Interactive Investor

Peter Spiller: ‘embarrassing’ discount will close soon and reward long-term investors

The Capital Gearing manager goes into depth on the discount control mechanism of the trust, which has broken down as a result of legal issues. He explains what has gone wrong and when the discount will close once again.

6th December 2023 09:28

Sam Benstead from interactive investor

Capital Gearing manager Peter Spiller sits down with ii's Sam Benstead to discuss where he is finding investment opportunities today.

He also goes into depth on the discount control mechanism of the trust, which has broken down as a result of legal issues. Spiller explains what has gone wrong and when the discount will close once again.

Spiller has been running Capital Gearing (LSE:CGT) for more than 40 years but in this video reveals what succession planning is in place.

Capital Gearing is a member of ii's Super 60 list of recommended funds.

Sam Benstead, deputy collectives editor, interactive investor: Hello and welcome to the latest Insider Interview. Our guest today is Peter Spiller, manager of the Capital Gearing Investment Trust. Peter, thank you very much for coming in.

Peter Spiller, manager of the Capital Gearing Investment TrustIt's good to be here.

Sam Benstead: Capital Gearing is a wealth preservation trust. You’re trying to protect the real value of an investor's portfolio over time. But this year the shares are down about 10% and inflation is quite elevated at the moment. So, on that brief, it appears you're failing at the moment. Why has performance been poor this year?

Peter Spiller: So, the first thing to say is that you're completely correct. It is not our ambition to produce negative returns. As we speak, we're having quite a good day today, helpfully. But the NAV return so far this year has been -3% (as at the time of recording in early November). But we have had an issue with the authority to buy back stock.

So, it's not that we changed our policy. We are going straight back to our zero discount mechanism (ZDM). But we do have to go through the courts in Northern Ireland to get permission to reclassify some reserves that enables us to do that. So, the shares do now trade at a 5% discount, which is deeply embarrassing to me because I've always assured people they would not. And all I can just say is I'm really sorry, particularly sorry if you have to realise your money in the next couple of months or so.

But, I think three months is the indicated, hopefully maximum, period. But, what we can do is we are buying in throughout that period. We're just having to restrict the amount that we do. So, I'm hoping that will provide a very good opportunity for long-term investors to come in. Because you can be sure that from this level of 5% discount, you can be certain that it's going to be -2% at most. And with any luck, we’ll go back to pursuing a plus 2%. And so you'll make the 7% up that you've lost essentially from this process.

And it should not have happened. There are lots of investigations going into why it happened and it is being put right. So nevertheless, it leaves us 3% down, even if we're talking about the NAV return. And the reason for that is, frankly, there has just been no place to hide. We've had plenty of low-risk stuff, short-dated bond rates have gone up a lot. The real interest rates, which I was just revelling in as offering up tremendous opportunity now (as he explains in our separate video interview), they were much lower. So that has been unhelpful too. And there have been particular sectors that have been a bit of an issue as well, which you might want to come back to.

Sam Benstead: Which sectors have hurt the portfolio and have you made any changes this year to what you invest in?

Peter Spiller: Well, we did, yes. Through to the first half of the year, we were reducing our property holdings, not by enough as it turned out. So, property is divided in two parts in our mind. One is offices and retail, which are subject to economic cycles and where we have no exposure and have not had any exposure because we believe it still is very uncertain what office values would emerge from the working from home phenomenon and so forth.

But what we have concentrated on are cash flows that are guaranteed index-linked or quasi index-linked, say. By quasi index-linked I would mean, for instance, the revenue associated with student accommodation where there's tremendous shortage. Rents for the wretched students, I say this unhappily as well as helpfully for the stocks, are rising at a double-digit rate.

In fact, rents generally on houses are rising at something close to that with possibly disastrous social consequences, if the truth is known. But nevertheless, these streams of income we thought would be consistently highly valued. We thought they'd be a good place to hide. But the characteristic of markets generally, and this is true of the TIPS market as well, is that investors have behaved as though inflation has been high.

It was wrong that it was transitory. But all that means is that we had an extra year or so of inflation and then it is getting straight back to 2%. So, the premium that people are prepared to pay, the break-even, has been very suppressed. And that was a big surprise to us. We thought it would go up a lot because we thought people would seek protection from inflation. In fact, it turned out they were not prepared to pay for that.

So, the other feature of all these cash flows and talking of renewable infrastructure and core infrastructure, as well as property here, is the valuation put on those. Those assets fell quite reasonably with interest rates rising. That was all perfectly rational. It's fair to say the boards of plenty of these companies were very slow to recognise that what was an appropriate balance sheet when they were set up in the teens is not appropriate anymore.

Some of them over-distribute, distribute more than they earn. And a number have been very slow to recognise that their balance sheets actually look rather stretched when the values fall. And on top of that, we see the very interesting technical situation where open-ended funds that owned a lot of these things, including multi-asset funds, have seen huge redemptions because they've been performing very badly.

And the result of that is that the shares have been driven down even more than the interest rate correlation would suggest, thus throwing up very good opportunity in our view. So, we think that the renewable energy stocks offer somewhere between 5 and 8 real returns, which is a pretty attractive return in this world. And the core infrastructure much the same. And property stocks are typically slightly lower-yielding returns on the assets. But, the share prices have been driven to such big discounts that once they have stabilised their balance sheets and adjusted the cap rates, we think they can be re-rated and therefore the discounts can get much less.

