly, in order of importance, we start at the top, then move clockwise around the chart. So the most important thing to us in our asset allocation is valuation. And so we look at the valuation of substantially all the major asset classes around the world and both with respect to each other and with respect to their own history. We're then guided by some core macroeconomic beliefs. And really, those can be summarized present with 2 things. The first is that we are concerned that inflation is going to be higher and more volatile in the future than it has been over the past 25 years. And we are concerned by the large levels of indebtedness in the world, and we are concerned by the large fiscal deficits that major economies are running. We think about the business cycle and where we are in the business cycle and adjust our asset allocation accordingly. We think about the monetary environment. So that's to say our central banks being accommodative and is that accommodation likely to be positive or negative towards asset prices. And finally, we give some consideration to investor behavior. Our investors excessively risk-seeking are engaged in speculative activity. And when we observe those behaviors, it causes us to be more cautious than we would otherwise be. And finally, we have at the bottom, the concept of duration, which underpins everything that we do. And that's really answer -- we ask ourselves a question. And the question is this. If prospective returns are good, how long do you want to lock them into? And the answer to that is pretty simple, is as long as possible. And conversely, if prospective returns are poor, how long do you want to lock them in for the shorter time as possible. And so this guides our asset allocation. So when we see cheap assets, we want long duration, and that either means owning equities because equities tend to be the longest duration asset of all or when we're just considering our bond holdings, we'll prefer long-dated bonds over short-dated bonds. And then conversely, when values are poor or when risk is high, we seek shelter by holding short-duration assets. So that would be things like cash, treasury bills and short-dated bonds. So this then leads us to having 3 core asset allocation pillars, which we'll talk about when we get into the results. So the dry powder on the left-hand side of your screen, that's the assets that we use to reduce the duration of the portfolio and also to provide us with optionality and that means that we can reinvest our dry powder into either risk assets or long-duration bonds when opportunities are thrown up by either. Our risk assets, that's equities and those are our return-seeking assets where we hope to get the highest returns. But of course, with those tends to come the highest level of risk. And so we're constantly trying to manage those 2 things. And as I noted earlier, we have a specialism of investing rather than picking individual equities, we invest in collective investment schemes, typically investment trusts and try and exploit discount opportunities in the investment trust sector. That's something we've been doing for over 40 years and has been a source of considerable additional return to our investors. And then finally, we have index-linked bonds and index-linked bonds are former kind of a key plank of our asset allocation. And I'll just touch on that on the next slide. So when you're thinking about constructing a multi-asset portfolio, you're trying to ensure that your portfolio can withstand whatever macroeconomic environment, the world throws at you. Now if you could only invest in one asset class, and hold that for eternity. Then I think probably anybody would agree that you should choose equities because while they are the riskiest asset, they have historically delivered far and away, the best performance of all among all other asset classes over the long term. So then the next question follows. If you could only invest in 2 asset classes, what would they be? Our view very strongly is that, that second asset class should be index-linked bonds. And this chart hopefully explains why. It's because index-linked bonds are in macroeconomic terms, the mirror image of equities. That's to say that they do best when equities do worst. And as you can see on this chart, equities do best in an environment of high growth and low inflation. And conversely, index-linked bonds do best in an environment of high inflation and low growth. As it happens, index-linked bonds also have an attractive characteristic that they're something of cowers investment, that's to say that they do pretty well under most environments, but they do especially well when -- just when you need them to when equities do worse. And that's why they're a fundamental plank to our asset allocation. That's enough about how we do things. Let's turn to how we have done over the half year. As Katie outlined, the total NAV return for the 6 months was 2.4%. And as you can see, all parts of the portfolio contributed positively over that time frame. On the left-hand side of the chart, you can see the allocation