In this episode of the abrdn Investment Trust podcast, we discuss the global outlook for 2022 with Adrian Lim, manager of Asia Dragon Trust, Bruce Stout, manager of Murray International Trust, Jennifer Mernagh, co-manager of Aberdeen Diversified Income and Growth Trust and Thomas Moore, manager of Aberdeen Standard Equity Income Trust. They share their views on what we can expect for the global economy in 2022, including the potential risk and opportunities in markets.
Recorded on 12 December 2021
Cherry Reynard: Hello, everyone and welcome to this Investment Trust roundtable. We're going to be discussing the outlook for 2022 which will include a look at the global economy, the health of the corporate sector, inflation and valuations amongst lots of other topics.
With me today are Thomas Moore, manager of the Aberdeen Standard Equity Income Trust, Bruce Stout manager of Murray International, Adrian Lim, co-manager of Asia Dragon, and Jen Mernagh, co-manager of the Aberdeen Diversified Income and Growth Trust. Welcome, everyone.
ruce, could we start with you. I wonder if you could give your view on the state of the global economy today? Do you think that recovery is firmly established? Or could we still be derailed by the Omicron variant?
Bruce: Thanks very much Cherry. Two minutes to go around the world isn't very long, but I'll tell you the way that we're looking at it within Murray International, we kind of look at it in terms of a split between what's going on in the developed world and what's going on elsewhere.
We do know that a massive contraction in 2020 and then a massive expansion in 21. Next year, it will probably return to some sort of normality of growth. But that would probably likely be lower than we've seen in the past, purely because of the debt legacy that we've had, in order to bail out the pandemic - it's come at a big cost, and it won't be a cost that will be easy to pay back, it's going to take some time, so it will be a constraint on growth.
I think when we look at the developing world and elsewhere, the cost hasn't been so high there in terms of monetary costs, there's been a much higher human cost, obviously. And it's certainly in terms of - there's been a delay in as much as vaccination rollouts have been slower elsewhere. And therefore, we'll probably see a better recovery in Asia and emerging markets next year, and the year beyond catching up for lost time as they begin to satisfy the pent up demand that's been growing since they were in lockdown.
Cherry: Great. Thanks, Bruce. And, Tom, from a UK perspective, how healthy do you believe the corporate sector is today in terms of earnings, dividends, all that kind of stuff.
Tom: You know, we've really encouraged by what we've seen Cherry over the last 12 months or so. And the reason for that is that corporates in the UK are seeing the benefit of the unlocking of all these different restrictions globally. In the UK, we were hit hard by the pandemic. But as a result of that, we're now in a position where companies are starting to look forward. Herd immunity is increased as a combination of both vaccines and natural immunity. And so actually, the advent of all these new variants - the latest one being Omicron - actually poses less of a risk now. And so there's a palpable sense of confidence among the corporates that we speak to, even despite the headlines that you see in the media. So actually, things are looking a lot better for UK corporates. They're well run businesses typically. And obviously, we also select companies that we think are going to be able to fare well, in the next 12 months - even if there is more volatility in the news flow in terms of new variants or lockdowns, whatever might come our way. So I think we're in a good place, the companies are reinstating their dividends, nearly all of the companies in my portfolio are paying dividends again, there's only a handful, four or five companies, I think it is at the moment which aren't paying. And actually, that's a conscious decision by me as the portfolio manager to own a handful of companies with significant growth prospects, which may prioritise growth at the moment rather than paying out dividends.
So things are looking good from a dividend perspective as well. Our portfolio incomes looking up as well, so yeah, very happy with the outlook from a, from a macro perspective. It's been a big test the last 12 months, but I think we've come through and things are looking up.
Cherry: Okay, great, thanks Tom. So, Adrian, let's talk valuations in Asia and how they look relative to history. I mean, as you look across Asian markets, do you see any particular pressure points? I mean, you sort of assume it's technology, but I guess there may be other areas as well.
