Global Trade, Local Groceries: Brunner’s Investment Lens

In this episode, Brunner Investment Trust’s Julian Bishop and James Ashworth unpack the economic and political forces shaping global markets – from US tariffs and trade tensions to the rationale behind one of their 2025 portfolio additions, Tesco. Tune in for a discussion on protectionism, inflation, and why cash flow still reigns supreme.

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JB: Hello and welcome to the podcast from the Brunner Investment Trust. I'm Julian Bishop, the co-lead manager of Brunner, and I am joined today by James Ashworth.

JA: Hello, Julian.

JB: James, my colleague, the Joe Rogan of investments, as I like to call him.

JA: Is this a compliment or a criticism?

JB: Whatever it is, it's completely untrue. So, we're here to talk in investment matters. We thought we'd talk a little bit about what's happening in the United States and then later on we'll talk about one of the new investments for the Trust. I'm just back from the United States, so I've just spent a couple of weeks in New York at a couple of investment conferences, meeting probably with about 50 companies, and of course one of the topics that is on everybody's mind at the moment is tariffs, so, Liberation Day, as it was called, back in April, when Trump announced a series of very high and wide-ranging tariffs on all sorts of goods that are being imported into the United States, put the fear of God into markets and a lot of businesses’ modern supply chains. Obviously, very complex. The US imports an awful lot of products from overseas and increasingly the Trump administration sees this as a problem. And we've been reading a couple of books that I think give a good insight into the Trump administration's thought process, you know, how they've reached this conclusion that the US trade deficit is bad, that reliance on imports from China in particular, is bad. And those books, which we think are most pertinent, well, first of all is the book that was written by now Vice President JD Vance called Hillbilly Elegy, which is actually the first time JD Vance came to my attention. It was actually the book I think that brought him to prominence.

JA: And to Netflix fame as well. I think it was later turned into a film.

JB: I believe so, yes, I've not actually seen it, but it's a, it's a good read, he's a very, very clever man and Hillbilly Elegy is essentially an autobiography of his growing up in the Rust Belt of the United States. So, he grew up in Ohio, in the Appalachian Mountains. So, he grew up amongst what I would describe as the losers from globalisation, the deindustrialisation of America, or at least, I think that's how it is seen. So, an area where there's a lack of decent jobs for working-class men, in particular. An area where diseases of despair, you know, opioid addiction, etc. is common. Where there's been a hollowing out of manufacturing in those areas, coal mining as well, where there's a resentment of elites, and JD Vance himself was brought up by an addict, Marva, an addict mother. No father present, but he did very well academically, got his act together against all the odds, got into law school and of course now he's Vice President of the United States. But I think this sort of background explains why he's such an asset, I think, to the MAGA movement, but also explains the backdrop that exists today. And then another book I was advised to read, and James, I know you've read it too, is by a man called Robert Lighthizer, called No Trade Is Free. Now, Robert Lighthizer was Trump's trade representative during his first term, and somebody said read this book, it will help you understand the current Trump administration's trade policy. So, James, do you want to perhaps talk us through what that is about?

JA: Yeah, absolutely, that's, you know, it's clearly an important part of the puzzle here in understanding the actions that Trump has taken. I think it was widely reported, you know, around the time of Liberation Day, that there were three decision makers driving, you know, Trump's decision to impose tariffs. Peter Navarro, who's a well-known China hawk, Howard Lutnick, and lastly, Jameson Greer, who's the US Trade Representative. Interestingly, Jameson Greer was the Chief of Staff to Robert Lighthizer, the gentleman you just mentioned, who wrote the book, No Trade is Free. So, we can get a little bit of insight, maybe into how, certainly how Jameson Greer thinks, about trade, and in that Robert Lighthizer book, he very eloquently sort of dismantles the effectively the conventional wisdom about trade, you know, Lighthizer really looking at what's happened in the US with the industrialisation, really argues that manufacturing jobs are critical to America's long-term prosperity. For many high school leavers, the type of manufacturing jobs that pay $25, $30, $35 an hour, are the best type of jobs that these individuals can get. They’re the highest paid, they're the stickiest, and the loss of all these jobs in the Rust Belt communities has led to as you explain in the example of JD Vance is a good one you've ended up with effectively, hollowed-out communities. Amy Goldstein wrote a really good book called Janesville about what happened when a component manufacturer closed its plant in Janesville and what happened to the basically rising levels of poverty that resulted. Lighthizer argues that these jobs - these are critical, critical jobs, they're high value jobs, and the workers who had these jobs can't be retrained as software engineers. They don't have the skills, there aren't enough software engineering jobs anyway, and the services jobs that they are likely to get instead are low-paid and insecure. So, he's really looking at it from an American first perspective, his book is subtitled ‘Taking On China and Helping America's Workers’. So, they really see this as a way to help the American populace, you know, this is America first. The other arguments he makes, he argues that China as that subtitle ‘Taking on China’ suggests, he argues that China is the US's major geopolitical adversary. It doesn't make sense for the US with Western liberal capitalist democratic values, to open its trade market and to rely on China, and he worries that, China is monopolising really key capabilities, things like batteries, solar power, which are going to be critical for future generations. With all of this is an upset as well that the playing field effectively is tilted, in his view, unfairly in China's favour and by imposing tariffs, which is what Trump's response was, this is a way of effectively levelling the playing field, Trump talked a lot about tariff and non-tariff barriers, and this is things like manufacturers not being able to export to China or China's theft of IP, or alleged theft of IP, which makes the playing field effectively, in the view of Robert Lighthizer and others, unfair for US firms. So, it's a really sort of interesting insight into how the men in the administration are thinking, and it was, it seems to be one of the sort of driving factors behind the tariffs that we've seen imposed in recent months.

