What time is it?
by Doug Brodie
In this blog:
/1. Example: National Grid 2024 5.875%
/2. All 747’s are planes, but not all planes are 747’s
/3. Lifting the lid on part of our analysis
We were experts in AIG products in the UK back in 2008; there was only one key product and that was used as a tax wrapper for dormant cash held by higher rate taxpayers. Every higher taxpayer got a 10% discount on their tax liability (they still do), and then it all went wrong with the collapse of Lehman Brothers on 15th September. We had several people come to us from UBS and that took us to the income markets.
Our strategy is natural income, simply because it is predictable, reliable and is a certain way of getting a measurable return on an investment. With the income data, we can measure the return against what cash is paying and that allows us to value that investment.
In July 2007 interest rates were 5.75%. By March 2009 they had fallen to 0.5%, however, bond yields did not follow suit. Remember, a bond is a loan to a corporate where there is a legal obligation to pay the interest, the interest is fixed at outset, and the term is also contractually fixed. Due to the dislocation in the bond markets at the time, we could get all the income needed for secure returns on a contractual income basis, as opposed to dividends which are discretionary.
/1. Example: National Grid 2024 5.875%
This is a table from a client portfolio that was put together when money was transferred across from UBS by a disappointed client. The price used to buy was £97.
Bear in mind that interest rates had collapsed to 0.5% and here was National Grid guaranteeing to pay £197 for a purchase price of £97, with annual income payments of £5.875p. We bought for client accounts the BT 2016 bond paying 7.5% fixed, paying £103.50 for that £7.50 annual income payment – with the £103.50 price being instantly offset by the first £7.50 income payment, meaning the annualised return to the client, contractually guaranteed by BT, was 8.28% per year.
We didn’t think BT was going to default, nor National Grid. Indeed three years later the BT bond price had ‘normalised’ and yield fell to 2.5% - so the £7.50 coupon / 2.5% = a share price of £300. The clients decided to take the money and sold.
We are income investors, and the outline strategy is simply defined by Charlie Ellis in his book ‘Winning the Losers Game’ – the title is a reference to the investing strategy of protecting the value from falling, rather than focusing on trying to hit gains all the time. The maths shows that if the market falls 15%, to get your money back to where you started you need the value to rise by 17.6% (15/85), so if you have only half the market fall, you only need an 8% rise to get back to the start (7.5 / 92.5). That’s it, no rocket science, and Charlie was on the faculty of both Harvard and Yale, advisor to the Singapore sovereign fund and a director of Vanguard. His core message is ‘do the maths and keep it simple’.
/2. All 747’s are planes, but not all planes are 747’s
There are 410 investment trusts in the UK - of these only 31 qualify for our research panel. Beware, you can come seriously unstuck if you don’t know what lies under the hood, and who’s in the driving seat. Being of a certain age, you may remember the ‘split caps’ crisis in the late 90’s, and although pretty much structurally sound today, there are still huge man-traps out there.
Digital 9 Infrastructure was listed in 2021, raising £300m to invest in what it says on the tin, including buying 14,300 km of the subsea fibre systems that form the backbone of the internet, climate-neutral data centres in Iceland and Finland etc. Shares were launched at £1 and it ended up raising just under £1 billion from investors. What’s not to like? Carbon neutral, digital sector, infrastructure, surely ticks all the boxes?
As I write its share price is down 20.8% since 8am, at just 18.37p. Its market cap is £162m, meaning investors have lost in real cash £743 million – that’s ¾ of a billion pounds.
I don’t know what went wrong, we won’t look at anything with less than a 5-year auditable track record, and for income, no newbies qualify. As it happens, our previous experience with firms connected to this trust means we would never recommend it anyway, no matter how compelling the story. If you were tempted to buy a bit of Bowie, you might have chosen to invest in the Hipgnosis Songs Fund, reassured by the 7%+ yield. This is clearly a specialist area about which we know nothing (other than the difference between Neil Young and Will Young), however, this is part of its balance sheet and its position on reserves shows it just doesn’t meet our needs (no matter what you might think of 10cc’s back catalogue).
It listed at 116p per share and today that’s fallen to 65p.
/3. Lifting the lid on part of our analysis.
We are more than happy (and qualified) to discuss Cob Records, David Duckham, Watneys Red Barrel, dark chocolate Clubs, things happening after a Badedas bath or the paying for four pints in a pub with a single £1 note. Even David Cassidy in the Partridge Family and the difference between Jackie and Bunty.
On our website you’ll see the ‘get started’ button in several places, and the resulting dashboard plus widgets. What you can’t see is the coding underneath, nor the output of the coding:
This is part of the coding our team has written to identify and quantify the dividend growth rate volatility of all the trusts that we analyse. This is the internal description of that single function:
There’s a man in Maidenhead who does this all day every day, and Kseniia in our office then cross-checks and audits the calculations manually to ensure that the income reliability and projections that form our recommendations to you, do actually pan out, they do deliver and they deliver a pension income to you that is very predictable and very boring. We take that as a compliment.
Now then – best guitarist of all time? Who wants to go first …
I always think the name ‘Blaise Pascal’ should be for a French 1970s pop singer, probably squiring Françoise Hardy, but I fear that’s mighty disrespectful to the esteemed 17th century polymath – mathematician, physicist, inventor, philosopher and Catholic writer. He is one of the first inventors of the mechanical calculator, he studied hydrodynamics clarifying the relationship between pressure and vacuum.
Of many, the relevant observation of his that we bring to your attention is “People arrive at their beliefs not on the basis of proof but on the basis of what they find attractive”. As we scan the media every day there is always a story of a scam somewhere, however, where this also applies is the amateur investor falling prey to illusory wealth. Scottish Mortgage was always a great example of that, in that retail investors poured money into it after it had delivered stellar results. That just meant that the previous investors had done exceedingly well for themselves, and that the share price was now very high – and much closer to retrenchment* than ever before.
Woodford funds were marketed the same way**, and gold is now back in the media because of rises. If a price rises that means the item is more expensive than previously, and closer to whatever peak it will inevitably have***. The S&P index passed through 5000 yesterday – ARM the chip maker**** has virtually doubled in value this year, it was worth $60 billion at the start of January, six weeks later investors are happy to pay twice the price for its shares, valuing it yesterday at $116 billion – it earns 18 cents per share, it’s p/e ratio is 632.72.
Hmmm. Stock traders can only book their profits by finding other people to offload their expensive shares to: don’t get suckered.
*industry term meaning ‘collapse’
**we as a firm did not recommend any Woodford funds to any investor, ever
***the markets are always cyclical, falls always follow rises, always follow falls
****used to be a British company, Intel and AMD used to be its biggest customers, now Apple and Samsung