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Brexit Not a Major Issue for True Investors
It's well known that the bookies normally have the edge over polls, but even the bookies' odds were tightening last week, making real the Brexit fears. Markets responded with a further bout of volatility. Looking through the narrow scope of investors' eyes, though, does Brexit really matter? Undoubtedly, yes, in the short-term, but we're not convinced it'll matter much to the global economy in the medium- to long-term. Clearly, a 'Yes' Brexit vote would have negative implications for the UK economy in the short-term.
In an interview with Warren Buffett on US television (mid-2015, I think), the interviewer asked Buffett if he was worried about the then upcoming Friday employment numbers. Buffett replied that he bought See's Candy, the Californian-based luxury confectionery maker, in 1972 for $25 million when it was earning $4 million annually. Today, See's Candy is earnings $80 million annually, a 20-fold increase. He said he didn't worry about the gyrations in employment numbers then, and he doesn't now.
That's kind of how this newsletter service thinks about Brexit. Sure it's an issue, but probably not overly relevant on a medium-term horizon, and certainly not hugely relevant to the vast majority of stocks and funds we cover and recommend to subscribers of this website.
Throughout stock market history, there have been many difficult times in economies whether the cause was war, recession, inflation, technological change or other calamities. And yet developed, democratic economies and stock markets have continued their upward progress over time. And we seriously doubt that Brexit ranks up there with any the real calamities that have occurred over time.
As we have often said, investment is the art of the specific and not the general. Know how to value an asset, understand what the real drivers of growth in a business or fund are. And, if you have the resources, buy when volatility offers you lower prices and better values.
As Warren Buffett once said "Buy what you would be happy to own in the absence of a market". If the global stock markets shut down tomorrow for, say, two years, we would not change our minds on owning any of the following stocks and funds (and we could quote many other examples). And here's why!
Hg Capital Trust
We are confident in stating that a 'Yes' Brexit will have little medium-term impact on a business (fund) that fundamentally understands how to find, value and buy into private businesses that have a competitive edge of one sort or another.
Over a long period of time, Hg Capital Trust, the London-listed private equity investor, has shown that it can provide an above average return on the capital entrusted to it by shareholders. As the chart opposite highlights, when you add back the dividends Hg Capital has paid out, the fund has delivered a compound per annum return of 13% over the 21-year period from 1995 to 2015.
And directors in Hg Capital Asset Management are significant holders of the trust's shares giving them the 'owners' eye'. Sure, sterling weakness on Brexit may provide a short-term head-wind if you are a euro-based investor, but, in our view, the shares are quality and good value. Investor nervousness knocked circa 60p, or 5%, off the share price this week. Such volatility should be taken advantage off, not feared.
With just 11% of assets exposed to UK equities, and the majority of that UK exposure to international companies, a 'Yes' Brexit vote should have little impact Murray International, the global equity fund. What does matter is the fund's ability to deliver a sustainable and growing dividend over the medium- to long-term.
As the chart highlights, the apparent undervaluation of Murray International is highlighted by the significant gap between the dividend trend and share price trend. We expect that undervaluation to be corrected by the share price rejoining the dividend line at some stage in the near future, and to continue growing over the medium to long-term from that higher base. Murray International's share price was similarly disconnected from the dividend trend during the 2001-04 period. Buyers then were handsomely rewarded over the following 10-12 years. History is most likely to repeat itself for investors in Murray International.
Yet, despite the apparent undervaluation, this defensive, high dividend yielding global equity fund's share price dropped 22p, or 2.5%, on the week. It could drop further on Brexit, but the fundamentals tell us it'll be a further buying opportunity.
A well-managed property REIT can make for a quality investment as the underlying dividend income stream tends to be highly stable - rental income on property, even industrial property, is less cyclical than corporate earnings in general - and rents can be increased in response to a general rise in inflation.
Hansteen Holdings is a North-European and UK industrial property REIT (with property assets mainly in Germany and the UK), and management has used the downturn in the industrial property markets to acquire portfolios of high yielding industrial property below replacement cost, principally by buying distressed assets from banks.
The larger distressed asset sale opportunities are probably a thing of the past, but with rental yields in the Eurozone and UK industrial property sectors still in the region of 7-8% and 10-year Eurozone bonds yields below 1%, infill acquisition activity is likely to continue to offer growth opportunities as will development land opportunities within its existing portfolio.
Hansteen's share price is largely flat since flotation in 2006, but shareholders have received total returns of 5.1% compound per annum over this period (principally dividends), less than the returns from global equity markets (8.5% c.p.a.) but easily out-stripping inflation over the same period.
In our view, the poor share price performance over the past year reflects a swing in the share price from trading at a premium to net asset value to a discount now, and this shift most likely represents a change in investor sentiment rather than any deterioration in the company's fundamentals.
Looking forward, a starting dividend yield of 5.2% plus the very real prospects of 3-4% annual growth in that dividend over the medium-term (fueled by reduced vacancy rates, modest rent increases and value-enhancing deals) suggests a pick-up in annual returns for shareholders from here to nearer 8-9%. Compression in rental yields - which happens when capital values rise so that the rental yield falls - in Eurozone and UK industrial property, which has been muted in this recovery to date despite the dramatic lowering in bond yields, offers further upside still.
As we mentioned at the outset, we'd be happy to own all three of the above stocks and funds in the absence of a market! The above three examples are just a sample of the types of stocks (Hansteen Holdings) and funds (Hg Capital & Murray Int'l) that we profile routinely for subscribers.
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18th June 2016