Q&A: Marlborough US Multi-Cap Income investment update

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“Companies have proved they can and will make money and grow whether it’s a Republican or a Democrat sitting in the Oval Office.”

Brad Weafer

Marlborough US Multi-Cap Income Fund Co-Manager Brad Weafer explains why profits are more important than politics for the US equity market and why he is avoiding banks, but backing an insurance broker.

How important will the result of the US elections be for US equity markets?

“While the US elections are certainly keeping the news channels and headline writers working overtime, when you look at what’s happened historically, the evidence is that the result may not be as important for stock markets as people might think.

“The Republican Party does tend to be viewed as more pro-business, so there may be an assumption that a win for them would be better for US equity markets. If you look at how the markets have performed over more than 50 years though, there’s no correlation between returns and the political allegiance of the president. Companies have proved they can and will make money and grow whether it’s a Republican or a Democrat sitting in the Oval Office.

“Looking at the two candidates, Donald Trump did cut the corporate tax rate from 35% to 21% and there is a concern that if Joe Biden becomes president he’ll increase the rate again, which would dent company profits.

“We need to remember though that we’re still in the middle of a pandemic and feeling the effects of an economic shutdown. I think Biden would be unlikely to act quickly to raise taxes in the middle of a recession – with unemployment close to 8%, it just wouldn’t be a sensible political move.

“Passing legislation also means getting it through Congress, so who controls the House of Representatives and the Senate will be very important too.

“It’s also worth remembering that while the president is elected for four years, there will be midterm elections in two years that could once again change the political makeup of the House of Representatives and the Senate. So, whoever is voted into power they will have a strong interest in ensuring the economy is in good shape for 2022.

“Of course, the prospect of a disputed election result is a concern, because of the uncertainty and the potential delay to further stimulus measures. But once we get the result and that uncertainty is removed it’s likely to provide some relief to markets.

“Ultimately though we believe it’s important not to overplay the importance of the election in shaping the direction of US equity markets. While politics certainly make headlines, it’s company earnings that drive stock markets.”

What single factor is likely to have the greatest influence on US equity markets in the months ahead?

“Without question it’s the pace of the economic recovery. While there’s always the risk of the economy getting locked down again to help fight COVID-19, our view is that whoever is in the White House they’ll be keen to avoid a shutdown, which has proved to be such a blunt tool.

“Meanwhile, we’ve been seeing an encouraging bounce in a number of key economic indicators, such as employment, manufacturing figures and consumer spending. While that’s all positive, it does though appear that after a strong snapback, the speed of the recovery may now be slowing.

“There’s been a lot of talk about the shape of the recovery and whether it’ll be, for example, a ‘V’ or ‘W’ shape. Our thinking is that it’ll actually be more like a reverse square root sign. By that we mean that after the sharp fall in economic output, we’ve seen a rapid partial bounce back, but that the next stage of the recovery may be at a slower rate.

“We wouldn’t expect the recovery to be a straight line – there will certainly be challenges along the way. However, you’d be hard pressed to find a scenario where the US economy is not in better shape in a year’s time than it is today. And what matters to markets more than the picture today, whether it’s good or bad, is the direction of travel, whether things are getting better or worse.

“There are other things bubbling away in the background, of course. The trade war with China, for example, is an issue for some sectors. As investors though, we identify companies with management we believe in and place trust in them to manage risks of this kind.

“We’ve seen companies diversifying their supply chains recently and we believe they’re in better shape now to deal with USChina trade tensions and tariffs. It’s an issue that’s not going away, but it doesn’t seem to be affecting overall sentiment.”

Where are you seeing risks – and opportunities?

“With interest rates so low and the yield curve indicating they’ll stay that way for some time, it’s a real challenge for banks to make money. At the same time, they’re exposed to a lot of risk with businesses running into trouble and bad debts.

“So, we’ve sold out of JP Morgan, for risk management purposes. We think it’s one of the best, if not the best, large bank in the US and we have a lot of respect for its management. No matter how well run the company is though, it won’t be immune to what’s happening in the sector. For that reason, we’ve exited our position.

“However, we haven’t completely turned our backs on the US financial services industry. We’ve identified an opportunity in the commercial insurance sector. The cost of insurance for businesses has been rising and that’s due in part to society, certainly in the US, becoming more litigious.

“Insurance pricing tends to move in cycles and, as you’d expect, when prices are firmer, insurers and insurance brokers generally tend to do quite well. On that basis, we added insurance broker Brown & Brown to the portfolio. The company sells insurance and is likely to benefit from the uptick in pricing, without the risk associated with underwriting policies itself.

“Our view is that businesses still need to insure themselves, regardless of whether we’re in a recession or a pandemic, and the company is well positioned to reap the benefits. Certainly Brown & Brown’s trading updates have remained strong throughout the crisis. In addition, the company has a great culture of investing in growth through acquisitions. All in all, we believe it’s a very interesting opportunity.”

How would you summarise the investment outlook?

“The outlook for the US economy is an improving picture and while there are clearly risks, these have, in many cases, already been priced into the market to some degree.

“On the other hand, valuations for US equities are now looking fairly high generally and that could mean returns from the overall market are more subdued as we look ahead.

“The key point though is that we’re conviction investors, holding only 25-40 genuinely exceptional companies that we’ve selected from around 4,000 actively traded shares on the US stock market.

“We look for individual companies with a real edge that means they can achieve stronger growth than their peers and continue to prosper, even if there are economic bumps in the road. So, for the companies we hold we certainly see a positive outlook.”

Brad Weafer 19/10/2020

Risk Warnings
Capital is at risk. The following is a summary only of some key items in the Prospectus and more details can be found in the Prospectuses. Investors in Protected Cell Company (PCC) must have the financial expertise and willingness to accept the risks inherent in this investment. Past performance is not a reliable indicator of current or future performance; it may not be repeated and should not be the sole factor considered when selecting funds. It should be appreciated that the value of Shares is not guaranteed and may go down as well as up and that investors may not receive, on redemption of their Shares, the amount that they originally invested. Investment in the Company should only be undertaken as part of a diversified investment portfolio. Investment in the Shares should be viewed as a medium to long term investment. Shares may not be redeemed other than on any Dealing Day. There will not be any secondary market in the shares of the Company. The individual cells of the fund act as feeder funds to various UK-authorised collective investment schemes, which may invest in smaller companies, and those listed on the alternative investment market (AIM), which carry a higher degree of risk than larger companies. The shares of smaller companies may be less liquid and their performance more volatile over shorter time periods. The cell invests mainly in North America therefore investments will be vulnerable to sentiment in that market which may strongly affect the value of the fund. All or part of the fees and expenses may be charged to the capital of the cell rather than being deducted from income. Future capital growth may be constrained as a result of this.

Regulatory Information
The Cells referred to are a cell of Marlborough International Fund PCC Limited (the ‘Company’), a protected cell company incorporated in Guernsey and authorised as a Class B Collective Investment Scheme under the terms of the Protection of Investors (Bailiwick of Guernsey) law, 1987, as amended. Investment may only be made on the basis of the current Prospectus, this can be found on the website www.marlboroughinternational.gg. Marlborough International Management Limited is incorporated in Guernsey. Registration No. 27895. Regulated by the Guernsey Financial Services Commission. It is not protected by any investor compensation scheme.