Introduction
Bruce Stout has been fund manager of the 102-year-old Murray International Trust since 2004. Since then, he has reconfigured the trust’s £1 billion investment portfolio away from developed economies and towards high-yielding equities in emerging markets. Born in Dundee in 1958, Stout was educated at Carnoustie High School and the University of Strathclyde (BA hons in economics). He started his career in industry, working for British Telecom and the General Electric Company. In 1987 he moved into asset management, working for 14 years at Glasgow-based group Murray Johnstone, where he carried out a number of roles including investment manager of North American equities, Latin American equities, and emerging markets. Murray Johnston was acquired by Aberdeen Asset Management in 2000, since when Stout has been senior fund manager responsible for global equities at Aberdeen. He has travelled extensively throughout the past 25 years across Asia, Latin America, Europe, and North America. Murray International Trust is today a large, globally diversified investment trust whose roots can be traced to Glasgow’s thriving industrial and shipbuilding past. In 2009 it delivered a share price total return of +35.2%.
Has balance of economic power shifted between the emerging and the developed economies?
For us, the macroeconomic backdrop looks horrible in the developed world, but the opposite prevails in the developing world. The long-run, positive, structural case is population-driven growth and rising real incomes. Where is the majority of the world’s population? In the southern hemisphere. And how old are they? They are young. Therefore they need jobs and growth. Their countries have the savings to ensure this can happen, whereas they didn’t before. Even though they will make mistakes along the way, they have the ability to achieve long-term sustainable growth. The danger for the developed world is when emerging market economies decide to deploy their own capital domestically there won’t be any left to fund over-consumption in the West.
Isn’t investing in emerging markets more risky than investing in developed economies?
First of all you need to define risk and the perception of risk. In 2006, we did a presentation on the case for investing in emerging-market equities; we showed a slide entitled Bank A and Bank B. Bank A was willing to lend you five times your salary on a property; it would lend you 125% of the value of the house, with no need for a deposit. For an extra 100 basis points, the bank would give you a self-certified mortgage—which meant you didn’t have to justify your earnings. And it competed in a very competitive market. Bank B was only prepared to lend you twice your salary. It demanded a 25% down-payment for any property purchase. It operated in an underdeveloped housing market, with low penetration and low levels of competition. If you put that slide up at an investment seminar and asked, “Would you invest in Bank A or B?” of course everyone says Bank B—they said they wouldn’t touch Bank A! But when you told them that Bank A was a Scottish bank, and B was an Indian bank and asked them which bank they would invest in, they said they wouldn’t touch the Indian bank because it was “much higher risk”! We did it time after time after time and the results were always the same.
It comes down to ignorance and prejudice, two of the most powerful forces in investment. These human frailties, along with sentiment and emotion, consistently hamper some investors’ objectivity, but provide scope for others to prosper. If you had perfect rationality amongst all investors, then there wouldn’t be any pricing anomalies and dislocations in markets which enable people like us to take a contrarian view.
In the Scottish vs Indian example, do you believe the Indian bank was more conservatively managed because of management responsibility or because of pressure from the Indian regulator?
It’s a combination of the two. On the streets of Sao Paulo or Delhi, nine times out of ten the customers won’t have any credit history. So banks in such places are intrinsically more cautious, insisting customers make 25% deposits so there’s a personal commitment. Most business models come from the school of hard knocks.
To what extent should Western countries be re-examining their banking sectors, to prevent the same dangerous cocktail of over-leverage and reckless lending destroying them again?
The madness in the banking sector has happened three times in my lifetime. That is not the issue. The real issue comes when a banking sector is adjudged by the authorities to be “too big to fail.” That leaves management with zero accountability either to stockholders or depositors. If banks think they can ride roughshod over stockholders and depositors, they will drive themselves as hard as possible in order to make profits, often with large share options for themselves, in the full knowledge that if it blows up in their faces the government will pick up the pieces!
However, if the banking system is going to be bailed out, it does need to be more heavily regulated. In terms of controlling banks’ behavior, the best answer is to impose fixed ratios of capital to loans. One of the most ironic statements you hear is: “If bankers don’t get large salaries and bonuses the industry won’t be able to attract the best brains to create new products and innovation.” Well in my lifetime these “best brains” and their innovative products have nearly destroyed the banking system on three occasions. Now that’s not what I’d call value for money.
Jim Rogers, author of Investment Biker, has said the financial system in developed nations has become “corroded and corrupted,” and that future financial centers will be in places where the surpluses are—so Shanghai and Singapore, not London and New York.
Yes, in its present structure, it is finished, the model is finished. That is happening, whether you like it or not. It’s not a question of what investment managers or pundits think will happen. This is already happening and it has been creeping along for 10 years. Western governments have been running budget deficits of 11% and 12% of GDP. In the United Kingdom, our budget deficit is 11% of GDP; and our structural deficit is 88%. Japan’s budget deficit is 5% of GDP and the structural one is 240% of GDP. Add ageing demographics and it becomes clear these countries can no longer afford their current rates of consumption.
Between 1990 and 2010, Japan introduced widespread fiscal programs, which the government thought they could afford because they had huge domestic savings. Now they’ve squandered all that and have little to show for it.