Adrian: The market as a whole is not particularly expensive, but there are segments like you say which are not cheap - parts of green energy, for example, and parts of certain online business models, for example, these are verticals or segments that are not particularly cheap, from a PE perspective.
They are, however, delivering decent levels of growth. So there's a decent amount of underlying growth in these segments. But we do have to be quite careful about valuations, because there are pockets of these expensive stocks or segments.
Overall, as the market as a whole, is not particularly expensive. If you strip out the distortions, during the last 18/ 24 months, where PEs were very high, because earnings were depressed. So if you go pre COVID, and look at the three years before that, PE levels were about 14 to 16x forward in the region as a whole. And now we're currently trading at about 16/17x. But there are some, there are some wins, that would give us a lift over the next 12-24 months, that should see the effective PE coming down. So, we're reasonably comfortable with what we've seen in the region. And the more important thing is to understand how earnings momentum recovery is developing over the next few quarters.
Cherry: And are you seeing that earnings recovery coming through Adrian?
Adrian: We are, we are, but it's not hitting all segments equally. So for example, the airline industry, the hotel industry, is still going through a very, very tough time. And we are looking at, you know, you need to look out maybe two, three years before you’re seeing a normalisation of earnings that will make us comfortable. But other than that, it's not just valuation, some of these companies need capital desperately. And so at this point in time, you know, are trading at understandable discounts. So they may be cheap, but they're definitely cheap for a reason. And we are not the type that would put our investors’ money at risk in that scenario.
Cherry: Great. Thank you. And Jen, turning to you, how optimistic are you feeling about the next 12 months and are you more optimistic on certain areas?
Jen: Sure – so, how optimistic. So I think we do expect global growth to slow from here, from where we have been. And although we do believe that we're past the peak of the recovery, we believe that growth remains high on a relative basis the next year, in fact, the next two years.
Just thinking about monetary policy as well. So we do expect a less accommodative stance, particularly in the US where the Federal Reserve has been key. But we believe it remains supportive, and that fiscal policy should take over in terms of market support in the long run.
And then thinking about the Trust that I help to run, whilst we do perceive kind of remaining uncertainties around how economies may evolve going forward, including the impact of Omicron, as I was saying, we feel that the company is well positioned for this uncertain environment. So because of the public and private nature of the Trust as a multi asset trust that can invest in public and private markets, it means that we can access private market investments that should deliver returns in excess of public markets. We also believe we can continue to enter to participate in the growth upside, where we think it's available in listed market equities. And also to participate in the income generation capability that we think we can continue to extract from fixed income and credit and listed alternatives as well.
Cherry: Great, okay. Thanks Jen. So, Tom, turning to you, again, the market has kind of flip flopped between value and growth for quite a long time now - it's either been all about tech or all about sort of recovery stocks. Can you see that changing in 2022? So you have a more kind of nuanced market, that that's more focused on the sort of individual outlook for specific companies?
Tom: The bond yields are really important here, Cherry. And the reason that you know that is if you take a look at the MSCI value index versus the MSCI growth index, it's a very high correlation with bond yields, and in particular real yields.
Now, though, that's inflation adjusted yields. And at the moment, what we're seeing is we're seeing higher inflationary expectations as, is evidenced by breakeven rates of inflation. If you, if you look at breakeven inflation, it's been going up all year, it's now about 2.6/2.7% in the States - US 10 year breakeven inflation.
Now, if you then look at real yields, you'll see they're still at the lows, they're still about -1%, which is historically, very rare, almost unheard of that real yields should be -1%, especially when you think that we're actually in the middle of quite a sharp economic upswing.
So the reason why real yields are still so low is that there's central bank intervention in the form of quantitative easing. Now, at some point, the central banks are going to look at inflation rates all around the world, Germany at 6%, US 6%, UK over 4%, and they're going to start to say, whatever the latest variants are, Omicron, or whatever the latest news flow is - we've got an inflation problem here.
