Bruce Stout: why I think UK shares are not a buy

Bruce Stout, manager of Murray International Trust, explains why he’s not finding value in UK shares and instead favours investing in Asia and emerging markets. He also gives his outlook for dividends in 2022 and shares his honest opinion on why his trust has underperformed rivals over three and five years. 

The trust is a member of interactive investor’s Super 60 list.

Kyle Caldwell, collectives editor at interactive investor: Hello. Today I'm speaking to Bruce Stout, fund manager of the Murray International (LSE:MYI) investment trust. Murray International has just over 40% of its assets in the emerging markets and the Asia-Pacific regions. This is much higher than other global investment trusts. What are the main attractions of investing in that part of the world? And could you run through a couple of stock examples?

Bruce Stout, fund manager of Murray International Trust: Yeah, of course. As you know, Murray International was put together from a bottom-up basis, so we don't sort of allocate money to different countries or different regions, it just sort of takes on that shape over a long period of time. So it's testimony to the quality of the type of businesses that we can find. If they happen to be domiciled in a place like Taiwan that is categorised as an emerging market, then that doesn't really bother us as long as the company is really good and has high quality and lots of growth then, of course, you always keep an eye on where it's domiciled, but does it really matter in the longer scheme of things?

Of course, the real attractions, you know, remain the demographics, remain rising real incomes in those parts of the world, and really that a lot of those areas, having done a lot of investment in infrastructure such as digitalisation, transport, housing, et cetera, are now in a position to really enter a period of consumption that we have all been through in the West for the last 20, 30 years, those markets have that ahead of them. So it's interesting, you know, to take advantage of those opportunities, especially when markets have not really been interested in those areas for the last two or three years. You've been able to build up good positions in high-quality businesses when nobody else really wanted them, so that's good.

A couple of examples, you know, that we would have are something like Taiwan Semiconductor (NYSE:TSM), which is the biggest holding that we own, around about 5% of the trust, and it is a business with really good gross margins, very, very strong operating history, semiconductors are required all over the world. And the moat, if you like, that stops competition. It's a very capital-intensive industry and it costs an awful lot of money, you know, to build and compete in that industry. So that's one that we like. And another one would be something like Grupo Asur in Mexico, which runs the main airports in Cancun and Cozumel, which are holiday destinations. Again, real asset, lots of operational leverage to traffic going through the airport, very high margin business, throws off lots of cash and no debt on the balance sheet and just the perfect type of stock. As long as it is at the right price for an income trust over the long term that you can get the capital growth and you can get the income growth, this is a company that has grown its dividend 10% a year for the last 10 years, so that's another example that we would put forward.

Kyle Caldwell: You just mentioned some of the qualities that you like to see a business possess. Is there a key ingredient at all that you need to see in every company?

Bruce Stout: Not really Kyle. I mean, as I mentioned earlier, we like to have a diversified portfolio. So every new business we look at, we hope it brings something different to the portfolio because we don't want to replicate things and have linkages and just own more of the same type of business. So yeah, it'd be great if every business had 60% gross margins, and that gives you a bit of protection on inflation and had no debt, and generated lots of cash, and we have lots of businesses like that in the trust.

But we do also have businesses that are more cyclically exposed, such as Sociedad Quimica Y Minera De Chile (NYSE:SQM) in Chile, which is a lithium producer for batteries, and that's a very cyclical industry at the moment. Everything's going well because demand for lithium is very high for batteries. But there have been periods where, you know, there's too much capacity comes on and it goes down. So, you know, you have to manage those cyclical exposures, but you have to acknowledge that they're very interesting investment opportunities at the right time and at the right place, so we like to have a balance of different types of businesses in the trust.

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Kyle Caldwell: Over three and five years, Murray International has underperformed the average global equity income investment trust. What are the main reasons behind the underperformance?

Bruce Stout: It's not something that I personally have studied in great depth because I do know that Murray International has a high yield, and I do know that what we seek to do is to cover that dividend from the underlying income that's accrued by the companies that we own. We do know that other trusts in the sector don't. That's not their policy. Their policy is they will pay dividends out of capital, and if you pay a dividend out of capital and explicitly say you will do that, then you can invest in anything you like, you can invest in technology stocks with no dividends because you don't need the income from the portfolio. So you obviously get a lot of investment flexibility and perhaps, I don't know, but maybe they've been invested in tech and areas that have been very, very strong in the market in the last year or two years.