Weren’t those programs supposed to restimulate the economy?
Yes but instead Japan got caught in a deflationary trap. They had two decades of deflation and ended up with an accumulated debt of 240% of GDP. You get stuck in a trap unless you can somehow reinvigorate the demographics. The population in countries like Japan and the United Kingdom is old and declining. Both countries have had their day in the sun.
There’s a generation of US and UK economists who have been brought up on only a single economic model—“the credit cycle.” So when the economy overheats the central bank ramps up interest rates and credit is withdrawn; when the economy slows, interest rates are cut and increased credit stimulates activity. But that no longer works. Credit has been crowded out by debt servicing.
If the West is now virtually bankrupt what’s been happening in the emerging economies?
Emerging countries such as China, Chile, Brazil, and South Korea are savings nations; they have current account surpluses, fiscal surpluses, and huge foreign exchange reserves. But, more importantly, they have young populations and they also now have pension systems into which people are paying, but from which little is currently being taken out. They are using more of their savings to invest domestically and can stretch out their bond market duration to 30 years, enabling them to wean themselves off dependence on foreign capital. So what happens in the developed economies no longer really matters to them. The turning point will come when they start using their pension funds and other savings, together with their surpluses, to fund domestic expansion. That’s when they will stop buying the junk we print—i.e. our bonds.
This buyers’ strike will be horrible for the developed nations. Everybody talks about the pain of adjusting to a lower standard of living; but they’re in cloud cuckoo land because they don’t know how that is going to feel. Any government that tries to fast-track the necessary measures is unlikely ever to be elected again. The only option is to try and “buy time,” thereby stretching out liabilities into the future. In the United Kingdom we have already consumed future growth and now must pay for it. Sadly, the people who are going to pick up most of the tab are the young.
How would you quantify the shift in the balance of economic power?
In 1997, the US accounted for 70% of incremental consumer demand in the world, and Asia was dependent on the US consumer. Today that figure is less than half. Brazil had a structural deficit of 80–90% 10 years ago. They have been paying off their national debt and today it is 45% of GDP. Chile now barely has a fiscal deficit, and a structural deficit of just 1.5%. Chile started to turn the corner in the 1990s when its pension fund reforms started kicking in.
The economics have already decoupled—this is the IMF’s view. China has gone from 3.6% of the world economy in 1990 to 16% today. In the same period the USA, has fallen from 22% of global GDP to 20% today. Emerging markets as a whole have gone from 36% to 50%. There is more inter-trade now between China and Brazil and the southern hemisphere than there is in the northern hemisphere.
What sort of investment approach do you deploy at Murray International Trust?
We are looking for 50 of the best business models in the world. It’s about finding sustainable business models and making sure that we don’t overpay for them. Ideally we want to buy such companies and hold them forever. Hopefully they will grow earnings and dividends faster than their share prices go up. A good example of a company we like is the global seamless pipe producer, Tenaris. Today it’s the world’s largest manufacturer of welded and seamless pipes for the oil industry, but when Murray International first invested in this company over 15 years ago it was only a small Mexican-based producer. We have been with the company ever since and watched it grow into a global giant of the industry. We are particularly looking for business models that have a very low sensitivity to nonoperational nonsense that’s going on in the developed nations.
What are the longer-term prospects for emerging markets from an investor perspective?
Markets have an uncanny habit of eventually seeking out growth. There’s no point in buying an equity if it has no growth in earnings and dividends. So ask yourself the question—if there’s no growth in the United Kingdom, the United States, Europe, and Japan, what price does the market put on growth in areas where there is real growth? It’s a tough question to answer, but in the tech boom it was 30 or 40 times earnings. In Japan in the 1960s, it was 50 to 60 times. So there is a limited supply of emerging market stocks, which bodes well for share prices, once the world shrugs off its prejudice and ignorance.
What about the volatility of emerging markets? Isn’t that a negative for investors?
Last year when there were all those shenanigans, did the Brazilians hike interest rates to stop money outflows? No, they actually cut rates. The macroeconomics are so strong they can maintain their own domestic policy initiatives irrespective of what’s happening in the developed world. In the past, the Brazilian Real was vulnerable to capital flight given the country’s dependence on foreign capital. Interest rates periodically had to be raised to prevent capital flight, which wrecked prevailing economic growth. But now, if you’re not dependent on imported capital, you won’t get any capital flight. Thus you don’t have to raise rates and go through that whole destructive cycle.
Doesn’t that mean the Holy Grail of “decoupling” has arrived?
We’ve had economic decoupling for ten years! But there’s no financial and equity market decoupling yet. That will happen eventually—when the market realizes that economic decoupling has happened and that the real profit growth will come from the emerging economies.
But might there not be some emerging economies that don’t get it right?
Well, Korea is probably the most vulnerable to a US slowdown, because it is the most industrial and into exports. It builds ships, all sorts of things, even luxury cruise liners. Is that discretionary spending? I would say so. So you have to watch for things like that. An Asian exporter, 90% of whose business is based on exports to the developed world, is also more than likely to struggle in this scenario. But that’s not investment wisdom, just common sense, a commodity that is often seriously underrated as a tool of investment management.
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