Now, perhaps it is transitory, at least, at least partially, but you can see that the central bankers like Jay Powell, are now starting to move away from that kind of transitory language. And so this is going to be very important for this value versus growth question that you asked Cherry - what happens in 2022.
Now, if you believe that central banks are going to need to start tightening, that's going to play an important role in how different sectors will perform in 2022. And what I am doing in my portfolio is making sure I've got plenty of decent inflation hedges in my portfolio.
If you look at the cash flow that's being produced from various sectors, such as mining, oil and gas, financials, and some of the consumer discretionary stocks, these are companies producing massive cash flows like on a level that we haven't seen for years. And these companies are producing so much cash, that we have a lot of confidence that the dividends that we're paying out, is sustainable.
The dividend yield, by the way on my investment trust at the moment is just under 6%. We are confident in the sustainability of the dividends. And so because what we're seeing is companies producing cash, companies with that kind of inflation linkage, which means that I am not sweating about rising inflation. I'm actually excited about what this portfolio can do in a new macroeconomic backdrop, and central banks are going to have to fight this one out and work out how are they’re going to confront rising levels of inflation, which is causing significant stress for consumers at the low end, you know, people whose energy bills are going up, food prices are going up and wages are going up now, you know.
So, it's all in the mix Cherry, it's a great question to ask. We believe we have positioned the portfolio extremely well for the environment that we're entering now. And I do believe it's a new environment, by the way. This is a new economic backdrop that we're entering, which I believe a lot of fund managers out there are not ready for. So it's really very exciting.
Cherry: Great thanks Tom. Bruce can I put the same sort of similar question to you about the characteristics that are likely to define the winners and losers in the year ahead. You know, do you agree with Tom, is it all about sort of, you know, finding the inflation hedges or what, what other things are likely to be important?
Bruce: Yes, it's an interesting question, because, obviously, we listen to the companies very carefully as to what they're seeing on an operational basis. And the one characteristics - you could probably take the ‘s’ off it - because there's one overriding characteristic that is causing a lot of dislocation at the moment, and that is inflation.
And it's coming in two areas - inflation in pricing, and inflation in labour. Now, that has big implications for the types of business that you want to own, going forward from here, because if you own a capital intensive business, such as telephone networks or pipelines, which are real assets, then you're far less likely to be impacted by wage inflation going forward from here. If you own labour intensive businesses, particularly in the gig economy, then once wages start to rise, it's very difficult for those companies to pass on wage increases and costs going up through selling prices - purely because they're in such competitive industries. And they have benefited so much in the last couple of years when we've been at home, that we're looking going forward from here, for more and more real assets.
Now it's very interesting because we now have a situation where a lot of the disruptive forces that cause deflation, such as globalisation, and technology, and disruption, are beginning to be reversed - we see more trade barriers, we see more tariffs, we see more and more impediments to the movement of goods and services around the world, which is actually all inflationary as well, which is coming at a difficult time.
Prices can come out of material such as oil, wood, concrete, whatever, and reverse if the market deals with supply bottlenecks, but where costs become established - higher costs become established is in wages, and when the retail price index is 6%, then you will not go with your boss and try and negotiate a 1% wage increase to see yourself 5% worse off in the next coming year, so there's definitely upward pressure on wages. And that's a key component of the type of businesses that we're owning in Murray International going forward from here, looking for capital intensity, rather than the vulnerability of high labour content.
Cherry: Great, thanks, Bruce. And, Jen I wonder if we could turn to you just to look at some of the key themes running through your portfolio as we head into 2022?
Jen: Sure. So I guess it's interesting, actually, what Bruce was just saying. So if I think about the portfolio as it stands today, so we have a good degree of inflation protection at the moment, so we have a reasonably high weighting to infrastructure and real assets, both in private markets and in listed exposures. Obviously, these assets have cash flows that are often linked to inflation, they generally kind of government or quasi government backed entities. So the Trust is offering protection that way. The other holdings that we have is in floating rate credit, as well. So if we are to see hikes and interest rates to whatever degree, then we should see some protection for the portfolio there as well.
