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The managers of the Capital Gearing Trust (LON: CGT) have recently issued a stark warning about the risks facing investors. Since they took over the role almost 40 years ago, they have built up an impressive track record of delivering attractive returns, whilst also protecting capital, so it pays to listen to their concerns.
In the recent interim accounts for the 6 months ended 5th October, they went to great lengths to draw attention to the fact that the volatility at the start of that month was unusual as it involved a sharp fall in the value of both US treasuries and equities.
Normally these two asset classes have been a good diversifier, as when shares were overvalued, the bonds would provide a safe haven and a source of acceptable returns, but the negative correlation between them seems to have broken down with the collapse in long-term interest rates helping them both to deliver strong gains.
The current market weakness could persist
With long-term interest rates now on an upwards trend, it is likely that stocks and bonds could both lose value at the same time, which creates a real challenge for worried investors who are trying to preserve their capital, especially as the managers believe that the current market weakness could persist.
Co-manager Alastair Laing recently said that there is a growing consensus that the current macro-economic and financial environment is in the ‘late cycle’ stage.
“Some indicators are relatively simple to observe, namely that the current US economic expansion and equity bull market are both the longest since the Second World War. Other indicators are based on historic echoes such as the Federal Reserve embarking on a tightening cycle resulting in a flattening yield curve. These all point to a cliff edge out there, shrouded in the mist that is the future.”
In order to protect the fund’s portfolio, they have concentrated on short-duration fixed income securities that are less sensitive to rising interest rates, with cash and short dated government and corporate bonds accounting for 42% of the assets at the half-year end.
Low risk assets that can deliver positive real returns
Another significant chunk of the fund has been allocated to low risk assets that can deliver positive real returns. The managers believe that there are very few of these to choose from given the current elevated valuations, with the standout example being US inflation-linked government bonds (TIPS), which make up 24% of the portfolio.
The rest of the capital has been invested in a range of investment trusts, funds and overseas property shares, with the largest holdings including the likes of: North Atlantic Smaller Companies (LON: NAS), Residential Secure Income (LON: RESI) and the PRS REIT (LON: PRSR).
Since taking over the management of the Capital Gearing Trust almost four decades ago, they have delivered positive total returns in all but one financial year, 1990, and over the same period they have comfortably outperformed the FTSE All-Share Index with considerably less volatility.
The management team is highly regarded and they have built up an exceptional long-term track record over a challenging period, during which there have been several severe market crashes. If you are at all concerned about the near term prospects for the financial markets, this is likely to be one of the safest funds to park your cash.