Money Makers

Global equities specialist SIMON EDELSTEN, lead manager of the Mid Wynd International Investment Trust, gives a manager’s perspective on how he is handling today’s market conditions. (First published in 2018 and not updated).

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How did you come to be managing this trust?

To start at the beginning, I got to know Nils Taube [a legendary equity investor] in the ’80s when I was a stockbroker. I was one of his firm Taube Hodson Stonex’s closer stockbrokers. I’d talked to Nils about leaving broking and moving into fund management quite frequently in the 1990s, and then, in 2000, it seemed like a good time to do that, and so I joined in 2001.

I think you’ll find most of the way in which we run money will remind you of the global, growth-oriented and thematic approach that Nils’ funds tended to have. I think that we have added some enhancements, particularly, about risk management, use of data, and use of modern technology, which has moved us a bit away from his more artisanal style. We use more data and structure, and less of a call on experience, because we have less experience!

In 2004, Cazenove rang us up and asked us whether we’d be interested in sorting out an investment trust called Electric & General, which was the rump of the litter in the Henderson stable, and we took over this fund, which had a 200 stock portfolio, a little bit of this, a bit of that. Nils had been on the board for a while, but it had rather lost its brand, nobody quite knew what it was there for, it had been used as an in-house vehicle by Henderson to pay people in shares to avoid tax, and of course, it was surrounded by other funds like Witan and Bankers which, for various reasons, had a higher profile and higher priority. Henderson’s marketing department couldn’t sell five trusts which were all in the same sector.

The takeover worked pretty well. We tightened the list up. We gave the trust our own rationale for trying to increase people’s real wealth patiently. We probably made it more capital-protective than the other Henderson trusts. We ran net cash positions, where the other trusts were structurally geared.

After Nils passed away, and John Hodson wanted to leave, I decided I wanted to go for a much more structured and disciplined approach to running money, less artisanal if you like. I felt it was time for me to move on.

Fortunately, I only had to move a few floors in the building, as Artermis, which was another firm I’d known from my time in broking, worked in the same building. The Scottish clients were on my patch when I was at Phillips & Drew, so I’d known John Dodd particularly and Adrian Frost very well from my years in broking. They had just bought out the business from ABN and it was very UK-oriented, they had ambitions to grow the business again because they had a new funding partner and they knew that I could bring them a disciplined, sensible approach to global equity fund management.

From my point of view, it was also another partnership and could underwrite my building a business without there being much time pressure. The lack of timetable pressure – wanting to know when you were going to be profitable and so on and so forth – allows you to run money the way in which you want to run the money rather than take on a higher risk profile in your early years because you’ve got to get that critical mass to attract retail attention.

We launched the unit trust here six and a half years ago now, called Global Select Fund. Then, lo and behold, a couple of years after that, in 2014, Cazenove again rang up and said we’ve found this Baillie Gifford fund which is a bit overshadowed by other Baillie Gifford funds, and the board and the family, with a big shareholding in the fund, feel that it won’t get the attention and profile of the other funds. I think 27 firms pitched for it. The shortlist included the incumbent, a shortlist of five – and the chairman of the board who set that ball rolling, by the way, was Richard Burns, the ex-senior partner at Baillie Gifford, which surprised me and other people even more.

As you can imagine, our proposition was to move it to a much more capital-protective structure, with a more focused portfolio. But that did not involve us having to sell the large number of internet stocks in there, which have done terribly well, so the reorganisation wasn’t that vigorous. The number of stocks in it went down to about a third of what it was. Mike McPhee [the previous manager] always had a section of the fund he called “get rich slowly but surely”, I seem to remember, and that is a bigger part of what we do than what he did, but he always did that.

The trust started life as a family trust, you said?

Yes, and there are a number of family members on the board. The Mid Wynd International Investment Trust is the family trust of jute mill owners in Dundee. It came to the market very late compared with some others, so it was floated in 1981, and Richard Burns was the first fund manager of it when Baillie Gifford was quite a small firm and very dependent on its investment trust client base. It was before the heady uplands that they’ve headed into since. Richard sorted the fund out, taking it on himself, and Mike McPhee was the only other fund manager that they’ve had.

The whole extended family probably owns about 13% or 14% now, because we have expanded the trust quite significantly since we took it over. When we took it over, it was just over £70m of assets. It’s now about £145m, so that’s a combination of performance, the market going up and net share issuance. I think it’s found a niche here in the global equity universe as being targeted to be a bit more capital-protective than the others.