I guess, you know, thinking about the way that we construct portfolios, we do obviously think about different scenarios - we're kind of position for a baseline scenario - but we do consider others and look at the portfolio to see that we're insulated, I guess some of the things we've been considering most recently is inflation. Obviously, we’ve had a kind of long discussion about that. We're also thinking about China, and the stresses that we've been seeing in China and how China will deal with those going forward. And one of the kind of, one of the other things we're kind of looking at a bit more at the moment, but have had on the radar, really, since the pandemic I suppose struck, is vaccine escape, and thinking about kind of how the portfolio are performing in those scenarios, as well.
I suppose the other thing to note is in the Trust, we do have some specialist investment vehicles, which are typically kind of unrelated a business cycle and economic climate. So, things like healthcare, royalties, litigation, finance, and so on. So, we do feel that we've got a reasonable degree of kind of insulation against some of the economic risks that we've been discussing.
Cherry: Great. Thanks, Jen. Adrian, the same question to you - the key themes running through your portfolio as we move into next year,
Adrian: Dragon will see quite a few, will check some of these concerns that, you know, have been talked about. So inflation is definitely an issue, the recovery from COVID related stress across various degrees of lockdown across the Asia Pacific regions is an issue as well.
I suppose what I would say about the Dragon Asia exposure, as there will be three additional things.
One is that inflation so far has surprised on the downside. So central banks within the region have created a buffer of expectation that inflation should be higher even now. And so that might come, we are still watchful for that risk. But it hasn't been a very - it hasn't been strongly evidenced quite yet.
We insulate that by looking at companies, business models, the ones that can pass on some of those inflationary aspects on to their customers. And also we look at the ecosystem and try and understand the products and services, which are more demand in elastic when it comes down to inflationary pressures.
Jennifer talked about China and China itself. It's not a two minute answer, but simplistically, China's trying to balance between a potential for growth and recovery and structural growth, with making sure that society as a whole is not left out. Over the last 20-30 years, there has been this push for growth almost at any cost. And there are now checks and balances that have been instituted in quite an intense period over a relatively short period of time, to make sure that, you know, the social fabric is not unduly stressed. So that's one of the things that we are looking out for, it's an interesting opportunity. But you know, we have to be very selective.
So, stocks that have been sold off, like Tencent, we still have an active weight in because what is important is that within China, we have been increasing the concentration of exposure into stocks that we feel very comfortable with. And then we've been trimming the ideas that are a little bit less convincing. And Tencent is one of those positions that we think has the strength and resilience to weather through this, this uncertainty.
India's also another area that's interesting, because of the underlying growth potential that remains in a developing market that comes from very low base. The interesting thing about India is that, unlike China, which has invested a lot in physical infrastructure over the last few decades, the current push in the Indian growth may be coming from its late entry into the digitization of quite a few business models. So, it's an area that provides selective ideas. But valuations as we talked about earlier, arent cheap. So, it's something that we have to be very selective about. So, it's COVID, it's inflation, specifically China and India, interesting. And we need to balance that out with the uncertainty of recovery over the next five or six quarters.
Cherry: And sorry just sticking with you, Adrian, I mean, what permanent changes are you seeing as a result of the pandemic in Asia?
Adrian: I think the most obvious one has been this shift from offline to online delivery of products and services, you could argue that, you know, you saw signs of this three years, four years, even five years back, but the pandemic has really accelerated this push. And although we've been looking for signs of a reversal of some of these trends, you know, the moderation to median, or the shift to, you know, a moderation of that trend, hasn't been very strong to date. So that might come as borders open up across the region.
