As both P.G. Wodehouse and the recent referendum reminded us, it is never difficult to distinguish between a Scotsman with a grievance and a ray of sunshine. But it is not hard to warm to Bruce Stout, lead manager of one of Scotland’s most successful investment funds, as he vents his rage at the ‘economic vandalism’ that the world’s monetary authorities have inflicted on savers since the global financial crisis.
A softly-spoken son of Dundee, Stout manages Murray International, a global income trust which has defied conventional thinking to rise into the top five of the UK’s investment trust sector. The object of his ire is quantitative easing, the policy that central bankers turned to in desperation to cough debt-laden economies back into life. The US Federal Reserve, the Bank of England and the Bank of Japan have been at it for some time, creating money to flush into their broken banking systems. The Fed has at last said ‘no more QE’, but the European Central Bank is still being urged to adopt it.
‘The ones who are penalised are the savers,’ Stout tells me on a foray to London, where his employer Aberdeen Asset Management occupies a modish block picked up cheap from one of Iceland’s bust banks. In the 60 years before 2008, he points out, the average return on a savings account in the UK was 2.5 per cent above inflation. Since 2008, the average return has been 2.5 per cent below inflation.
That loss of purchasing power has badly hurt anyone who relied on cash and government bonds to preserve capital and generate income. Interest rates are the lowest they have been since the Bank of England was founded in 1694. Most gilts yield less than the rate of inflation. ‘The authorities are not allowing the bond market to reflect reality,’ Stout says, ‘And the reason they are not allowing the market to reflect reality is that the reality is so grim.’
What he means is that the UK, like the US, Japan and most of Europe, is so bogged down with debt that were the authorities to allow interest rates to rise to their natural level, it would bankrupt banks and governments, as well as causing havoc for mortgage holders. As a recent report from the International Centre for Banking Studies pointed, despite six years of so-called austerity, far from running down borrowings, the world has accumulated roughly 30 per cent more debt today than before the crisis.
And the problem for savers is going to get worse, says Stout, thanks to the demographic landmine that is the post-war baby boom generation reaching retirement age. ‘What the policymakers are doing … is letting all these newly retired people see their savings eaten away by inflation. And you can’t do that. What you get without savings is contraction, because nobody is interested in investing in fixed capital any more.’ The result: low growth, stagnant wages and no imminent prospect of improvement, the scenario which Japan has lived through for the past 25 years.
What central banks are trying to do, I suggest, is allow inflation to erode the value of the debt pile. Yes, but that’s a short-sighted endeavour, Stout replies — even if it was working, which it clearly isn’t at the moment, with inflation weak or falling in most developed countries and growth mostly well below its former trend rate. The whole policy regime is ‘a massive political failure, driven by the misguided belief that by creating asset price inflation, you will generate some kind of wealth effect which in turn generates confidence… That’s just wrong. All you do is line the pockets of a very small minority.’
All the money printed by the authorities, he points out, has simply disappeared into banks and stayed there, because they need to recapitalise. ‘It is a completely futile exercise. What you should do is let the banks go bust and start again. That is what any normal country would do. Sweden, Mexico, they’ve been there and done that. But not us, oh no, we have to keep the banks alive as zombies. The conduit for capital in an economy is the banking sector and if the banking sector is in a zombie state, then that is what your economy is going to be in.’
The fundamental problem now is that monetary stimulus has boosted asset prices so high that hardly anybody below middle age can afford a house. That stops new household formation, ‘the most powerful dynamic in any economy’. The average house in Edinburgh, Stout points out, now costs nine times average income. Thirty years ago it was more like two-and-a-half times. The average age of first-time buyers is 33 and rising. Governments are so unwilling to take hard choices, he suggests, that their next unorthodox step may be to write off all outstanding student loans.
Amid all this, Stout’s primary concern remains the pragmatic one of how to invest his trust’s capital. Murray International, founded in 1907, has had a remarkable late flowering. Shareholders who invested in the trust ten years ago have more than trebled their money. Despite a nothing year so far in 2014, the trust has returned around 65 per cent over the past five years. And it continues to offer an attractive dividend yield of 4 per cent, drawing in a flood of new money. As a result, its shares have consistently traded at a premium to net asset value — almost unheard of for an investment trust now valued at more than £1.3 billion.
What is the trust’s formula for success? With the developed world facing stuttering growth and companies obsessed with boosting their share prices through financial engineering rather than investing in capital projects, Stout says you have to go where there are still some positive tailwinds. He means emerging markets: ‘They still have real income growth. They still have inflation, so prices go up, not down. Companies can have volume increases. And as real income rises, you get people trading up from lower-margin products to branded products and higher-margin products. You’ve also got increased access to credit; you’ve got household formation, and young populations — 80 per cent of Mexicans are under 40.’
These conditions are the opposite of those in most developed countries. But the key is to find companies that can deliver profitable growth: it’s not enough, says Stout, to think that big western companies can dominate these markets. ‘You’ve got to have distribution, and the right connections. You can’t just go into India and buy the best supermarket shelf space. The local competition isn’t just going to say “Come on in, please yourself.” ’
A look through the Murray International portfolio shows a varied bag of 16 developing country bonds (good for income) and shares in 51 companies whose only common thread is their exposure to growing markets. Some are less well known, such as Tenaris, an Italian steel pipe manufacturer. Others are more familiar, such as Petrochina, or the French supermarket group Casino, which makes two-thirds of its earnings from emerging markets. Stout points out the contrast with Sainsbury’s or Morrisons, struggling with wafer-thin profit margins in a sluggish UK economy.
Isn’t he worried about what will happen to emerging markets when US interest rates finally start to rise, as many expect next year? Not really. Yes, there may be a kneejerk reaction as there was last year when Fed chairman Ben Bernanke first talked about ‘tapering’ QE. But look how much better prepared many emerging markets are now compared with earlier crises, when nearly all their external debt was in dollars. Stout has been topping up his holding in emerging market bonds for just that reason.
And in any event he isn’t expecting a big rise in interest rates for years to come. ‘If you think that [the Fed et al] have just spent five years keeping ten-year rates at 2.5–3 per cent and they’re suddenly going to let go to 5.5–6 per cent, you’re very naïve.’ But — returning to his central theme — that means ‘savers will be watching their savings being eaten away for a long time to come.’
In this environment, developed country bonds will remain uninspiring, while shares in companies with a 4 per cent dividend yield and good dividend growth will continue to look ‘very attractive indeed’; finding enough of them at the right price remains the biggest challenge. After such a strong run, Murray International notes in its latest report, ‘capital preservation remains the prime investment objective’. No ray of sunshine just yet, in other words.
Jonathan Davis is the founder of Independent Investor and a columnist for the Financial Times.