It's a funny thing in an investment trust business because when people look at three- and five-year records, it's an accumulated thing, so you can have one year where everybody does really well and you don't, and suddenly you're bottom for three or five years. But that can reverse very, very quickly, as we've seen in the past, particularly in years like 2008, 2009, 2010, and even years like 2002, 2003, 2004, where if the market changes and, for example, technology no longer leads, then maybe, you know, markets broaden out and that would certainly suit us very nicely if they did because we are very diversified.

Kyle Caldwell: The trust's dividend yield at just under 5% is higher than most other global equity income funds and investment trusts. How sustainable is the trust's dividend?

Bruce Stout: Well, I mean, first and foremost, I mentioned that we went to cover the dividend so, 2020 was, you know, a really difficult year for the world, for dividends. Most companies, you know, cut dividends that had higher yields, the UK dividends I think were down 44% in 2020. Our revenue per share was down just about 14%. So the type of businesses we own have very strong balance sheets, and in the past they have driven, you know, strong dividend growth because of that, because the balance sheet is very strong. And things obviously improved in 2021, and we see things improving again in 2022, particularly in Asia, where we have a lot of exposure, because a lot of Asian companies pay out dividends as a proportion, a ratio, a fixed ratio of net earnings. So the dividends in 2021 weren't very good in Asia because they were based on the year before, 2020 earnings, when there was lots of business interruption. However, there wasn't so much in 2021, so a lot of those earnings have been much stronger for those Asian businesses. So if they keep the ratios the same, we would expect a nice improvement in dividends in Asia this year and perhaps the year after, because remember, Asia is lagging the rest of the world in recovering from the pandemic because they had more lockdowns and more business interruption last year.

Kyle Caldwell: So you think in 2022 then, the outlook for dividends is going to be another year of recovery?

Bruce Stout: I can't really make a generalisation about it, Kyle, because, there have been a lot of companies in the developed world where they cut their dividends and reset the dividends lower and that's probably because the dividends were too high. So companies that used to pay 4% or 5% took a look at the bond markets and realised there were bond yields at 1%, why are we trying to pay these higher dividends, and have reset at 2.5% or 3%. But in other countries, in other parts of the world, it's quite normal to have a 6% bond yield in India or in Indonesia so an equity yield of 4% or 5%, you know, it's quite normal. So we would expect those parts of the world to have good dividends and good dividend growth. Other parts might be a bit more difficult.

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Kyle Caldwell: The UK stock market is considered to be cheap compared to other global markets, particularly the US, but I assume that you are not finding much value in the UK, given that Murray International holds only around 5% in the UK?

Bruce Stout: Yeah, it's always been difficult for us, there's so many really good companies in the UK, particularly small companies in the UK. But small companies don't pay dividends, because small companies need the cash that they generate to grow, unless they want to borrow. And it's probably better that they don't borrow and they just use the free cash flow to grow. So there is, you know, areas of the market where there's some very interesting investment opportunities, but not for a global growth and income trust like Murray International, because those businesses just don't deliver what we want.

There is another thing about the UK, I think, that we should just very briefly mention and that is that the UK bond market looks particularly vulnerable. At the end of the year, a 10-year bond yielded 70 basis points and inflation was 7.5%. Now that is the highest negative real yield in the UK we've ever seen, so there is something wrong there, and either a bond yields have to rise, and they've already doubled this year to 1.4% from 70 basis points so either they have to rise a lot more, in which case growth could be chalked off, and it could happen at the same time as, you know, energy bills are going up, so there's less money for consumers to spend. Maybe mortgage rates start to go up, maybe rents start to go up. So there could be a lot of pressure on the economy in terms of spending, in terms of consumption.

So for domestically focused businesses in the UK, the outlook is a bit opaque until we get a bit more clarity on where interest rates are going and where bond yields are going to ultimately end up in the UK, because they do look very, very low relative to inflation. And our past track record on managing a tightening cycle is not good. They tend to be behind the curve, and then by the time they are putting rates up, the economy's decelerating. So there is that out there, and if you have the choice of the world, then you're best to go where there's a tailwind rather than where there might be a headwind. And we use our investment flexibility to do that.

Kyle Caldwell: And finally, a question that we ask all fund managers, do you have skin in the game?

Bruce Stout: Yes, I most certainly do. Obviously, I've been involved in Murray International for a long time, as deputy manager and manager, probably well over 30 years now. So, like all Scottish people, I guess as soon as it goes to a discount, I'm always very interested.

Kyle Caldwell: Bruce, thank you very much for your time today.

Bruce Stout: Thanks very much Kyle.