The Defensive Three: 2000-23 review

[Luniversal]

The Defensive Three (D3) are investment trusts designed to protect and increase capital's purchasing power 'in that order', as stipulated by the archetypal wealth-conservator, Personal Assets Trust (PNL). The D3-- like the more sportive Growth Ten, which was reviewed on the Growth Strategies board on Aug. 12-- has been back-calculated from Nov. 2000 to run alongside the story so far of pyad's 'HYP1' High Yield Portfolio.

The Ten date from a Motley Fool post of August 21, 2012. The D3 was conceived only in Jan. 2022(1), but its concept is not a retrospectve fiddle. If one were seeking above all to hang on to the real value of what one had in late 2000, these three trusts would have picked themselves. There was no other choice then outside expensive hedge funds. Indeed, there is little more today apart from Ruffer Investment, launched offshore in 2004 (2). Lindsell Train (2006) has features in common with the D3, but is not as dedicated to preservation of real value as PNL and the doyen of the art, Capital Gearing Trust (CGT).

Neither, it could be said, is the third member, RIT Capital Partners (RCP). In the early 2000s RIT was a somewhat swashbuckling growth vehicle; it calmed down after converting to investment trust status, beginning to stress how it outperformed when equity markets rose while resisting falls. This line is less apposite after its recent showing, as we shall see, but RIT has gingered up the portf,olio in the past without unduly destabilising it.

Outcomes are calculated to compare with HYP1's £75,000 gross outlay-- £25,000 per trust- after deducting 1% for purchase costs. Statistics are based on aggregated annual financial statements filed between May 2000 and Apr. 2023, the best fit for timeliness. RIT's year end is Dec,. CGT's Mar., PNL's Apr.


CAPITAL

End-Apr. anniversary values in nominal amounts; percentage changes year by year deflated by the Retail Prices Index/performance against the FT All Share Index in percentage points... and the priority, real change in purchasing power taking the launch date as 100:

2001: £76,890, +0.7/+7.3 (from Nov., 2000)...107
2002: £79,306, +1.6/+15.6...124
2003: £77,633, -5.2/+22.6...152
2004: £97,127, +22.6/+6.8...162
2005: £109,437, +9.5/+5.5...171
2006: £136,174, +21.8/-3.8...165
2007: £136,961, -3.9/-8.6....151
2008: £148.762, +4.4/16.2...175
2009: £137,936, -6.1/+22.6...215
2010: £160,312, +10.9/-15.5...182
2011: £186,823, +11.3/+6.4...193
2012: £182,297, -5.9/+3.0...199
2013: £201,437, +7.6/-3.1...193
2014: £192,732, -6.8/-11.8...170
2015: £213,611, +9.9/+7.3...182
2016: £218,906, +1.2/+11.7...204
2017: £245,194, +8.5/-3.8...196
2018: £252,021, -0.6/-1.3...194
2019: £265,426, +2.3/+7.2...207
2020: £257,789, -4.4/+18.3...245
2021: £308,251, +16.7/-5.3...232
2022: £320,212, -7.2/-1.2...230
2023: £274,564, -25.7/-16.6...192
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2023 (Oct. 6) £267,119


The All-Share rather than a world index is used as a practical benchmark. The D3 is for British investors whose customary resorts are UK equities. It has far outdistanced its comparator: up 256% since Nov. 2000 against 34%.

That is by the way. Since launch the D3 has compounded at 5.7% pa against inflation of 3.5%. It has thus more than satisfied the central objective of safeguarding purchasing power-- not so in the last two years, though in the five months since Apr. it has reverted to beating the All-Share on the down side, falling by 2.7% versus 5.3%. In real terms the D3 has almost doubled in almost 24 years, increasing in value 13 times year-on-year, but it shed one third of its value between Apr. 2021 and 2023.

The portfolio struggled during the shallow bear market which set in after the brief relief rally in equities in late 2021. Joy about anti-covid vaccines was dampened by the outbreak of war in Ukraine and a sudden take-off of borrowing costs. Both negatives persisted longer than expected, not pole-axing share prices but creating a stagflationary backdrop, with less optimism that tech disruptors can kick-start a new phase of economic expansion.