How do you manage the trust with your team?

There are three of us doing the job: I’ve had my THS background; Alex Illingworth ran very similar funds at Rothschild and Insight; and Rosanna Burcheri comes from a European background and worked for M&G and Shell. We’ve got three experienced fund managers. It’s a bit like the old THS style of having three grumpy old people who argue endlessly until, finally, somebody shuts up. But that keeps your standard and quality up. The hurdle to get in the fund is set really very high. But it also means, even though there are very few of us, we know a lot of stocks, and what we’re looking for is pretty consistent and we agree on the quality that we’re prepared to go down to.

What is different about your approach to managing a global equities fund?

There are some very good trusts out there in the investment trust universe, with excellent performance, but because it’s 10 years now since the financial crisis, many have forgotten how badly some of the global equity funds did at that time. Structural gearing works in both directions! This is an ungeared trust basically. Although we do have a credit facility, we don’t often use it, whereas for most of the trusts which have outperformed us, the contribution from their structural debt is quite significant. Some of them have also picked stocks better than us, but generally we are pretty solidly in the pack on the stockpicking, if you de-gear the performance figures.

When I look at the universe, what surprises me is how unbalanced some of the other portfolios are becoming because they allow successful holdings to keep going up and they don’t trim them. We are the other end of that policy. We take more active bets and are more valuation-sensitive. When we took over the trust, we had as many internet stocks as other people, we had consumer staple stocks like other people, which were the right things to own, but as valuations have carried on going up we started selling our consumer staples 18 months ago, because we felt that paying over 30 times earnings for Nestle when it’s only growing, top line, at 3% per annum is just not very good value for money. As we have quite a broad view of interesting stocks around the world, we generally think we can find something more interesting to do.

Can you give an example of how the profile of the fund has changed?

This year, we sold our biggest holding, which is Amazon, when they did the Whole Foods acquisition. We have no criticism of that. We understand what they’re trying to do, but it’s just a valuation issue. If it means that they’re becoming more capital-intensive than the other internet companies, then they shouldn’t be on a rating as if they are very low capital intensity. As the market moves on, and particularly in the last couple of years, our portfolio – which was quite like other global growth-oriented managers when we took the fund over – is becoming less and less like them. We are trying to find decent quality growth themes that are on more modest ratings.

We’ve also sold our Facebook recently, as we think some of the internet stocks are now quite pricey. We’ve built up a new theme recently in automation stocks, which seem to be having a boom and which has led us back to Japan. You won’t be surprised that the average multiple of cash flow of the stocks we’re buying is a fraction of the internet stocks, however you analyse them. The growth rate will not be quite as heady, but some of the robot companies are seeing 20% or 30% increases in order books. One of them saw a 100% increase in order books this year.

Again, I think this is very like the way we managed money at THS. You never know that you’ve got a new theme coming along, but if you find that you’re starting to get a bit uncomfortable with one part of your portfolio, that it seems to be a bit too fashionable, and the multiples really seem to have gone through the limit of where you think things should be, you always have other themes and new ideas you have been working on in the background to fall back on. There’s generally something out there which allows you to recycle money gently over time into a new idea which is less fashionable and certainly more modestly rated and yet keeps the fund reasonably fully invested.

You also have a sizeable personal stake in the trust?

Yes. I always have been an investor in my funds. When I turned up to THS, I put as much money into that as my mortgage would allow me. Personally I happen to think that my fund is the best way to make real returns for savers out there! I back it up personally in quite a lot of size. While I’m open to ideas, I really can’t think of anything better. It’s an enormous privilege being allowed to buy little bits of other people’s hard work globally, and currently, with no exchange controls, the investment trust allows me to invest in an efficient manner round the world, keep my money outside the UK, which is not a currency I particularly want to invest in, not that I have terribly strong currency views, and to invest in growth where I can find it round the world.

It is important for investors to know that the fund manager has a similar attitude to risk, is it not?

Yes. If I lost all my money now, I haven’t got time to make it back again, and we’re quite a long way into a massive bull market, which was, to be blunt, one of the other reasons that I left THS. In 2009, I thought this is the best opportunity to invest I’ve ever seen and probably the best I will ever see, and so I was, I think the correct term would be, “aggressively bullish”. You have got to take these opportunities. Does that mean that I think it’s now time to sell equities? No. I don’t think you make that decision on the basis of whether you’ve made a lot of money out of the bull market. You make it on the basis of whether the valuations are telling you that there’s a problem, or whether the macro is telling you that there are imbalances you need to worry about.

