Emma Wall: Hello and welcome to the Morningstar Series "Why Should I Invest With You?" I'm Emma Wall and I am joined today by James Harries, manager of the Trojan Global Income Fund.
Hello James.
James Harries: Hello.
Wall: So, this fund has been running for a year, but you have been running funds of this nature, since 2005.
Harries: Yeah.
Wall: The environment that we are in now is becoming one where there are interest rate rises. We've had one in the UK last week and we’re indeed expecting one from the Fed in December. Interest rate rises because they have been so rare, have meant that people have looked to equities, to funds of this nature for income. Does this mean that when interest rates rise global income stocks will not do as well?
Harries: Well possibly if you did think that interest rates were going to rise a lot. Now my contention is I am not sure they will. Now you might say – I would say that wouldn’t I, because I am an income investor. But we generally believe that the backdrop remains one, where inflation is remarkably quiescent. I mean the reality is we've had nine years or whatever it is of incredibly aggressive policy and inflation remains incredibly subdued.
CPI for instance, ex-shelter, in the States is hovering around 1% and falling. Elsewhere in the world inflation remains very low, and that’s pretty remarkable to me. And the markets actually have a similar view. You would have noticed that the yield curve in the States particularly has been flattening. That’s an environment where potentially the bond market is saying that longer term inflation expectations are falling rather than rising.
So, although I accept that there have been one or two rate rises and after all they would love to put rates up because they got to have something to cut in the next downturn. I am just not so sure that they are going to go up nearly as much as people think and therefore I am afraid I reject the premise of your question.
Wall: And a lot of your fund is invested in US equities. The follow-up question would be, are you worried about that sort of allocation, but it sounds to me like you are not because the things that have been propping up US equities, this central bank support, you don’t think is going to change any time soon.
Harries: Well actually I do think it's going to change. They do seem to be reaching a point where they think they are capable of being able to roll back some of the aggressive policies put in place. Where I differ perhaps from received wisdom or potentially the consensus is, I think that quantitative easing has raised up the price of assets and has led to therefore greater confidence, greater consumption, greater activity than otherwise would have been the case. If therefore you reduce QE and potentially then risk assets were to do less well, then it wouldn’t be total surprising to me if the bond market were to strengthen if rates were to actually to fall in the absence of QE. And therefore, policy being less aggressive and continuing to invest in the manner we do notably in the US I think is entirely consistent.
I think the last point to make on that is although the US market in aggregate is relatively expensive at least relative to some other active markets. We think the cycle is likely to end with a strong US dollar. Either because of the relative vibrancy of the US economy or because of interest rate differentials or because there's a problem. And for whatever reason if that's the case, then you want to make sure that you've got a full allocation to that currency in the latter part of this cycle.
Wall: And of course, you are an income investor, but valuation must be important, because you're not going to buy income at any price. Are you finding at this particular juncture with markets having done so well that it's harder to find those opportunities or actually do you find in a market as diverse as that, that actually you are still seeing options?
Harries: Well, it is undoubtedly harder to find value than it was. There is no doubt. It's no secret that markets are at a pretty elevated level. In terms of valuation, of course, that tells us very little about what markets are likely to do in the short term, but it gives us quite a robust framework with regard to what expected returns are likely to be from here and they are likely to be pretty low.
We do continue to find companies that we are excited by and that we can invest in. In aggregate, we are generating a free cash flow yield of just over 5% in the portfolio, which we would expect to grow at some 5% in the future. So, if you're starting at 5%, you're growing at 5% and you add a bit of inflation, then you could expect your return in the future that's adequate. I wouldn't want to promise it and it won't be over a year and it's not guaranteed. But we think there are reasonable expectations even from here.
Wall: And looking at the portfolio finally, it is majority in developed markets at the moment. But I know as a global income investor in the past you have allocated as much as 20%, even more than that, to emerging markets. Do you foresee a time that you will do the same again in the near future?
Harries: Well, maybe not to quite the same degree. But it's undoubtedly the case that the opportunity is going to present itself at some point in emerging markets. Now, my belief is this cycle has all been about reach for yield, ironically enough, as an income investor. In my view, the most egregious reach for yield there has been is in emerging market debt markets. Now, I suspect therefore at some point we're going to have quite an interesting credit cycle in emerging market focused on emerging market debt areas.
If that's the case, if you've got a problem in emerging market debt markets, you're likely to have a problem in emerging market currency and equity markets and I think then you will get a great opportunity. Because if you are able to buy fantastic companies by then in cheap currencies with all the structural favourable attractions of emerging markets of young populations and functioning banking systems and low levels of debt and all those things that we know about on the far side of a credit cycle, then that would be a terrific opportunity and that's something we'd hope to exploit in time.
Wall: James, thank you very much.
Harries: Thanks very much.
Wall: This is Emma Wall from Morningstar. Thank you for watching.
