13 Questions for Diverse Income Trust's Gervais Williams

Which Sector Shows the Biggest Promise in 2024?

That’s easy. UK smaller companies have outperformed the mainstream stocks by a large margin since consistent UK stock market data was first collected in 1955. With the scale of ongoing UK fund sales over the last two or three years, smaller companies have underperformed dramatically. When the local selling fades, we expect UK smaller companies to have a major catch-up, which appears overdue.

With the strong showing from US megacap technology stocks, and cryptocurrency breakout in the early months of 2024, if anything the exact timing of the UK small cap recovery still appears elusive. Although these arguments carry weight, it is important to remember that the UK small cap asset class is tiny in comparison to others. More like a thimble amongst buckets elsewhere. At present the drip drip drip of UK OEIC redemptions maybe supressing their share prices. Yet even a modest change in flows could lead to small cap share prices suddenly catching up. We note the increasing number of cash bids for UK equities this year, and if that continues in our view it will be enough to overwhelm the local sellers, such that UK small cap share prices jump. Such a move would probably lead to fewer local sellers, resulting in UK small cap share prices accelerating.

What's the Biggest Economic Risk Today?

Recent economic data implies that global growth is slowing, and inflationary pressures are moderating. Many investors are now hopeful the global economy will avoid a significant recession.

In my view, the biggest risk is that global interest rates will remain too high for too long. Don't get me wrong, US economic growth accelerated in the second half of 2022, and hence even with elevated interest rates, it is unlikely to fall back into a recession for a while yet.  But for those economies that haven’t had the fillip of the Inflation Reduction Act, the weight of elevated interest rates is supressing growth. Some parts of Asia are very slow, and Europe may be worse. There have been some profit warnings, but for now US growth appears to be offsetting the downdraft. We are fearful that keeping interest rates at current levels will ultimately supress economic activity from here.

Describe Your Investment Strategy

Over very long time periods, the return on stock markets can be wholly explained by two factors. The initial yield at the start of the period, and how much it has grown subsequently. In order to outperform, all a fund has to do is either to offer a yield that is currently above that of the mainstream stock market and grow that dividend at a slightly faster rate than others. The funds I manage with Martin Turner seek to deliver these objectives. We believe that investing right across the full range of UK quoted companies, including stocks that are overlooked on account of their lesser market capitalisations can deliver better yields and/or better dividend growth. 

Which Investor(s) Do You Admire?

I have always admired Benjamin Graham, the fund manager and author of The Intelligent Investor. Few investors appreciate that the real return on the S&P 500 Index over the 50 years to 1950, was zero in real terms. Yup, your read that correctly. The total return on the mainstream US stock market between 1900 and 1950, after deducting inflation, was zero! As fund managers, we may lament the odd disappointing years for markets. For a large part of Benjamin Graham’s career, he had one difficult year after another. And yet he found ways in which he could consistently add value for his clients. Methods to generate an absolute return in contrast to a near nothingness from the mainstream stock markets is so impressive. 

Name Your Favourite 'Forever Stock'

Most tests on hospital testing machines are produced by the machine manufacturer. But sometimes the results of the generic test are somewhat variable, and at these points other independent companies can develop their own tests, that have the potential of displacing the generic test. Bioventix (BVXP) is just such a company and has brought a series of highly successful tests to the market. And when they become established, the hospitals use these tests year after year. So, Bioventix’s revenues consist of new tests being layered on prior year successes.

Since the end of December 2012 to 12 March 2024, its growing dividend income and share price appreciation has totalled more than 27-fold (source: Bloomberg). This is a rate of return of over 34% per year, which compares with something like 26% per annum for Apple over the same period. And yet, the market capitalisation of Bioventix is still only around £250 million. That’s a good example as to why we include smaller companies in our clients' portfolios. 

What Would You Never Invest in? 

We always avoid anything where the company’s operations appear to be at odds with the spirit of the government’s regulations. In the past, some gaming companies have operated in what they described as ‘grey markets’, where governments hadn’t got legislation that specifically excluded their activities, but where they were unhappy. PartyGaming was an IPO with these kinds of activities, that were described in the prospectus. In our view, these kinds of stocks shouldn’t be listed, and in the case of PartyGaming, its share price delivered very poor returns in time. 

Growth or Value?