But I prefer to own the equity of the stocks that we own in this fund than have my money in anything else. Gold? I’ve never met anyone who comes up with a sensible view of what the price of gold should be – people have very strong views on which direction the price of gold should go in, by and large always up, and it’s always the same people – but if I can’t value something, I don’t want to own it. And any bond I look at in the world either is what Buffett calls “reward-free risk”, as far as I can see.

So what I spend my time worrying about for the fund is of course informed by my own caution and desire for capital protection, and it is: can I find assets in global equities which will balance the fund if things go wrong? The main thing that could go wrong is that inflation goes from massively subdued and much lower than people expected to something different. It has undershot everyone’s expectations in major economies for the last seven years.

Are you as surprised by that as many economists seem to be?

No. When I went to college in 1980, it was all about monetarism, and quite clearly Milton Friedman’s proposition that, if you expand money supply this much, you will get inflation, is wrong. It is interesting that there are still global equity managers who try to run money using economic theory when it clearly is of no practical use at all while secondly, the central banks are also listened to with enormous awe and wonder, when, quite clearly, they haven’t the faintest idea what’s been going on at all! It is much easier having a stock-picking approach to have confidence about the future.

My confidence in the future of my savings is principally down to the 20 big holdings that we have in the fund, which are fine companies, which I meet every now and again and seem to me to know how to run capital much better than anyone else I meet. They are also diversified. We have half the money in America, but we also own Chinese banks and many other quite different things. If you look at the THS long-term record and the unit trust record, you’ll see that, over the whole piece, including big bear markets, we’ve been chugging along at 11% per annum in real terms.

I’m not confident that I’m going to carry on doing that, but even if I miss that by quite a bit I can afford to have a couple of bear markets. And where else are you going to put your money? What on earth is the argument to put some money in an infrastructure fund or something like that if equities generally deliver that kind of return for the patient investor? That’s the key thing: you’ve still got to be patient. We do say to anyone considering investing in the fund, what I used to say at THS as well, which is this is for people who can afford to wait.

If you’re serious about trying to deliver an equity product for investors, it is worthwhile giving up quite a lot of the last bit of the bull market to put that insurance in place so that people don’t panic. Even people who don’t need the money panic in bear markets. The best work we did at THS was making sure that none of the clients were panicking in 2003, at the bottom of the bear market. That wasn’t the worst bear market I’ve sat through, it was nothing like ’87 in terms of panic, but goodness me, people were still ringing up saying, “Oh, should we sell everything and buy bonds?” and all sorts of nonsense went on. We also kept people in successfully in 2008 and 2009.

I think that our policy is quite a distinct policy compared to others and as long as you’ve got that mindset, the tools you use to bring it about are quite technical: they are concentrating on valuation, trying to make sure your fund is diversified by stock, theme and country, trying to make sure that currencies and interest rates don’t hit you too hard. This is where I think I’ve tried to improve the use of data compared with the THS approach, which was quite artisanal.

What does that mean?

I set rather stricter limits on how much money we can have in any one theme, any one stock. The portfolio is built around eight or nine investment themes, which is the same as it was before, but we take the stocks we have in each of those themes and then we analyse the historic correlations between those themes. You can’t have an oil theme and an emerging markets theme and call them two separate themes without spotting that they go up and down completely together and they’re both very volatile. If you want to have those two themes, that’s fine, but you need to limit the total amount of capital you have between the two themes. What we want here is to have eight or nine themes which are properly diversified, at least in terms of their historic correlation. It does not guarantee that they will not prove to be correlated in the future, but at least you’re trying.

Just like at THS, we have an emerging market consumer theme – much smaller than it was because that tailwind is less vigorous than it was. Some of these countries are getting to have an aging population issue rather than a youthful population advantage. That emerging market consumer theme clearly has a correlation with another theme we had at THS, which is called tourism here, but was called ports and airports there. As tourism is now dominated, 15 years on, by Chinese tourism, in terms of the heady growth rates, there will clearly be more correlation now than there was 15 years ago.

Of course 15 years ago, media and technology stocks were very highly correlated, but now, as you may have noticed, the media sector is seen as complete trash and nobody wants to have anything to do it with it while the internet is going to dominate everything. The two are completely uncorrelated. It is a great thing to have seen through cycles in markets. I remember Nils always saying every year that he hoped he might get it right this year and eventually he would get enough experience! But you can also be wedded to some mythology you’ve built up for yourself, believing that you know what a defensive stock is and how to make the fund cautious, while actually markets move on, and sectors that were defensive prove not to be defensive the next time round.

