Capital Gearing posts second annual loss in 41-year history

The wealth preservation trust, a member of interactive investor’s Super 60 list, failed to make a positive return in a year that saw both shares and bonds come under pressure due to interest rate hikes. Kyle Caldwell runs through the results.

Capital Gearing (LSE:CGT), one of a small number of wealth preservation trusts that aim to limit losses when stock markets tumble, has reported a rare loss over its latest financial year, which runs to the end of March.

The trust, managed by veteran investor Peter Spiller since 1982, saw the performance of its underlying investments, the net asset value (NAV), decline by 3.6% over the period, while its share price total return was a loss of 7.1%. It is only the second time in the investment trust’s 41-year history that it has failed to make a positive return. The other occasion was in 2014.  

The trust has been a great preserver of wealth in bear markets, including the dot-com crash and the global financial crisis and, most recently, during the Covid-19 market sell-off in 2020.

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The trust does not have a formal benchmark, instead using the Retail Price Index (RPI) as a minimum target to beat over the long term. Over five years, the trust said its returns are in line with inflation, with the NAV up 31.6% versus 31.9% for the RPI inflation measure. Its share price return, though, falls short over this time period, up 26.9%.  

Why it was a challenging period

Over the 12-month time frame both shares and bonds unusually fell in unison in response to rising interest rates attempting to control inflation, despite a slowdown in economic growth.

In particular, high inflation and interest rate rises are headwinds for bonds. Because bonds pay a fixed income, the real value of that income is eroded more when inflation is high. And when interest rates rise, investors can get a better deal from cash savings or newly issued bonds, meaning bond prices fall. 

Rather than using exotic strategies or derivatives, the trust’s approach to avoiding large drawdowns has been to hold a highly diversified portfolio of assets with plenty of defensive armoury that's negatively correlated to risk assets.

Capital Gearing holds around a quarter of its assets in risk assets – equities. The rest of the portfolio is mainly invested in index-linked government bonds (gilts and US TIPS), which comprise 46% of the portfolio.

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The trust also holds corporate bonds, and has 10% in alternative assets – infrastructure and property. The latter exposure proved to be an Achilles heel, explaining the rare year of making a negative return.

In its annual results, the fund management trio of Peter Spiller, Alastair Laing and Christopher Clothier, explained that in hindsight it was a mistake to increase exposure to alternatives.

“Ironically, it has been outside our bond holdings that the effect of the change in interest rates has been most acute. In recent years, confronted with a sterling government bond market which we judged un-investable, we replaced it with a modest allocation to alternatives (property, infrastructure, etc.), judging that their high spreads to government bonds, combined with the index-linked nature of their cash flows, would deliver satisfactory returns even in a rising rate environment. We got this wrong.

“Indeed losses from our property holdings were responsible for the entire loss the company experienced in the year. In response, the company’s weighting to property was reduced from 16.5% to 4% by year end. We judge the prospective returns from the remaining holdings to be excellent, if volatile.”

The outlook

The three fund managers running Capital Gearing are extremely cautious on the prospects for stock markets. They have increased the investment trust's exposure to index-linked bonds to record levels to take advantage of the higher yields available following bond price declines in response to interest rate rises.

The trio think that it is likely that a recession is on the horizon, and they are concerned about the prospect of further troubles in the banking sector that could cause the next financial crisis.

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The managers point out that “rising rates have led to, or brought into focus, financial fragility: mark to market losses on bank balance sheets; consumers refinancing large mortgages and highly leveraged businesses rolling their debts at much higher rates”.

The trio continue: “What makes central banks’ jobs even harder is the largesse of fiscal authorities even as monetary authorities attempt austerity. The US is the most extreme example: unemployment is at generational lows, inflation is proving persistent and yet the forecast budget deficit this year is 5.3% of GDP.

“Monetary policy works best when fiscal policy is working with, not against, it. To compensate, monetary policy has to work harder than would otherwise be the case. This increases the likelihood that it will be the financial system that breaks before the economy does.

“We have already seen several examples in the financial sphere: LDI Pensions, FTX, Silicon Valley Bank and Credit Suisse. It seems unlikely that these will be the last shoes to drop.”

How Capital Gearing fared against other defensive options

Over the one-year period to 31 March 2023, figures from FE Fundinfo show that Capital Gearing’s NAV loss of 3.6% and share price decline of 7.1% was in line with the average declines of the two lowest risk multi-asset sectors: IA Mixed Investment 0-35% Shares (down 5.8%) and IA Mixed Investment 20-60% Shares (a loss of 4.7%).

Its two main wealth preservation rivals, Ruffer Investment Company (LSE:RICA) and Personal Assets (LSE:PNL), returned a positive 1.2% and a loss of 4% over the same time frame.

Super 60 choice

Our analyst team view this trust, one of our Super 60 investment ideas, as a good fit for a core holding due to its defensive stance and high levels of diversification. In addition, the trust would complement funds and investment trusts with more adventurous risk profiles.

The trust adopted a zero-discount policy in 2015 to ensure the price of shares in the trust trade as close as possible to the underlying NAV per share. Therefore, there’s little likelihood that this investment trust will trade on a sizeable discount.