to those 3 big buckets that I referred to. So 32% of our portfolio is in dry powder, 34% in index-linked bonds, 34% in risk assets. So why is it that we have each of those allocations at present? But I'll start with the risk assets. As ever, we're motivated by fear and greed and those 2 are in reasonably equal tension with one another. So the greed part is that in the investment trust market, which is where we fish for risk assets, we're seeing amongst the best opportunities that we've seen since the great financial crisis and there are big discounts to go out. There are lots of interesting situations, and we think that we'll be able to generate excess returns from these investments. On the flip side, we are also looking at amongst most expensive equity market valuations in history, at least as it relates to the U.S. So if you use the cyclically adjusted P/E ratio, the cape ratio, popularized by the economist, Robert Shiller, that currently stands at 37x. The last time it was at 37x was in 2021, which was, I guess, what you might call the everything bubble. And then the only other time in history when it's been higher, it reached 40x during the dotcom boom. And so we're very concerned by valuations on American equities. And we observe that in history, when equity markets fall in the U.S., potentially all risk assets around the world fall with it and so that constrains our overall appetite to equities, while American equities are expensive as we judge them to be. Within index-linked bonds, we think that index-linked bonds are somewhere between fairly and attractively valued today. So the real yield in the U.S. is 2%. So that's to say that you earn 2% on top of inflation by earning index-linked bonds, and that is pretty good against the history of the index-linked bond market. And then finally, dry powder. If you went back 2 or 3 years, the returns from our dry powder were frankly terrible because we are in the 0 interest rate environment. Whereas today, even a treasury -- on a treasury bill, we can earn a return of just a little under 5%, and that's taking no duration risk and no credit risk. And that provides a fantastic underpinning for our portfolio returns and also provides a really good hurdle, a really good benchmark against which all new investment opportunities can be judged. I mentioned that investment companies are trading at attractive discounts. This chart just serves to illustrate that, and I won't go into it any further than that. This chart -- what this does is tries to break apart how are the 2 parts of our portfolio have been working. So on the left-hand side, you can see the performance of our risk assets, and we compare that against the darker line, which is the Investment Trust Index and the lighter line, which is the U.K. Equity Index. And you can see that through our specialist approach to investing in the investment trust market, we've been able to generate some fairly attractive outperformance, and that's particularly come to the fore over the last 3 to 4 years. On the right-hand side, you can see the performance of our bond portfolios. And this, we compare to sterling aggregate which I guess might be a kind of as we sort of passive bond holding that a U.K. investor might have. And here, you can see, while the performance in absolute terms has been less exciting than for our equities, as you would probably expect. The outperformance relative to Sterling Aggregate been really quite significant. How do we do that? I guess, really, there were a couple of things. The first is that, we have quite a large weighting to overseas government bonds, particularly U.S. index-linked bonds or TIPS, as they're commonly known. And the other was that we were very concerned, particularly in immediately post-COVID. The bond prices were being pushed by the extraordinary monetary policy that central banks were undertaking up to levels that were just not sustainable. And so in response to that, we kept our duration very short. We invested in bonds that were only a small number of years to their maturity and avoided the very long duration ones. And it's those long-duration bonds that we're responsible for those large losses that you see in the Sterling Aggregate Index. And then finally, this is our performance as compared with the PIMFA conservative index, which I guess is a passive index for somebody that has a similar sort of mindset to ourselves as to say they're trying to deliver conservative returns, trying to avoid losses. And you can see that we've quite handsomely outperformed that since December 2015, which is as far back as we're able to carry out this analysis with our systems. And the other thing that I would note is that the PIMFA conservative carries quite a lot more equities than we have held over that period. And so in fact, you can see that they've had steeper drawdowns. And so despite taking less risk PIMFA conservative, and we've generated some reasonable outperformance. I think that's enough on positioning and performance. I'm now going to hand over to Emma, who will take you through a macroeconomic outlook.