Such doubts are a concatenation of headaches for the wealth-preservers; they lean on asset classes variously blighted by the gray weather. Gold carries no income and is less potent as insurance against wars and rumours of wars, now rife, than in the hyperinflationary 1970s. T-bills and other investment grade bonds lost value as yields spiked. Growth stocks such as biotech and AI have been sold down, offering little income to cushion their fall; the preservers avoided the FAANG majors but their 'unicorns' have not perked up as much in 2023.

Property rents and values are depressed, with remote working and dearer mortgages shaking demand more than cyclically. Unquoted investments have become hard to appraise in stock markets starved of flotations and bids: a sore problem for RIT, whose holdings include 28% in private equity funds and 12% in directly held hopefuls.

Currently the D3's market value is £5,000 below that of the Growth Ten equity-only collection. However, the Defensives leaped around less. Each compounded at c.5.3%:pa in money terms, but the D3's nastiest stumble between year ends was 14% and its best gain 25%; for the G10 it was 27% and 62%, though it increased more often-- in 19 of 23 periods. Tranquillity as well as security of value over time ought to be a feature.

Nevertheless the Three are becoming less reliable. They have completed a hat trick of losing to the All-Share year on year, the first such sequence. Six of the last ten years have witnessed such failures, after only four in the prior 14 years. How so?

The harsh truth is that the D3 went into a hedgehog posture during the Global Financial Crisis, was vindicated for the time being but have found timidity difficult to grow out of. Financial repression was great for risk assets and lasted far longer than the hedgehogs expected. They missed the party, grumbling that with so much fiat money sloshing around the system it was sure to sink. Nope, not yet... and it's been 15 years.



INCOME

Actual totals collected in years to Apr., including specials/ growth of real income (2002-03-100)/real percentage changes each year:

2001: £0 (none due in first five months)
2002: £501/100
2003: £516/100/-0.2%%
2004: £545/103/+3.3%
2005: £560/102/-0.5%
2006: £596/106/+3.9%
2007: £656/112/+5,6%
2008: £710/117/+4.0%
2009: £823/137/+17.1%
2010: £1,046/167/+21.8%
2011: £897/134/-19.4%
2012: £1,063/154/+15.0%
2013: £2,185/313/+102.7%
2014: £2,179/304/-2.8%
2015: £2,253/312/+2.5%
2016: £2.295/314/+0.6%
2017: £2,369/313/-0.3%%
2018: £2,401/306/-2.1%
2019: £2,471/306/+0.0%
2020: £2,545/311/+1.5%
2021: £2,616/310/-0.1%
2022: £2,637/278/-10.3%
2023: £2,732/257/-7.8%


Dividends were never important: up to Apr. 2023 they contributed 17% of the portfolio's combined return, paper profit plus payouts. RIT paid out little in earlier years before adopting a progressive policy from a jacked-up dividend in 2012-13, but Personal Assets went the other way, freezing its rate since 2006. Capital Gearing has always treated dividends as a minor incidental factor; were it not legally obliged to disburse a minimum 85% of revenue, it would probably retain the lot.

The portfolio has distributed £34,600 to date, £25,000 less than the Growth Ten, which among my experiments comes closest to the D3 as a conserver of capital. The Growers and Defenders yield respectively around two-thirds and under half as much as the All-Share. That said, income grew faster at the D3, by 8.4% pa to the G10's 7.0%.

It does not look like topping £3,000 pa soon. I suggest patient holders regard it as a bit of a bonus for fun, fun, fun (till your daddy takes the T-bird away).



CONSTITUENTS

Share price change between launch and Oct. 6; number of financial years in the past decade when share price lagged the All-Share index; current and average year-end discount, or (premium), during that decade/latest FE Trustnet Risk Score:

Capital Gearing Trust: +363.9, 5, 2.3, 2.1/58
Personal Assets Trust: +115.4, 5, 1.4, 0.8/47
RIT Capital Partners: +289.2, 5, 22.7, (0.9)/150
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D3: +256.2, 6, 8.7, (0.9)/91


For total return fans, share price TRs (%) with income reinvested, over ten and five years:

Capital Gearing Trust: 30, 10
Personal Assets Trust: 40, 15
RIT Capital Partnerss: 50, 9
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D3: 39, 1

Source: FE Trustnet at Oct. 6, 2023


Capital Gearing produced a negative total return in its accounting year to Mar. for only the second time in 41 years. Peter Spiller has managed it all along. He has two seasoned lieutenants-- will they fight after he goes? The portfolio is 15% in equities, 13% in equity funds, but is dominated by fixed interest: 14% conventional gilts, 43% (sic) in index linkers. The obduracy of inflation haunts Mr Spiller. (Ominously, the trust mulls a switch from the RPI to the easier CPI as a way to measure its resilience. Non nobis, Domine.)