So, consumer staples might be a good example of that?

Well, one of the things that I personally think makes a stock enormously undefensive is being on completely the wrong valuation. And yet I sat through a lecture the other week from the biggest endowment in the country, where they said, “Because we have such long duration, it doesn’t matter if we’re paying huge multiples for Unilever and Nestle because we know that they’ll be around forever, so we’re not taking a risk”. If you’re paying 38 times earnings for something and it goes down to 20 times, it may not be permanent loss of capital, which is bankruptcy, but Vodafone at £2 today compared with £4.75 in 2000 is a pretty substantial temporary loss of capital! lt’s certainly more temporary loss of capital than I’m prepared to put up with.

Now, I’m not saying that the valuation of Amazon or whatever is as stretched as the valuation of Vodafone was in 2000, but I am saying that some of the same mindset is creeping in, that it’s more important to have the right stocks in your fund than to worry about the valuations. That’s not what we think active fund management is all about. As long as people are trying to do the valuation, if they want to put in very low discount rate and say that they’ve done a valuation, that’s fine, but you will find some people who are saying “we just think this is a great stock and we won’t do the valuation”.

How do you prepare for the next market downturn?

My view of active fund management is that you apply common sense and are always on the lookout for getting carried away. I do these old-fashioned thought experiments like pretending that we had an 1987 moment and I walked in and the market was 25% lower, and there was no liquidity, no opportunity to trade, and then you sit there and you look at your list of stocks and you think: which of these stocks would I really regret having in the portfolio if that had happened? Not which stock would have gone down the most, in a way, I don’t care about that. It’s which stock would I just say, “What on earth did I buy that for?”

And are there any stocks where I think I’d get no liquidity? Obviously the great advantage of a closed-end fund is that you don’t have to trade in a bear market, but it still matters if you’re in an emerging market whether they suspend the currency or whatever. I think some of those differences in mindset do come about by having some money in the fund. I just think it makes life easier. It does help being a global equity manager if you think global equities are the best way to make real returns! I’m very glad that I didn’t end up as an expert in say Algerian small caps because then I’d feel very reluctant to have all my money in the fund. Having your own personal greed and fear instincts totally aligned with your job and your friends’ savings and endowments that you care about, I think that just makes life quite easy. It really does make making decisions terribly simple.

Can you give me an example?

When Trump got voted in, for example, we had half a day to make decisions before Wall Street opened. We looked at all these American banks we bought last year, and saw that they were all going to get marked up a lot because everyone would get terribly excited about the reflation trade, but we basically also thought this man Trump is a bit odd. Our thinking was along the lines that this was a bit of a windfall that we hadn’t been expecting. I’m very pleased we’ve made this much money much more quickly than we expected to, but we bought these bank stocks expecting Hillary Clinton to have got in, and Elizabeth Warren too, but they’re not that good! They’re still banks.

There’s this big growing sector of the savings market who have chosen to find their own way to invest, and we’ve seen that on the shareholder list here – it is one of the reasons we’re issuing stock very consistently. People are finding their way to the fund despite it having had a very low profile under Baillie Gifford. People are finding it and I think are just picking up that we’re offering, hopefully, a smoothed version of the market cycle. They may not understand the maths that means you end up with a better return over a number of cycles. That ratchet effect hasn’t been apparent for the last eight years, and that’s quite a long bull market. But I think people coming to the market now looking for a way to get more of their savings outside the UK appreciate the point of giving up money to a fund manager who is taking a relatively cautious view on valuation, and yet keeping fairly fully invested most of the time.

The board are keen to grow the trust, however…

Well, it would be nice to get it up to £250m-odd because you’re running this losing battle at the moment where the large wealth managers keep getting bigger, and they keep saying the smallest fund we’ll look at is £250m, or whatever. Do we need them to pay attention to it? I don’t care that much. I’m perfectly happy to spend my time talking to the medium-sized wealth managers who are interesting and care and it’s not as if this fund is really in competition with anything. It’s a solution for a particular sort of client. Most wealth managers, the old stockbrokers, have got plenty of people this fund suits, and we probably couldn’t accommodate those who have rules that say it’s not big enough.

My experience is that managing global equity portfolios is not easy and successful fund managers in that space are quite few in number.

