Hidden influence

Portfolio management even runs on this notion – the idea that bigger forces than the selection of individual securities shape portfolio performance. It is important enough to be factored into the core models that drive the investment industry. For example, the capital asset pricing model, perhaps the most important of the lot, says the expected returns from a security will be determined by the likely statistical relationship between the security itself and its biggest single influence. Usually, that’s assumed to be the market in which the security trades. So for UK-listed shares that’s likely to be FTSE All-Share index.

But it does not have to be. Macroeconomic factors may exert a major influence. For a commodities processor, the price of its most important raw material is likely to play a leading role and I have long suspected that the fortunes of the biggest holding in the Bearbull Income Fund are driven by the dollar/sterling exchange rate.

The holding in question is in Record (REC), a currency manager running funds mainly for institutional investors chiefly with the aim of stabilising their returns. No matter that Record progressed decently during the year to end March 2019 – during which period, pre-tax profits rose 9 per cent and earnings per share 8 per cent – its share price fell over 40 per cent. Similarly, from last October until this spring, the share price bounced almost 30 per cent as the group produced a set of results that were acceptable – management fees were up 8 per cent although earnings per share were down 16 per cent – but no more than that. And, most recently, the share price has dived from above 100p in June to its current 76p even though first-quarter trading for 2021-22 seemed okay, with assets under management rising 5 per cent in the period to $84.5bn (£61bn).

However, the common denominator in these three instances is that Record’s share price was tracking not the firm’s trading performance but that of its biggest influence – the dollar/sterling exchange rate. The chart shows this nicely. When sterling’s dollar-purchasing power rises – ie, a given amount of sterling will buy more dollars – then Record’s share price rises too. When sterling falls against the dollar, Record’s share price generally does likewise.

Yet there is more to it than that; ‘tracking’ is not really the word for it. The chart suggests the share price and the exchange rate move almost in unison because each variable is anchored to its own axis and, true, 70 per cent of the time the two variables move in the same direction. But changes in Record’s share price are also a geared play on the dollar exchange rate. Over the four years to this month, the maximum year-on-year gain that sterling has shown over the dollar is 21 per cent, while Record’s maximum year-on-year rise is 176 per cent. Likewise, sterling’s biggest one-year fall is 13 per cent, but the share price has maxed out at a 45 per cent drop.

The question is, do I want the income fund’s biggest holding to be a play on sterling’s popularity? Diversification is usually fine, so that would also apply to diversifying the source of major influences on the portfolio. Chiefly, however, this exercise serves as a reminder that, with a weighting of 12 per cent of the portfolio’s value, the holding in Record has become too big. It is a third larger than the second-biggest holding, which is in GlaxoSmithKline (GSK), and which I see as a defensive play ahead of that rather sad group’s break-up into two next year.

The upshot is that, even as I write, I have sold a third of the fund’s holding in Record. Combining the proceeds with the cash to come from the impending takeover of spirits distributor Stock Spirits (STCK) means that over 10 per cent of the fund’s investible assets will soon be in cash. That’s enough for two new holdings.

Instinct says one should be a safe play, allowing the other to be comparatively racy. They don’t come much safer – or, at least, more reliable – than Primary Health Properties (PHP), landlord to a £2.4bn-healthcare estate of mostly GPs’ surgeries. With 90 per cent of its rent roll effectively guaranteed by government bodies what else would be the case? True, the flip-side of wonderfully secure revenues is that growth is no better than acceptable. On a per-share basis, PHP’s net assets have grown 7 per cent a year over the past five years, but only by 5 per cent a year in the past three.

Even that lower rate would be okay to meet the Bearbull fund’s target of returns averaging 8.5 per cent a year; and, incidentally, it does not matter how that return splits between capital gains and income received. Assume that over the long haul PHP’s share price more or less matches the group’s movement in per-share net asset value (NAV). Combine that with the 3.9 per cent yield on offer from 2021’s forecast dividend and average returns would be clear of the Bearbull target and would stay that way, assuming dividends rise approximately in line with NAV.

There is a catch. At 155p, PHP’s shares already trade well above their pro-rata NAV – the 44 per cent premium to NAV is really going it (see Table 1). So much of the future growth in NAV may be already in the share price.

Sure, that premium might be justified by the quality of PHP’s assets and the near certainty of its income. Then again, as the table also indicates, shares in similar real-estate investment trusts trade on more modest premiums. The other two in the healthcare industry – Assura (AGR) and Impact Healthcare (IHR) – don’t have PHP’s longevity and can’t match its growth in per-share net assets over the past three years. Assura’s business is a near carbon-copy of PHP’s; Impact Healthcare, meanwhile, is a nursing-homes operator. But both deserve a detailed look before I decide.

Which leaves the racier new holding and, somehow, a sense of irony and liking for paradox points me towards the oil companies on the eve of COP26, an event that will surely mark new extremes of virtue signalling and doom-mongering as carbon miners are demonised. Hated though oil and gas producers may be, even the developed world will continue to be powered by their output; better, perhaps, that more of it should be produced by reputable companies than dodgy ones in the hands of nasty regimes.

Yet, as Table 2 shows, the effect of the western world’s war on carbon emissions is affecting the willingness of its oil companies to develop new and existing oil and gas resources. That may yet have to change, especially for gas. Meanwhile, share prices in the majors have been recovering, but not as much as the oil price which, at $84.8 for Brent crude, is almost at a five-year high. So perhaps share prices of, say BP (BP.) and Royal Dutch Shell (RDSB) – especially the latter – have further to run, a proposition to be examined next week.

bearbull@ft.com