But we think that quite a few of these structural shifts are now semi-permanent. There are certain areas, for example, also in areas like property where retail, real estate, you know, as a case, is less appealing than it used to be, you know, pre COVID, as well. So, there are some bargains there. But we need to be very mindful about very basic things like cash flow, like strength balance sheets, and like, you know, the quality of locations of these assets before we really jump right in and embrace them. So, these are some of the key changes, some will retrace back some of these plans over the next five, six quarters. But we think that some of these structural changes are here to stay.
Cherry: Great. Thanks, Adrian. Right, just to wrap up, I was just going to go around the sort of virtual roundtable and just ask everyone, you know, to sum up in in a couple of lines, how you're kind of feeling about the year ahead - risks, opportunities, that kind of thing. Tom, I was gonna start with you on that one.
Tom: Yes. Thanks, Cherry. So, I would characterise the year ahead in the following way, I would say that the macroeconomic backdrop is changing. So, as I mentioned, we're going to have inflation for a little while. And that's going to make people reassess how they should be positioned in terms of their portfolios. And I think that everybody needs to be comfortable that they're in a good place - we certainly are. We've got an abundance of stocks in the UK market with very high free cash flow yields, which support very high dividend yields. They're seeing dividend growth as well. So, these are definitively not value traps. So, I think that those people who've been saying would be a bit worried about that yield should think again, you should be excited by yields which are elevated, you should not be frightened by them, you should be embracing those yields. And you should be saying, I will have as much of those stocks as I can in my portfolio because they are sustainable, because the earnings that support those dividends are going up as the economy picks up. And so, where we see that, particularly are resources, mining, oil, financials, consumer discretionary, there are some incredible opportunities at the moment in those areas.
And you know, what, if the market says we're not interested, other companies, other corporates will do, private equity will do. We've had four bids in the last 12 months, we've got another two in the new financial year coming through. We’ve got Playtech and Vivo Energy, both completely underappreciated stocks. That will continue, in my view, if the stock market remains as bizarre as it as it currently is.
The reason why the stock market is behaving in a strange way is that central banks have engineered quantitative easing in a way that has changed investors mindset, it's taken people away from conventional metrics such as price to earnings, price to cash flow. That's why you're reading more about price to sales. Bruce here knows perfectly well, that is not sustainable on a long-term view, we've had lots of good chats about that around the desk. So, we are positioned in a way which will ensure that we are protecting our clients capital, shareholders capital, at a time when that unravels and the macro trigger for that to unravel will be when quantitative easing turns into quantitative tightening, the discount rate starts to go up from zero to something that is higher than zero. And there will be probably, in my view, the most almighty rotation at that point, and that is when people who have stuck to the basics of finding companies with lots of cash flow, and not overpaying for that cash flow will be rewarded.
And that's why I'm confident that you can look at the dividend yield on Aberdeen Standard Equity Income Trust of around 6% and say - that's great. I will have that. I will grab it with both arms. So that's how I'm feeling about the next 12 months.
Cherry: Great, thanks. Same question to you, Bruce.
Bruce: Yeah, well, it's probably a longer horizon than 12 months actually, just looking at maybe for the next two or three years for Murray International.
I think the main areas that we are excited about, where we think the markets mispriced and where there's real upside in both earnings and dividends, is definitely Asian operational leverage to recovery that has been postponed by continuing lockdowns and things this year.
And we do like our exposures in the capital intensive industrial such as Epiroc, Atlas Copco, Hon Hai Precision in Taiwan. We do like digital networks and telecommunications. We do like pipelines that move gas, very difficult to replicate those real assets nowadays. And of course, we do like the commodities particularly special ones such as Sociedad the Chilean lithium producer or Vale in Brazil.
But we're also mindful, the areas that we don't like are consumer services and we don't like areas such as tourism or hospitality. They have very, very high labour components of their business models and if wages really do start to rise, then the margins will be squeezed there. And the same goes for high end consumer discretionary. We are slightly concerned about that.