We won’t really know which of the global managers who’ve done well this decade understand all the tricks of it until we’ve seen a proper correction. When we saw a little bit of the correction back in 2015, people noticed that suddenly we went right to the top of the pops, and a lot of the funds which people felt very warmly towards, or were putting fresh money with after the market had gone up a lot, had a dreadful time because their portfolios were very lumpy. There are people who say “you should buy and hold these consumer staple stocks forever because they never go down”. Well, it’s not that long ago that Unilever was the lowest rated stock in the market! I got shouted at the other week by a 32-year-old discretionary manager, who told me that I was talking nonsense about Unilever and it should never be sold.

That’s the kind of idiotic remark you look for, anecdotally, as a sign that things are getting a bit silly.

Yes, but I wouldn’t go over the top on this. I think Amazon is on the wrong valuation. Nestle was the main stock we sold 18 months ago, but we recycle the money and we put in the fund a company called Daifuku recently, which, as I’m sure you know, is the world’s leading maker of automated warehouses, which is having a boom with e-commerce, but, being Japanese, that stock was on about 15 times earnings when we bought it, cash on the balance sheet, orders up 30% year on year. So there are bits of the market where I’m worried about valuation, but not too many, and then there are bits of the economy where I’m worried about debt. The level of debt in private equity seems to have got very high, moving so much into infrastructure funds and that sort of thing.

My list of 60 stocks has enormously stronger balance sheets than average so why wouldn’t I want my money anywhere other than large, listed, profitable, successful businesses? These businesses may trade on a slightly higher multiple of earnings or cash flow than we were used to in the past, but their margins are fat. On top of that, they’re incredibly financially strong. When I worry about a recession turning up in America, or a big interest rate cycle or whatever, these stocks aren’t going to be that troubled by it. One or two of them will have a worse time than others, but most of them will sail through that pretty well.

So, your point there is: where is all this debt going then if it’s not going into these places?

Well, the debt must be somewhere else. Another fascinating thing at the moment to me is that most of the M&A in the world is happening in private equity and not in public companies. It is extraordinary that all these big businesses, with good credit ratings, strong P&Ls, are not tempted to go and buy anything cheap, even when all the investment bankers of the world are running around, knocking on the doors, saying if you buy anything, I can issue you a bond to make it earnings-enhancing in week two. And yet the level of discipline being shown out there by chief executives of large companies is unusual to say the least!

The last big deal we saw was Bayer buying Monsanto and that was debt-funded, weirdly enough, by Germany’s second highest credit-rated company. Why did they buy it? Because they could afford it. I mean, there’s not much strategic value, but they are buying quality. Nobody is buying anything because it’s cheap. I think that’s one of the reasons why the value trade isn’t working very well. There’s not much mean reversion going on. People don’t want assets at a discount. They want decent businesses with new products which are fully invested. The fact that there’s very little of that going on is quite a healthy sign. It certainly doesn’t feel end of cycle-y. We may well get there because that’s one of the things I worry about. But there’s no sign of it at the moment.

I am sure that when the next crisis happens, everybody will say, “Of course, we should have seen that coming…”

Well, also, I think back to retail pressures. It’s hard for young fund managers to make heavy counter-cyclical calls. People are quite comfortable sitting there waiting for something to go wrong and then saying, “Oh, how on earth could I be expected to tell?”! Take Brexit. I did a presentation that week, and there were three UK fund managers, me and a bond bloke, and the three UK fund managers all said, “Oh, we work in big houses and we know that we’re going to stay in, so we’ve positioned our fund for Brexit”. I said, “Well, I do global, and I think politics is unpredictable, so I’ve taken all my money out of sterling for the week because it’s easy.” For me, it’s not a very big decision. There’s a big old world out there. You were saying that you thought global equity management is hard. In some ways, I think it’s easy because the number of options you’ve got is always quite high, and so the hurdle to move on to something less troublesome is quite low. You’ve always got choices.

Yes. I take that point.

When Trump came in, we sold the American banks because it was easy and we had other things we could do. You could just afford to take some money out, take your profits, move on to the next thing, sit back. Being able to duck political issues is a great advantage. It’s a shame that politics is mattering more in the market than it has for most of the rest of my career. I would make one caveat on that, which is that I think people are worrying about politics more than they should. I try to stick to listening to companies and trusting them to get through the political cycle. On the other hand, you can move money around from place to place easily enough, in order to step back from the politics.

SIMON EDELSTEN is a partner in Artemis and has been managing the Mid Wynd International Investment Trust with his colleagues Alex Illingworth and Rosanna Burcheri since 2014.