JB: Yeah, I think that's a really good summary, thank you. It's interesting, isn't it? Because if you do take the view that America and China are geopolitical adversaries, they're incredibly reliant upon each other in a way that certainly wasn't the case in the Cold War, for example, so there was virtually no trade between the Soviet Union and the United States. But these days, there is a huge amount of trade and mutual dependency between these two countries that have very, very different systems of governance. I thought the book made some good points, but it does end up as a bit of a diatribe against trade in general, I think. It's slightly protectionist. It sort of ignores the role that imported goods have reducing prices for American consumers, you know, as part of American prosperity. I'm not sure if it makes sense for Americans to be assembling iPhones or stitching together Nike trainers, for example. So, there's elements of sort of good old-fashioned protectionism. And I think that does ignore, and I think this is a conventional economic view, it does ignore the view that some jobs are simply done better elsewhere outside of the United States and that trade is generally a way of lifting prosperity for all.

JA: That's not a new idea, right. If we, if I stretch back into my training as an economist and, you know, David Ricardo 200 years ago, who wrote the theory of comparative advantage, and the gains from trade, effectively this series’ been around a long time. People know that trade is generally a good thing. It's something that lots of people could show mathematically is true, that trade is good and everyone benefits in aggregate.

JB: Yeah.

JA: Although there can be winners and losers within that trading exchange and I guess that's really what the issue that lots of American politicians are worried about, and Lighthizer himself in his book, argues that for each $1 of net gain to the United States from trade, there's about $50 of reallocation between groups of people, so in the example of importing car parts, for example, you might have a load of losers who, who'd lose out from that, and you might have a load of winners in terms of consumers, and the reallocation there is really large relative to the total, like, absolute net gain within the economy.

JB: Yes.

JA: That's one of his other sorts of criticisms of trade, that people look at it as there is a net benefit, but the winners and the losers, can see very large swings in how much they win or lose.

JB: Yes, I guess an economist's tendency is to be very utilitarian to look at the sort of net aggregate gain. But that ignores, of course, the human costs on the losing side. I grew up in Liverpool in the 1980s. Unemployment very high. A lot of similarities, I think, between the situation then and now. It was deindustrialisation. The Southeast was flourishing, but the Northwest was not, and people in that situation feel like they've been, and probably deservedly so, dealt a tough hand in life and eventually those people will rise up and make their voice heard. There's a focus on trade deficits, so America in general does import more than it exports. I think there's various views on whether that actually matters or not. But one thing that Trump has really focused on is this idea of bilateral trade deficits, so the trade deficit that is between two countries, so e.g. the US and China, or e.g., the US and Vietnam, and I think that particularly is pretty misguided. I read the FT recently, Tim Harford, the economist in that made a good point that he has a trade surplus with the FT, his employer, you know, he gets paid by the FT, but he doesn't spend all that money buying thousands of copies of the Financial Times, and he has a trade deficit with his local cheese shop, but I think that's a sort of good illustration that capitalism, it depends upon specialising in what they do best. And then trade and money allows us to exchange those specialisms for the good of all.

