The last couple of columns have suggested good opportunities in certain sectors were emerging given the extent that investment trust discounts had widened year-to-date, despite assets broadly keeping pace with markets. Private equity and UK smaller companies were cited. There are others. Last month’s column ‘Taking the long view’ (27 July 2022) also briefly touched upon the case for the UK in general. In each case, the consensus is looking away. These remain largely unloved assets. And therein lays the opportunity for long-term investors given the sound fundamentals that deserve better recognition.
The UK revisited
The column ‘Trade of the decade?’ (13 May 2021) explained why prospects for the UK market were promising despite the consensus thinking otherwise. We should remember, as highlighted recently by the Investors’ Chronicle, that the FTSE 100 has produced an annual total return of over 7.7 per cent since its inception in 1984 – twice the UK inflation rate over the same period. But this is still well behind the S&P 500. In the last decade the US market more than quadrupled, while the MSCI’s UK index produced a total return of just 65 per cent. Yet straws in the wind suggest things may be about to change for the better.
The composition of the UK market has been a factor. A heavy exposure to financials and commodities has proved a headwind during a long period in which ‘growth’ was the rage, and we had few if any pioneering entrepreneurs guiding our larger companies. Yet energy, mining and banking are now safer ports in this inflationary world. With inflation set be ‘stickier’ than policy makers anticipate, further interest rate rises will continue to exert pressure on the rating of growth companies. This bodes well for the UK given its more value-orientated composition.
As for the economy, inward investment remains robust. The ‘comparative advantage’ of lower tax rates, labour market flexibility, good universities, skilled workforce, rule of law, language and time zone are just some of the reasons global businesses head to the UK. In recent years, this investment has been twice that of Germany and France combined. Such investment also has a positive knock-on effect regarding smaller companies, which often assist with these businesses’ supply chains, which in turn helps to create further employment.
And unemployment is at a record low. This is important. Not only is high unemployment a corrosive social evil, in a world where estimates about economic growth are usually wrong, the level and trend of employment is often a better measure of how well an economy is actually doing. Furthermore, the public finances are presently better than expected because employment and taxes have remained strong. This allows a chancellor more flexibility, as evidenced as households are helped with their higher energy costs.
Meanwhile, trade deals abound which should provide further opportunities. And negotiations to join the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) are making good progress. This free trade agreement embraces 11 countries (excluding China) around the Pacific Rim which represent nearly 14 per cent of the world’s GDP. An example of the potential on offer relates to Scotch Whisky – tariffs in the region can approach 100 per cent and more, and these will fall to zero if and when the UK becomes a member.
There are, of course, economic challenges. The most immediate facing whoever wins the Conservative Party leadership contest is the cost of living crisis. Rishi Sunak’s impressive performance during the pandemic shows he has the experience and judgement to steer the country through difficult economic times. And while both candidates believe in the desirability of tax cuts, which is positive, they need to be funded in the short term if still higher borrowing is to be avoided.
Regardless of who wins, few can deny that the rating of the UK market is leaving little to trust. The FTSE 100 index is standing at a 20 per cent discount to its long-term average. By way of comparison, figures suggest UK equities trade at a near-40 per cent price/earnings discount to the rest of the world. This is close to a 30-year high according to MSCI index data. And smaller companies are also looking cheap. There are many good quality companies in the UK which are cheaply valued when compared to their direct counterparts overseas.
And many of these businesses come with handsome yields. In fact, the market’s yield compares very well internationally, with commodities helping to push UK second quarter payouts to the highest on record. Few other markets look as attractive – it is perhaps no coincidence that the FTSE 100 index has been the best performing major index year-to-date. The tide may be turning. And investors will do well to seek and hold those companies and sectors that look particularly attractive, before the wider markets catch on.
Unloved sectors and trusts
Benchmarks cannot be beaten if portfolios simply imitate them. Investors know they need to invest differently, often when sentiment trails the fundamentals, even if this is a cost to short-term performance. Investment trusts often provide sound opportunities as a consensus can create unduly large discounts from which investors can benefit as net asset values (NAVs) rise and discounts narrow. Of course, the converse is true. But the pursuit of this logic has certainly helped the performance of the 10 real investment trust portfolios managed on the website www.johnbaronportfolios.co.uk – the ‘open’ Performance page has more details.
So where are the opportunities? As suggested in the column ‘Crises and opportunities’ (21 June 2022), one reason to be positive about private equity is the increasing tendency for businesses to remain private for longer, as they have less need to go public in order to access funding for expansion. The managements of a number of investment trusts tend to be long-established with good track records and sometimes conservative valuations as seen when valuations are crystallised. Discounts have widened considerably of late because of concern that NAVs have yet to reflect the economic uncertainty, but this may now be approaching the point where it is already priced in.
For example, Apax Global Alpha Ltd (APAX) invests in private equity funds globally, while also holding debt and equity investments. The company has proven expertise covering four sectors (technology & digital, services, healthcare and internet/consumer), which should continue to offer sustained performance over time across the economic cycles. The company also pursues an attractive dividend policy which distributes 5 per cent of NAV. As such, the company was yielding 7.2 per cent (based on last year’s dividend of 12.33p) when added to recently in the website portfolios at £1.70 – courtesy of a 30 per cent discount to its last reported NAV. A respected management team and depth of company resource suggest optimism.
Meanwhile, Abrdn Private Equity Opportunities (APEO) invests predominantly in private equity funds in Europe, with US holdings accounting for less than 20 per cent of the portfolio. The company has handsomely outperformed its benchmark (the FTSE All-Share index) over most time frames. It has balanced exposure across the technology, healthcare, industrials, financials, consumer discretionary and staples sectors, and focuses on medium-sized enterprises where competition tends to be less intense. The board has delivered a progressive dividend policy, which equated to a yield of 3.3 per cent when recently added to portfolios at £4.33 – helped by its discount of 40 per cent relative to the last reported NAV.
The column ‘Elephants still don’t gallop’ (16 December 2021) highlighted the long-term case for smaller companies, particularly in the UK. The recent widening of discounts has therefore presented further opportunities – UK smaller companies not having been as attractively rated for over a decade. For example, JPMorgan UK Smaller Companies (JMI) has a very good track record under its long-established and respected lead manager, Georgina Brittain. Its five-year NAV figures are second only to Oryx International Growth (OIG) in its peer group. However, recent underperformance courtesy of JMI’s modest ‘growth’ tilt saw the discount widen to 16 per cent when it was recently bought at £2.73.
Other such opportunities exist in commercial property – a sector which the portfolios embrace to assist with diversification and income levels. The sector is very much out of favour given concerns about an economic slowdown, and wide discounts reflect this uncertainty. For example, Abrdn Property Income Trust (API) and Regional REIT (RGL) stand on discounts of nearly 29 per cent and over 21 per cent, respectively, while yielding 5.1 per cent and 8.7 per cent. But the market is tending to ignore the element of correlation between rents and inflation, while the extent of discounts again suggests little is taken on trust.
Next month’s column will continue with the theme of sector opportunities, including investment trusts helping to combat climate change.
Portfolio performance
Growth Income
1 Jan 2009 – 30 Jul 2022
Portfolio ( per cent) 398.6 281.0
Benchmark ( per cent)* 218.0 153.3
YTD (to 30 July)
Portfolio ( per cent) -10.2 -5.7
Benchmark ( per cent)* -3.5 -4.8
Yield ( per cent) 3.4 4.1
*The MSCI PIMFA Growth and Income benchmarks are cited (total return)
