Capital Gearing Trust (CGT ) has increased its ‘dry powder’ holdings in cash and Treasury bills to 31% – almost a third of net assets – as the wealth preservation fund prepares for a US slowdown that could see elevated stock markets come crashing down.

Portfolio managers Peter Spiller, Chris Clothier and Alastair Laing said the US economy’s dashboard was flashing red with the normalisation of the previously inverted Treasury yield curve, signalling a rapid succession of interest rate cuts in the next two years.

In addition, growing doubts about the massive investment in AI, weakening consumer confidence, falling wage growth and rising unemployment were all indications of an ‘assured’ slowdown that they said could ‘make for a testing time for investors in US equities’ given their extraordinarily high valuation of 37 times cyclically adjusted price earnings (Cape).

While this was less than the all-time Cape high of 42 times earnings before the 2000 dotcom crash, the managers drew a comparison between the current surge in AI stocks to the nascent internet boom at the start of the century.

The bursting of the dotcom mania then proved that a slowing economy combined with post-bubble asset write-downs could inflict serious losses on investors even in the absence of a bad recession.

While US equities were not quite at their valuation peak 25 years ago, they were vulnerable to geopolitical tensions that could cause a broader market repricing.

For that reason, although yesterday’s results did not refer to the re-election last week of Donald Trump as US president, the managers said they were maintaining a low 21% weighting to equities, or shares, in the £977m multi-asset portfolio. 

However, overall risk assets in equities and property rose to 33% from 28%, reflecting gains and new additions in heavily discounted investment trusts.

Of the £303m of ‘dry powder’ in cash and bills, the managers said this has been bolstered by taking profits in positions that performed well.

‘This will help to ensure that the portfolio could withstand the stern test that may be coming our way, and will provide optionality to redeploy these resources into yield-seeking assets as the risk environment moderates, said Spiller, Clothier and Laing.

Data from Morningstar suggests Capital Gearing would be a good holding in a new dotcom crash. Between December 1999 and March 2002, it returned 28% to shareholders while the FTSE All-Share plunged 38%.

The interims showed a return to form for the trust after a difficult few years. The shares gained 3.1% on the back of a 2.4% investment return that beat the 0.9% rise in consumer price inflation. Gains in risk assets and corporate bonds were partly offset by a 7% appreciation of the pound against the dollar in which the portfolio has 28% exposure.

Trust discounts bottom

Such is the fund managers’ concern about a US-led correction they haven’t continued to use their extra liquidity to mop up more cheap investment trusts. These already make up a quarter of the portfolio, reflecting how share price discounts in the sector are their most attractively wide for a decade.

This could be a short-lived opportunity, however, as they said discounts had likely bottomed out after two years of poor relative performance with the investment trust index’s 3.9% gain over the six-month period.

Nevertheless, the trio added SDCL Energy Efficiency Income (SEIT ) at a discount wider than 30% and a dividend yield over 10%, while a position in hedge fund BH Macro (BHMG) was increased.  

They noted that the hedge fund, which Spiller previously said did not take share buybacks seriously enough, was still an immature holding but performed well and remained a key diversifier.

The investment team established 14 other positions in trusts, including Mobius (MMIT ) and BlackRock Energy & Resources Income (BERI ), and exited Witan when it merged with Alliance Trust.

Elsewhere, the allocation to corporate credit lowered from 12% to 9% after strong returns, while index-linked bonds were cut from 44% to 34%, with UK ‘linkers’ nearly halved from 22% to 12% as the pound rose. Instead, more was added to US inflation-linked bonds (Tips), 5%-yielding Treasuries and Japanese bills denominated hedged back to sterling.

Chair Jean Matterson, who is retiring at the annual general meeting in July, noted that the significant increase in share buybacks after the discount control policy was interrupted at the end of last year, meant the trust’s market value had fallen just below £1bn.

On Wednesday the shares closed at a 2.1% discount to asset value. Deutsche Numis analyst Ewan Lovett-Turner said Capital Gearing Trust and its near rivals had all delivered ‘relatively dull performance, which is often an ominous sign for equity markets and can be an attractive time to add to more defensive holdings.’

Over the last decade, the trust has grown net assets by a total of 68% against the 68% and 55% returns from Personal Assets (PNL ) and Ruffer Investment Company (RICA ), Deutsche Numis data shows.