And I guess it wouldn't be a season of goodwill without a nice fact to leave you with. And I guess the last time the retail price index and the UK was 6% was exactly 30 years ago. And the last time the retail prices in the UK were 6%, base rates were 11 and a half and today base rates are 0.1. So perhaps the biggest concern for us, is a policy mistake in the developed world, because they let the inflation threat run for too long.
Cherry: Great. Thank you, Bruce. And Jen, same question to you.
Jen: So, I guess, you know, we do have to have - because of the nature of the Trust being invested in private markets, as well as public - somewhat of a longer timeframe as well.
But in terms of the next 12 months, I guess, you're feeling relatively confident in the kind of global economic growth, we're feeling relatively confident in kind of the way that the portfolio is structured, in as much as it's as broad spread of risks. So that's the way it's designed to be, multi asset nature and to be diversified. So that we can take into account all of those scenarios that we've been discussing.
I suppose, just thinking about kind of private market investing in general, we, we see kind of quite a spread of returns around the mean in private market investing. So, we feel that we have an edge to be able to extract those returns towards the top quartile of returns. So, we feel somewhat insulated from kind of, I guess, any kind of gyrations or expected cuts going forward. And I guess that the environment that we're going to face in the next 12 months probably will be a bit more volatile than it has been, up until now, for all the reasons we've discussed.
I guess that's kind of the investor appetite for infrastructure remains key, and the Trust has quite a lot of exposure to infrastructure. So you know, the key social and economic infrastructure with long term inflation, then contracts, they will continue to provide a yield and inflation protection through the next 12 months and beyond – we’re quite confident in that.
Thinking about private equity, obviously, there's huge amounts of cash available to put to work in private markets, which I think Tom was alluding to earlier. We think that that means that the environment continues to be quite competitive in private equity, but at the same time, when we're looking for exits from our kind of more mature investments, that's quite a positive environment. Thinking about private equity, private credit as well who have investments in private credit. I guess, as government starts to taper, there will be more opportunities in private financing, which you know, where borrowers are facing a tighter lending environment. So, we have to be careful and make sure that that the investments we're making are really kind of, I guess, that we're sharpening the pencil on those to make sure that the rest we're taking the right ones.
And then just thinking about real estate again, because you know, the kind of the more kind of, I guess, idiosyncratic things that we've been talking about in terms of, kind of, I guess, the, you know, the big secular trends that have occurred and been even amplified by the pandemic continues. So, if you think about the dissipation of the office market and tailwinds for residential, we're trying to take advantage of those as well in real estate, in the real estate, part of the portfolio.
So, I think just broadly, you know, we're pretty diversified. I think that the markets probably going to be trickier to navigate going forward, more volatility, slightly less growth, but we still feel relatively constructive.
Cherry: Great, thank you, Jen. And Adrian, last word to you.
Adrian: I think the near term is interesting, the recovery is interesting. And I think we have balance in Dragon, that will take good exposure to that recovery story. But across Asia, there are a few themes that are structural that are longer dated as well, that excite us. We've seen companies now that didn't quite exist 15-20 years ago. They are they still got a long pathway to growth.
For example, in electric vehicles, we've got some chemical companies in North Asia like LG Chemical that is really important and crucial to the adoption of EV batteries and engines going forward. We've got things like SunGrow, big solar panel manufacturer in China, which is huge, which is a leading player in market share terms.
We've got companies like, we've got companies like PolicyBazaar in India that are revolutionising the way insurance is distributed in India as well. So, in addition to the nearer term recovery story, we've got some medium - long term ideas that are interesting. But, you know, it is going to be a volatile environment, the, the map is not going to be visible all the time. And that's where we need to be quite proactive about the way we shape the portfolio always, but I think Asian is in a good place, and we have position to cover that.
Cherry: Great. Okay, we'll wrap up there. Thank you to our managers for their thoughts today and if you have any further questions, please do look on the website, www.invtrusts.co.uk.
And thank you to everyone for listening.