JA: Yeah, I mean, there's a really great example here that we'll probably get cut from this podcast because it's probably too long, but there's a great apocryphal story of an American politician going to see a factory in the US that is an amazing magic factory. It takes in all the things that the US produces really well; aircraft, processed plastic, wheat, corn, and out the other side, it spits out iPhones, cheap TVs, cheap plastic toys, and the politician thinks, wow, this is amazing, this factory will solve all our problems. It's a way of turning what we do best into the things that we want and obviously what turns out to be the case is it's not a factory, it's a port. And all of that's happening is that the US is trading the things that it does best for these imported goods, the TVs and the like. And absolutely, the gains from trade are enormous and I think the thing that lots of this discussion misses is that the gains from trade exist even if one country is better at everything than another country. So, going back to David Ricardo's original example, he had a very simple model of two countries, England and Portugal, and two goods; cloth and wine, and in his example, Portugal was better at producing both cloth and wine. It needed less labour to produce cloth than England did, and less labour to produce wine than England did. But Portugal was relatively better at producing wine than cloth, but England was relatively better at producing cloth than wine. And he showed, mathematically, that there were still gains to be had from trade, to happen, you know, even though Portugal was, in his example, better at producing both goods, and there's a very clear parallel here where perhaps China has very low labour costs, very highly automated factories. Maybe it can produce iPhones much cheaper than they can in the US. Maybe it can produce other goods much cheaper than the US, but there'll be something that the US is relatively better at producing. The Nobel Prize winner, Paul Samuelson, said that this result is something that's undeniably true, but not obvious even to very clever people. And I think that's a great summary of where we are, right? We worry a lot about trade deficits, we worry a lot about how cheap it is for China to produce goods, but this proof from more than 200 years ago, shows that ultimately that doesn't matter, there's something that you'll be relatively good at. We can think about it in our own sort of households. My wife is better at cooking than I am, and she's better at doing the washing up, but we'll share those tasks, and I am relatively better at doing the washing up, and she's relatively better at cooking, so … there's gains from trade, and, you know, the specialisation is a clear, effectively it’s one of the few free lunches in economics.

JB: Yes, but at the moment, that's sort of under threat, under threat by tariffs. Certainly, a great deal of uncertainty, it sort of looks as though, perhaps these tariffs as proposed do settle at a lower level, it seems like markets are assuming that.

JA: Maybe we can switch this back to thinking a little bit about Brunner, what do we what do we expect, and do we have many businesses that are directly affected by tariffs?

JB: It’s actually surprisingly few companies that we hold that physically import into the United States, we have a lot of asset-like, service-related businesses, software businesses and so on. But we do have shares Amazon, they import a lot, because a lot of what they sell are imported. A company that springs to mind is Asa Abloy.

JA: This is the Swedish locks and entry systems business.

JB: Exactly, so they have quite a lot of business in the United States where they actually import from Mexico, but the thing is, all their peers have a similar manufacturing footprint, so they're all in the same boat if there were tariffs, they will pass those prices through to the consumer in the form of higher prices.

JA: So, what's the net result then of all these tariffs, is this effectively inflationary for the consumer?

JB: I think yeah, general it’s very hard to conclude anything but that. So, you have a policy that is seemingly well-intentioned, but the net result may be that prices end up higher. That reduces living standards in real terms for a lot of ordinary Americans. So yeah, inflationary, if enacted as proposed, I think it's indisputable that the price of goods will go up.

JA: Yeah. OK, so maybe we mentioned at the beginning we should talk about Tesco.

JB: Yes, I mean, I think we're always looking for attractively valued, cash flow streams. I mean, that's how we think about equities. Equities exist because they generate cash ultimately, and they can return to shareholders. We're always happy to consider more mature businesses where we think the cash flow yield is high, safe, growing. We think that's a perfectly good way of getting a good equity outcome. So, Tesco, obviously, everyone will know, it's the UK's leading grocer. They have about 28% market share, which is about twice the next largest player, which is normally Sainsburys. And there's a real benefit of scale in this industry, so benefits in procurement, the price at which they pay for foods that they buy, the economies of scale that come from leveraging corporate overheads. So, Tesco consistently has the highest margins in the sector at about 4%, they're about 100 basis points or 1% higher than Sainsburys, so in fact Tesco, 28% market share, they make about 50% of all profits in the UK grocery market.

JA: I think that's probably a good segue into the competitive structure, because the UK grocery market has changed quite a lot in the last few years. We've obviously had the rise of the discounters, we've had Aldi and Lidl grow over, you know, the last 20-25 years, but some of the others, some of the other players; Asda, Morrisons have also had quite a lot going on, maybe just touch on what's going on the competitive front for Tesco.