So I'll spend the next 5 minutes speaking through our macro outlook, which will be an outlook on centered on U.S. interest rate inflation and economic growth, which underpins our current cautious asset allocation. I think to summarize it really briefly, the outlook for the U.S. economy is not straightforward at the moment. And there are essentially 2 sets of considerations, which play off against each other. In the very short term, the concern is with the outlook for monetary policy and the direction of travel in the U.S. real economy. And as you will likely be aware, the FOMC in the United States has started its rate cutting cycle and remains concerned with the direction of travel in the real economy, particularly around the rise in unemployment in the U.S. that's taking place over a short period of time. So all of this plays into a direction of travel in the short term of falling short-term interest rates. The offsetting consideration is one which is more medium to long term, which is the outlook for fiscal policy. You'll also probably be aware that there is a fiscal sustainability issue in the U.S. The U.S. currently runs what's forecast to be a $6.5 trillion deficit fiscally and with the result of the latest election and that is set to continue. And all of this is set to put push upwards on the outlook for U.S. interest rates, but also likely for inflation. And so our macro outlook and the asset allocation, which then flows from that is a trade-off of falling short-term interest rates and then macroeconomic fragility over the more medium term. So turning to the high-level indicators at the moment, sort of without all of that backdrop, at a high level, the U.S. economy looks to be reasonably resilient. On the left-hand chart, you can see estimates from the Federal Reserve Bank of New York, which shows that the U.S. economy is currently running with a positive output gap by which they mean that the current level of economic output is actually higher level of output that would be consistent with the economy being fully employed. And what that means in practical terms is that the economy is set up to generate a rate of inflation, which is sustained at some level above 2.5%. But as you can see from the direction of travel in that chart, while there is still a positive output gap, it is beginning to close. Similarly, the headline macro indicators remain fairly strong that while unemployment has increased, it is still at a relatively low level. Wage growth has come down, but it's still consistent with some level of inflation, which is above 2%. The savings rate is largely unchanged. And while CPI has come down, it's still above target. The question is really about the direction of travel in these indicators. And one indicator of the direction of travel is basically what's going on with the bond markets and what a bond markets expectations of interest rates and economic activity in the U.S. Now there have been 2 major U.S. interest rate developments over the past few months. One being that the Federal Reserve took its first decision to cut interest rates and has subsequently done so again. So short-term interest rates in the United States have fallen by about 40 -- about 75 basis points. The other thing that's come with that is that the U.S. yield curve has disinverted. And what that means in practical terms is that long-term interest rates are now higher than short-term interest rates and why that's important is that historically, this has been a move, which is always preceded recession. So the question then becomes, well, have the bond markets been right on this, yet? And there's a host of economic data out there to suggest that the U.S. is indeed perhaps not heading into a recession, but at least slowing down in the short term. For example, credit card arrears are rising and indeed on the investment side, capital purchases have been falling. The development that financial markets have focused on the most is the movement in unemployment and indeed that has moved a long way in a short space of time. The particular metric that has been focused on is something called the Sahm Rule which effectively focuses on the rate of change in the 3-month moving average of U.S. unemployment. And the key level that, that cross was increasing by more than 0.5%. The reason why this is important is light yield curve disinversion. It's generally been associated with recession. Now the namesake of the Sahm rule, Claudia Sahm herself has come out and said, well, this time might be different because while U.S. unemployment has risen, it has also been a lot of immigration into the U.S. rather than a lot of people being laid off or leaving the jobs. So the interpretation of that is unclear, but it remains an important feature of the U.S. economy that there has been a large move in the rate of unemployment in a short space of time. With the last few minutes, I think it would be remiss to ignore perhaps the largest macro development in the U.S. this year, which has been the U.S. election and we've now had a very decisive result in favor of President Trump. So while the result of the election is one key uncertainty, which is now out of the way, it is true to say still that the range of economic outcomes for the U.S. economy under Trump presidency is very wide. What's shown on this slide is essentially the range of outcomes as calculated by the U.S. nonpartners and think tank, the committee for a responsible federal budget. While you can take from that the range is very wide, you can also see that irrespective of which outcome we have for the fiscal situation. It's certainly on a higher trajectory than would have been the case under a continuation of the Biden administration or likely under a Harris administration. The key takeaways are that under a higher fiscal deficit regime, that's likely to come with higher interest rates in the U.S., both in the short term and in the longer term. Higher inflation from greater government stimulus, but also likely to the extent that this fiscal position is sustainable higher economic growth. Now the key planks of the Trump fiscal policy at this point are essentially broad-based tax cuts and an uplift in tariffs on import and the uncertainty is basically the extent of the baseline tariff. At some point, it's been listed as sort of 10%, some 20%. The delta between those in terms of fiscal spend is about $2 trillion over a 10-year period. So it's very, very wide or indeed whether these are simply a negotiating tactic. But while those remain to be worked out, the key takeaways are and this is an outlook of higher levels of debt, higher levels of inflation and higher interest rates probably across the U.S. curve. So to summarize the outlook. In the short term, we're looking at sort of further short-term interest rates cuts most likely and monitoring signs of real economy deterioration. But over the more medium term, some of the concerns are widening deficits, fragility in the U.S. government bond markets and more persistent inflation. So the consequence of all of that on our asset allocation is essentially, we'd like to keep our positioning defensive at this point. We have capped risk asset allocation. This is -- as Chris mentioned as a function of stretched equity market valuations. We have a focus on index-linked bonds because we are concerned about the outlook for inflation and we also have an elevated weighting to dry powder as a function of fragility in equity markets and potentially in bond markets. So with all of that, I will leave the outlook and hand back Q&A.

