The defensive multi-asset Capital Gearing Trust (LON: CGT) has just released its interim accounts for the six months to the end of September. It was a challenging period for the £1.1bn portfolio with the NAV down 1.3% on a total return basis, well behind the 2.4% increase in the Consumer Price Index (CPI).
Things haven’t been going well for Capital Gearing, or its closest rivals Personal Assets (LON: PNL) and Ruffer (LON: RICA),with none of them managing to protect investors’ capital during 2023. In fact, over the first 10 months of the year, CGT’s NAV declined by 3.4%, while its shares lost 9.2% as the discount widened.
The sharp increase in interest rates over the period meant that the fund’s nominal and index-linked government bonds both made negative returns, as did their gold holdings. These losses were only partially offset by the positive performance from its relatively small allocation of corporate bonds and risk assets.
The Underlying Portfolio
At the end of October, Capital Gearing’s largest position was its 48% weighting in index-linked government bonds. This was followed by: 27% funds and equities, 13% corporate credit and 10% conventional government debt.
The managers say that evidence is mounting to support the reliability of the published NAVs of the alternative investment trusts, with asset disposals at or above book value across multiple sectors. They point out that the wider discounts are a product of supply and demand, with the fall in demand being driven by redemptions by wealth managers, as they shift towards more tax-efficient alternatives such as low coupon gilts.
They believe that supply needs to be withdrawn from the sector, preferably by selling assets and buying back shares or returning capital to shareholders, but say that they have seen little evidence of this to date. Capital Gearing’s main exposure is its six percent holding in infrastructure trusts and four percent allocation to property.
The managers note that the US economy has been surprisingly resilient over the last six months, with market expectations now leaning towards a soft landing. However, they remain sceptical, as the effects of the extended rate hiking cycle have yet to fully flow into the economy, while credit availability is declining and the money supply is shrinking.
Peter Spiller and his colleagues expect short-dated bonds to rally as markets anticipate rate cuts. The problem is that if the cuts are implemented before inflation is brought under control, then longer term interest rates may have to rise as investors demand an additional term premium to compensate for the extra volatility.
Ultimately, the managers believe that financial repression, where interest rates are kept below inflation, is the only viable route by which hugely indebted governments like the US will be able to sustain their borrowings. When this happens they think that index-linked bonds will outperform, hence their high 48% allocation.
Widening Discount Creates A Potential Buying Opportunity
Since 2015, Capital Gearing has operated a zero discount policy, buying back shares at a two percent discount and issuing them at a similar premium. This was recently suspended when it ran out of distributable reserves.
The fund says that the move is temporary and has blamed the technical and administrative delays that led to the suspension on ‘a series of errors and omissions on the part of third parties’. It is currently seeking approval from the Northern Irish Courts to reclassify its share premium account as a distributable reserve, which would enable the policy to resume.
It is expected that these reserves will become available to be distributed in early 2024, with the Board taking direct control over the whole process. In the meantime however the shares have slipped to a wider than normal discount of 3.6%, which could offer a reasonable long-term buying opportunity for cautious investors.