Sam Benstead: I know you've been buying more property and infrastructure investment trusts?

Peter Spiller: Well, a little bit, but with 10% already, that seems probably an appropriate level to have in one small asset class. And what we've really been buying has been UK index-linked bonds and that's been the big change this year because, if you remember, not very long ago they yielded famously -3% close to real, and we just didn't have anything in UK index-linked at all. But now they do offer real value.

In fact, we strongly [do we] believe that we're just setting up a fund to invest in UK index-linked bonds because we think investors should have exposure. So, if you buy an ETF, the index is very long, it's about 16 years with unbelievable volatility. Volatility, we think, that is just too great for most private investors. So, we have set up and will shortly be marketing a fund with a duration of about five years, but more stability. But, as I say, against the background of a very difficult economy in the UK and so forth, just to have a better than 1% real return. So, it's not something you write home to Mummy about. But it's a really solid base and preserves capital in a way that I think would be appealing.

Sam Benstead: And you said earlier you liked UK shares as well. So, what companies do you own in the UK, and have you been buying any new positions recently?

Peter Spiller: Right. So, we largely have an exposure to smaller companies in the UK. So, the UK market as a whole trades about 11 P/E and it's clearly at a discount even to Europe. So, Europe as a whole also stands at a significant discount to the United States in its valuations. But smaller companies stand at a discount to that. And there are a number of investment trusts which own smaller companies, which trade themselves on significant discounts. So, although there are clear reasons of liquidity that have driven prices of small companies down, [we] just think the valuations are very good and we're prepared to have some exposure provided we can do it on good discounts. We also have been buying some investment trusts that play around the world, again, typically with a mid-cap bias rather than the large-cap bias. But there are some interesting mismatches between promises made by the boards of those trusts and the actual discounts which prevail.

Sam Benstead: Which trusts have you've been buying, can we get some names?

Peter Spiller: No, because we're still buying them. But I think you can look in our reporting accounts and so forth to see what we have earned. But we might buy two new ones very recently. We just started to build up positions. So, forgive me, I'm not going to.

Sam Benstead: Fair enough. We will leave that for people at home to do their own research.

Peter Spiller: So, there are other features, which are just very interesting, which I haven't mentioned, but I should. So, one of them is currencies. So, [we’ve] seen the most extraordinary move in some currencies, so that the Japanese yen, for instance, has fallen dramatically for the very obvious reasons, the interest rate differentials. There's good reason to believe that at a minimum, those will get no worse. They might get better as there’s some normalisation of monetary policy in Japan. But the levels of valuation are extraordinary. So, I'm told, it’s cheaper to rent or to employ a software engineer in Japan than it is in Vietnam. I mean, astonishing numbers.

My colleague, Chris Clothier, came across someone who eats the same meal every day in Tokyo, and it's basically salmon and rice and pudding or whatever, and it costs them $8. And he went to the same restaurant in New York, it’s the same; it’s a chain, and the cost was $32 plus tip. That's the devaluation of the Japanese yen, it is quite extraordinary and therefore it could have really quite a big run. We have about 9% exposure, including on Japanese equity, of course. And the other currency that looks very cheap is the Swedish krona. They've had a big problem with property, residential property. So, it's now in recession like Germany. And so there are all sorts of negatives. But it is a country which runs sustained current account services. Fiscal discipline is quite extraordinary, very unusual in this world, and it just is very competitive. Once again, probably about 30% or 40% cheaper than it should be on purchasing power parity.

Sam Benstead: You’ve been in charge for 40 years, and I’m sure a lot of investors would like to see you in charge for another 40 years, but that’s probably going to be impossible. So what succession planning is in place? Can you tell me about the team approach at Capital Gearing?

Peter Spiller: Yeah. So, thank you for the implied compliment. But it is something that I have been aware of for 15 years, and I have been building a team around me that will do even better when I'm gone, than I do. And I'm not saying that frivolously, because they obviously have a number of skills from previous work that I don't have. So, we have Chris Clothier, who is now the co-chief investment officer. Those of you that have met him, I'm sure will be very impressed by his detailed analysis of situations.

Alastair Laing came from private equity and he has done supremely well. And he is the CEO of the management company, and that's for a very important reason. The reason why he was appointed originally was that he could tap me on the shoulder if it's not quite as good as it was, then he can say ‘the time's come’. And then we have the younger Hassan Reza, who was at HSBC doing corporate work there and who is immensely bright and has a wonderful backstory, which we don't have time for, but immensely bright. And finally, Emma Moriarty, who came from the Bank of England 18 months ago, where she wrote the Financial Stability Reports, which you might understand, we think is particularly relevant today and is also proving to be a very able fund manager. So, if I were to step under a bus tomorrow, I have every confidence that my wife's holding will be very well looked after.

Sam Benstead: Well, that brings us on to the final question, which we ask everybody. Do you personally invest in the trust?

Peter Spiller: Yes. Not just all my money, but all our money substantially is in the funds that we run. So, I've been happily invested in Capital Gearing for a very long time, which has been great because the return has been about 235 times. So, it's been OK.

Sam Benstead: Peter, it's been amazing having you in. That's all we've got time for. But thank you very much.

Peter Spiller: Sam, thank you.

Sam Benstead: And that's all we've got time for today. You can check out more Insider Interviews on our YouTube channel where you can, like, comment, and subscribe. See you next time.

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