Thank you very much. [Operator Instructions] We have already received a few, so I will get started on these now. So the first question is CGT is often grouped together with [Ruffer] and personal assets as a wealth preservation vehicle. Can you justify that characterization? Anything that makes you think the CGT is a better vehicle than them for investors to see their wealth preserved?

Thank you for that excellent question. Can you justify that? Yes, will be the short answer. And the slightly longer answer would be, I suppose, I'd refer back to the track record slide that we showed at the beginning, which shows that over the 42 years that we've been managing Capital Gearing Trust, we've only had 2 down years. Would we say that we are a better wealth preserver than Ruffer in personal assets? I wouldn't like to say that we're better than them. I think they're both very well-managed vehicles and have a place in investors' portfolios. I'll stress -- highlight a couple of differences. The first is that Capital Gearing Trust is rather cheaper, we charge lower fees than them. And while we're intellectually very similar and are trying to achieve the same thing, and we go about it in different ways. So personal assets, I think you would say, has a quality growth aspects to its equity allocation and tends to have a higher allocation to gold than we have. And we just obviously served it very well recently. And then Ruffer tends to use derivatives to provide portfolio protection, which isn't something that we do. And I would say that we -- so -- and by contrast, I think that we tend to focus a little more on index-linked bonds and a little bit more on deep value situations. But yes, hopefully, that answers the question.

And that actually moves on very nicely to the next question. And Emma, I'll hand it over to you. So your views on gold as a holding in the trust?

Of course. So included in our previous allocations, so we have a 1% holding to gold in the trust. Historically, we have had this holding at 1% effectively because we had viewed the price of gold as behaving essentially similar to a long U.S. government bond or long-dated TIPS, which is to say that essentially, the value of gold -- the price of gold would go up at the same time as generally interest rates were falling in the U.S. Some environments of economic uncertainty. Obviously, more recently with the geopolitical developments as they have been, there has been a structural change in the demand for gold, such that particularly central banks that have either been sanctioned or risk have been sanctioned, have essentially increased their demand for gold, and that's been one of the factors that's led to the price for gold rising. But more generally, the part of the price for gold has been lately more difficult to understand, and it has -- brings with it a volatility that we believe is inconsistent with a wealth preservation trust. So essentially, the reasons that we don't fully understand what's driving the prices and it brings a lot of volatility. We've tried to keep our allocation to reasonably limited despite the fact that, as Chris mentioned, it has -- it has served its hold as well more recently.

The next question we have here is, your views on China as an element of your equity holdings.

Sure. So we have today kept our exposure to China reasonably contained effectively, that's as a function of a macro and geopolitical view on China. The Chinese economy has been one where there's been a lot of sort of government debt-driven growth. It's largely reasonably unbalanced in terms of the extent to which growth has been financed by the government versus domestic demand. There's a separate geopolitical issue, obviously, in terms of direction of travel of extent to which China will be included and how in the Western economy over the future. As such, our appetite for Chinese equities has been reasonably constrained and likely will continue to be.

That's actually all the questions we have received. But if you do think of anything else, please feel free to e-mail me at [email protected]. Chris, do you have any closing remarks?

No. Thank you very much for dialing in.

Thank you very much for your time.

Thank you, everyone.