To some degree we equate growth with the hare in Aesop’s tale, and value with the tortoise. The hare has long legs and can run really fast at times. Most investors get excited about all the capital appreciation that often comes with investing in hare-type stocks. In contrast, tortoise-type stocks are less exciting, and much of their return is often generated by compounding the stream of dividend income they pay out. During periods of strong market returns, such as over the last couple of decades, hare-type stocks have typically massively outperformed tortoises. Beyond globalisation however, hare-type stocks have already suffered some setbacks. These are the kinds of conditions when tortoise-type stocks outperform. And ultimately, as in Aesop’s tale, the tortoise wins the race. We are tremendously upbeat about value outperforming growth, next year and indeed for many years beyond.

House or Pension?

Whilst houses have done well for years, we need savers to step up their willingness to invest via a SIPP or equivalent. After years of an absence of productivity, and the cost of capital rising, especially for UK quoted smaller companies, it is now very hard for companies to justify significant capital expenditure. Numerous UK quoted companies are buying back their equity, in preference to capital expenditure. All of us need to step up our willingness to invest in UK-quoted smaller companies, which will help reduce their cost of capital, that in turn will then boost the number of capital expenditure projects that are viable. SIPPs are a golden opportunity for us all.

Crypto: Brilliant or Bad?

At this stage cypto is a very immature area of the capital markets, and as such there is room for all sorts of scandals etc. But over time, as the sector matures, we do believe there will be features of crypto that do deliver improved productivity, that ultimately improves the efficiency of the corporates. In short, financial markets are socially useful, because when they work well, they deliver additional skilled employment, productivity improvement and when local businesses succeed, they increase the UK tax take. These are all good outcomes for the electorate as a whole, not just those with savings. We should welcome innovations like crypto. 

What Can be Done to Improve Diversity in Fund Management?

Many of the patterns within the financial markets during globalisation favoured largeness. The current scale of the largest US companies is a good illustration. Whilst there will always be room for bigness, we also need to foster smallness. Smaller companies tend to be more innovative and typically offer greater potential for junior staff to develop their capabilities and responsibilities relatively rapidly. We need a sea change in the perception of risk, to embrace more smallness in the financial markets. We need more small fund management companies to be set up. If this occurs, they will bring increased diversity with them, including increased diversity within the fund management community itself. 

Have you Ever Engaged With a Company and Been Particularly Proud (or Disappointed) of the Outcome?

As we are an investor that is willing to consider the risk/reward of any UK-quoted company irrespective of market capitalisation, we review the potential for all those that are often perceived as too microcap for most other professional investors. Some of these may have outstanding opportunities to thrive and create additional skilled employment, and yet sometimes never get the capital to put their plans in place. Fortunately, we have clients that are able to invest in these, and in some cases our clients’ capital gets these deals over the line. Whilst we may have only been a part of the capital providers at the end of a long process, the marginal amount of capital our clients provide may have changed the outlook for the company and their staff in a very meaningful way. We are proud that these kinds of outcomes typically happen numerous times each year, especially as we believe they also help our funds to deliver stronger client outcomes than those of some competitor funds over the longer term. Some recent examples include LifeSafe (LIFS), Ensilica (ENSI), Zinc Media (ZIN), Beeks Financial Cloud (BKS), and CyanConnode (CYAN).  

What's the Best Advice You’ve Ever Been Given?

Early in my investment career, an experienced colleague took me aside to highlight why a mismatch in the terms of assets and liabilities can be so troublesome. In short, if a bank has customer deposits that can be withdrawn at any time, that goes on to make loans to companies that are generally unable to be called back for a fixed period, then even a slight change in perception can lead to disaster. History is littered with examples of bank runs, including quite a few during the Global Financial Crisis in 2008.

There are plenty of other versions of this mismatch. If a company’s losses crystalise into a loss of ready cash, within a capital structure where the breach of various covenants leads to the corporate loans having to be repaid, then what appears to be minor change in trading conditions can lead to a going concern suddenly becoming insolvent. Mr McCawber, from the book David Copperfield, had it right. This is the interface between these two states, it is the difference between happiness and misery.

What Would You be if You Weren't a Fund Manager?

In the past I became a fully qualified Chartered Engineer, with past experience in docks, harbours and coastal protection. I guess if I wasn’t a fund manager I would be working on these kinds of projects. As it is, there are several large jetties, breakwaters and other portside facilities that I was involved in years ago, which remain in use even now.