We canvass the views of five managers of IC Top 100 Funds to see what they can see in store for investors in the property, commodity, technology and biotech sectors in 2016.
■ Last week we canvassed the views of 15 managers of IC Top 100 Funds to see what they can see in store for equity and bond investors in 2016. You can read the article here.
Property: rental growth
Marcus Phayre-Mudge of TR Property Investment Trust (TRY) says
A key driver of real-estate returns over the past four years has been falling yields. You've had a strong correlation between bond yield compression and real-estate returns. In 2016 we will see a divergence in that, particularly in the UK.
In the UK we are starting to see rental growth in the office and industrial and distribution markets in the south, but also in markets such as the West Midlands. Around the six major UK cities logistics is a very strong sector.
The retail market is weaker and it's difficult to see what's going to drive rental growth there. The market is in the middle of a seismic shift in the way that we shop and you can no longer draw a straight line between wages and spending in the shops.
In a normal property cycle you would have expected the increases in value that we've seen to lead to speculative development, but there is very little speculative development. Where there has been is in central London, but buildings such as the Walkie Talkie haven't been built using money borrowed from the banks but from the deep pockets of large listed property companies or overseas money. This is clearly a demand/supply imbalance, but for that to become an opportunity the UK economy will need to remain robust in 2016 and sterling will need to not strengthen so much that it chokes exports.
In Europe we have a different situation in 2016 because Mario Draghi is expanding quantitative easing (QE) and increasing bond purchases. The euro has responded already by weakening and that is positive for fixed assets that have leverage. Wages are rising in Germany, so there is more demand for apartments there than ever before and an influx of migrants, all of this is very positive for German rents.
In 2016 the Investment Property Forum (IPF) forecasts a total return of 9 per cent for the UK. Very few real-estate investment trusts and UK-listed stocks are standing at premiums and we think that's an attractive valuation point. On the Continent it's more of a mixed bag and we are expecting returns of 8, 9 or 10 per cent, but the QE backdrop helps us remain positive about dividend yields in the high 4s - we think the market will want to own that.
Fiona Rowley, M&G Property Portfolio (GB00B8FYD926), says:
I don't anticipate double-digit returns as we go forward, but I am still cautiously optimistic about the market because we're getting capital growth from rental growth. In the office market we see better value outside of central London. In the core south-east regions of Reading, Staines and other areas and markets such as Edinburgh, Glasgow, Brimingham, Manchester and Leeds we're seeing rental growth.
Then in the south-east we've not had much speculative development and we've got good supply/demand dynamics there too. When you get stronger tenant demand then developers become more confident, so we've seen some new developments. But what we haven't seen this time is a high level of development. It takes two years to build an office building, so if developers haven't started now those won't be ready until 2018, which means that we're likely to have good rental growth in 2016 and 2017.
The highest demand for distribution is in last-mile distribution centres. A lot of retailers have satisfied regional and national demand, but to get timely delivery of their products they need last-mile delivery and those centres are around 100,000-200,000 square foot. That's where we also see rental growth.
Retail property is where growth continues to be the slowest, but it is polarising. You will still see flattering rents and downward pressure in tertiary or secondary locations. Unlike the office and industrial sectors, in retail you have high vacancy rates and retailers really need to make sure they are in the right locations. Food and beverage is also doing really well.
I think commercial property will continue to perform strongly in 2016 and 2017, but retail property will no longer be lagging as much as it has since the downturn because we're starting to see tension in rents and you can buy retail properties at better yields.
COMMODITIES
Robert Crayfourd, co-fund manager for City Natural Resources High Yield Trust (CYN), says:
The one thing I can say for certain is that the market will be volatile next year. We have one of the most extreme short positions we've seen since 2008 in the mining sector. A short-term pullback in commodities would be a good thing because it would cause greater rationalisation and the closure of some high-cost mines and would force some difficult decisions to be made.
We are seeing a level of oversupply in the market and Chinese demand not being as strong as anticipated. Currency has also had an impact on reducing the cost for producers. We've seen currencies such as the Australian dollar, Canadian dollar and rouble all decline against the US dollar and those things have reduced costs within those countries and allowed those companies to reduce those cost curves and we've seen that across the sector. It's resulted in a lot of supply. Effectively we need some short-term pain for longer-term gain.