At Personal Assets the breakdown is 34% American Treasury bills, 11% in other short-maturity US bonds, 19% short-date gilts and 19% equities. Unlike Spiller, Troy Asset Management's Sebastian Lyon retains faith in the protective power of the barbarous relic: 11% is in gold and related positions. The equity portion is in only 16 shares, mainly safe 'moatish' dividend payers such as Unilever and Diageo.

Fidelity took RIT off its buying platform this summer, deeming it too risky for hoi polloi. Since Jacob Rothschild fell out with his son, put his daughter on the board, quit as chairman and let outside pros run the show, RIT has plunged to a deep discount. That was driven by doubts about the split betwixt its asset 'pools', with particular concerns about how trustworthy valuations are for the two-fifths of net asset value in unquoted funds or directly owned private equity. The board talks up every profitable disposal, and vows to be franker about what it is incubating. Investors may also be uneasy about the 9% in hedge funds (to which the D3 is in some ways a less exorbitant alternative) and the 22% in debt instruments.

The D3 trio is fully invested, needing little cash on the balance sheet when they hold so much in easily saleable bonds. None of the three constituents uses gearing, pace CGT's monicker. It and PNL employ tight discount control; RIT professes willingness to buy back more stock than in the past, though family holdings may cramp it (cf Brunner, Caledonian) as they may have influenced the gigantic rebasing of the dividend a decade ago. RIT will, one suspects, always be more of a mystery tour than the others. Outside investors may choose to go along for the ride, provided they are not taken for one.

Ongoing charges are 0.46% for CGT, 0.65% for PNL and 0.89% for RIT. Quite stiff, when each is capitalised at over a billion, but not ruinous.

The troika is supposed to function with trusts swapping the lead to produce a steady advance. Their risk scores point to a 'barbel' design with RIT as the most up-and-down conponent, steadied by the others. In practice this was the pattern until all three began to lag simultaneously. Capital Gearing and RIT have each been the best performer in ten of 23 years, Personal Assets-- the least volatile-- in three. The worst results arose ten times from RIT, seven times from Personal Assets and six times from CGT.

RiT's lapses should not be overstressed. Throughout the D3's time it has averaged 37% of the portfolio's value, never dipping under 30% since early days. At Oct. 6 the breakdown was CGT, 43.4% PNL 20.2%, RIT 36.4%.



OUTLOOK

The trusts zre still becalmed by caution. Capital Gearing thinks getting supra-inflationary returns from anywhere save index-linked debt will be tough for a while. RIT points out that most of Wall Street's revival of appetite for tech benefited the big names more than the seedlings and saplings cultivated at Chateau Rothschild; otherwise RIT aspires to fish for bargains in a drab market. Personal Assets is shifting into linkers, believing that even the touted relative cheapness of London's equities is a snare: the new normal of dearer money and smaller payback from risk capital has not been fully priced in.

In theory, timing your entry should matter little if you plan to hibernate your wealth for 20-40 years, but most of us like to buy cheap. So with little income to console you, it boils down to whether and when the gloomy triplets will decide the day to go nap on shares has at last arrived. Troy has been saying it will be gung-ho when the turn comes, but apparently it never does. Will the hoarders and squirrelers miss the starting gun again? One thing is sure: their performance since lockdown puts them under more pressure to get it right than ever before. Maybe they will restock too soon, just for a change.
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(1) Review of year to Dec. 2021 (from Jan. 2006 lsunch):

viewtopic.php?f=8&t=33269&p=479360&hilit=Defensive+Three#p479360

(2) Ruffer has been tracked but would not have enhanced the D3 if substituted for RIT since the former's inception. It has proceeded with immense circumspection, lacking RIT's bursts of elation which on balance have helped the D3 do more than preserve value. Hitherto Ruffer's target of a total return of twice bank base rate was soft; it will be tougher henceforward. The equity allocation is down to 14%, anticipating a full-blown recession.