JB: So, when you look at the competition, it's fair to say it's a very competitive market. We generally avoid companies that operate in very, very competitive markets, but I do think it's a stable environment. The trend has certainly been, you're absolutely right, Aldi and Lidl, winning share. Although of late, it does seem that that has reached a bit of a natural limit. On the other side, you've got two companies that are really struggling, so you've got Asda and Morrisons. Who are both becoming pretty consistent, shared owners. So, they're both owned by private equity, both pretty indebted. Both have very low margins, which means that they’re not really in a position to be able to invest substantially in lower prices to win back that share and retailers do get into death spirals of this nature. So that's part of the argument for owning. There are some other arguments as well; the market is actually growing a little bit now, so there's a bit more inflation in the system. One important factor as well is that for many years people would eat away from home more and more, so you'd be eating out at a Pret A Manger or a restaurant. But that has actually changed a little bit since COVID and the real reason there is just simply how expensive it has come to eat out, which you've probably all noticed, so this reflects a lot of inflation, increases the minimum wages, etc. This means that there is a shift of back to people eating at home. So, for example, at Tesco, their finest range, they're sort of, you know, posh, ready meals, essentially…

JA: Dining out at home, the premium meals, absolutely.

JB: Exactly, it's going really, really strongly. So, it's a reasonably mature business, but we think the competitive environment is stable. Some growth. And just coming back to sort of the concept of free cashflow yield, when we bought in April, at that point, if you looked at the trailing 12-month free cash that they generated, so, this is essentially what they could pay as a dividend if they decided to distribute 100%, at that point it was about 8% yield.

JA: So, 8% of the current share price effectively could be returned to shareholders each year through dividends and buybacks, if the company decided not to, you know, increase investment in the business.

JB: Yes, exactly. Well, that doesn't, that is after their capital expenditures.

JA: OK, so they're already growing, probably still growth at this point for Tesco's not particularly high, but they do need to keep the stalls fresh, they need to keep it an attractive place to shop. And this is, this 8% said effectively yield is after making those sort of ongoing…

JB: Exactly. It’s what’s available to distribute to shareholders, and they are distributing doing it, so about half of that 8% comes back in the form of a dividend. And then the rest is going into buybacks, at the moment. So, buybacks are effectively a sort of dividend reinvested. So, if you assume that the number of shares between which the profits of the company is divided, goes down, the profit per share for the remaining owners goes up commensurately. So, yeah, we think a good place to be, good port in a storm.

JA: And I think it's interesting the timing there as well, because this is obviously a business that we know well, we've watched it for a long period of time. What was the catalyst that made us do something here in April? I guess there are a few things that were going on at that point. We talked about tariffs, we talked about uncertainty, the peak of the Trump tariff concerns, the stock market did fall quite markedly and Tesco's obviously, a bit of a safe haven there. But Tesco's had its own worries, you touched on competition, but there were some worries and concerns there, maybe touch on why, what the opportunity was when, at the moment we bought it.

JB: So, that precise point in time as well, there was a bit of a sell-off in Tesco shares because Asda announced that they were going to be investing in price, which is a euphemism for sort of taking prices down…

JA: Yeah, so cutting costs.

JB: So, a bit of a fear of a price war. Our view, I think it's been borne out in the sense is that they were in no position to reduce prices, they're just too close to being a lossmaker. And whatever they did to win back their share losses, probably wouldn't have that much impact on Tesco's business. So, we think very resilient, in a good position to withstand what happens in the market. 8% cash yield when we bought it, and that's why we buy shares. You buy shares ultimately for that cash that people, that businesses, can return to shareholders.

JA: So, that's probably a great summary of a type of investment we might look for in an all-weather portfolio. We have some of these businesses, as you say, more mature, very defensive, good cash yield to shareholders. Good ‘sleep at night’ business, with some positive sort of dynamic you as you mentioned with Asda and Morrisons struggling, and perhaps a little bit more growth than they've had in recent years, with some inflation and volume growth. That's a good summary. So, it's a business where we get jam today. I like those types of businesses. Yeah, so maybe we'll wrap it up there then. I think that's a good point to bring the podcast to a close.

JB: Yeah, I think we're done here. Thanks for listening, everyone. I'm Julian Bishop, joined by James Ashworth. If you want further information, please visit our website at Brunner.co.uk. Thanks again and see you next time.