We have a very diverse position and are conservatively positioned right now, so have a large fixed income weight within the portfolio. We are looking for further market weakness and opportunity to add to positions where we can see the market balancing, so in those areas where we see production cuts. We are starting to see that across a number of metals - copper, zinc, coal and iron ore. We have very little weight in coal or iron ore, but they are commodities that, when we get to a certain level, we could add to.
In copper we are seeing more mine cuts come through. The main thing with positioning will be focusing on companies that are able to reduce their costs and still generate strong margins even in a weak environment, so central Asian metals for example.
TECHNOLOGY
Nick Evans, senior fund manager at Polar Capital Technology Trust (PCT)
We are now four years into a new technology cycle and many new technologies are hitting positive inflection points whereby they are becoming substitutes, rather than complements, to legacy technologies. In the words of Jamie Miller, chief information officer at General Electric, "cloud computing has gone from the probable to the inevitable". The greatest risk facing investors could therefore be underestimating the scale and disruptive nature of many new technologies, particularly the deflationary impact of public cloud computing (embodied by Amazon AWS, which based on last quarter is now operating at an $8.3bn annualised run rate, with growth of 79 per cent year on year given growth in Q3 2015).
In addition, the accelerating pace of innovation and ease with which you can start a new business (enabled by the cloud and mobile computing) is increasing the challenges of investing in the sector. This is something we try to address with a team of seven dedicated sector specialists doing detailed research on secular themes, penetration cycles and emerging technologies, as well as through portfolio construction (minimising stock-specific risk through portfolio diversification).
Our preferred themes for 2016 include: online advertising, ecommerce, software as a service (SaaS), games software (including virtual reality), mobile payments, online travel, TV over internet, data analytics, cyber security, factory automation, additive manufacturing and the internet of things (IoT).
Eighteen months ago valuations for growth stocks looked a little stretched, but during the intervening period many stocks have experienced significant multiple compression - providing a headwind to our approach in 2014. In many cases this has been a combination of lacklustre stock price performance and strong growth (investors often underestimate how quickly high-growth stocks can 'grow into' their stock prices). Fortunately, multiples have stabilised more recently and growth appears to be driving returns.
In our view 'cheap' valuations can be a dangerous starting point for investors - luring them towards more mature and fundamentally challenged companies (often the most likely to embark on value-destructive M&A).
In 2016 global IT spending is likely to grow broadly in line with global GDP, resulting in low growth for many larger traditional technology companies, especially those overly exposed to emerging economies. As new technologies, especially public cloud computing, grow so will the deflationary headwinds facing these incumbents. Equally, the fundamentals for many next-generation companies remain robust, so for those with sensible valuations the prospects look compelling. The challenge, as fortunes diverge, is avoiding the losers and identifying the winners, but we see plenty of interesting opportunities.
BIOTECH
Geoffrey Hsu, The Biotech Growth Trust (BIOG), says:
The recent biotech sell-off is no bad thing. We've been in a bull market in biotech for a number of years and it's healthy to have an occasional dip. This recent dip was really driven by sentiment and fears around drug pricing in the US. It was also related to a speech by Hillary Clinton where she made some comments about proposals she would seek to be enacted if she was elected president. We don't think that those proposals will get passed and, anyway, most of the things she suggested were proposals that have been suggested in the past.
The fundamentals for biotech that led us to be constructive on the sector in the past remain. There is a lot of innovation going on in the sector, we have a friendly regulatory environment and M&A continues to occur. We do expect that to remain at the pace it's been going at and think that valuations in the sector, given the recent downturn, remain attractive.
Prior to the downturn that we saw in September 2015, I would have said the valuations among the large-cap biotech companies remained compelling and there were still pockets of overvaluation among smaller-caps. Since the sell-off, the larger-cap names are still trading at compelling valuations and some of the pockets of overvaluation among the small-cap names have come off.
I think in terms of themes, immuno-oncology will remain an exciting area of drug development and we will see a number of clinical trial updates for immuno-oncology therapies in the course of 2016. So that theme is going to be very prominent and we are going to have high-profile readout in Alzheimer's disease in the first quarter of next year.
There is a lot of development in Alzheimer's right now, it's a serious need and demographics continue to shift towards older generations so we will see a greater need for treatment.
With regard to drug pricing, the companies that truly innovate and introduce a new class of drug with novel mechanism of action that result in a better clinical benefit for patients than currently available therapies will continue to demand a premium price in the marketplace. However, if companies introduce drugs with no incremental efficacy over current standard or reformulation of generic drug, those drugs will have a tougher time maintaining premium pricing.
