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A view on financial markets, ahead of 'B' Day

Friday, 4th October 2019 07:38 - by David Harbage

This blog has regularly provided an update on what has been occurring in financial markets and, as we turn into the final quarter of the year, it may be helpful to follow up the previous article dated 30 June 2019 by sharing the author’s current thinking ahead of 31 October – also known as ‘B’ Day (mark 2). In particular, to comment on the prime issues or concerns that long term investors in stock exchange assets face, provide brief feedback on the performance of previously mentioned investments in 2019 to date and comment on the outlook.  


This report can be summarised by saying that, disappointingly but not surprisingly, there has been no real progress made on the major macro issues which are dominating the investment landscape. Uncertainty can be a greater negative headwind than actual bad news, and the unhelpful protracted tariff negotiations between the United States and its trading partners (in particular China, but increasingly Europe) has led to a slowdown in global economic activity, as the world’s biggest multinational businesses understandably defer major capital expenditure plans.


Closer to home, the immediate outlook for the UK’s economy, its currency, fixed interest and equity (company share) markets remains clouded by the all-consuming Brexit issue - with the much-debated consequences of a ‘No Deal’ departure from the European Union. Predictions from political pollsters suggest that the country’s deep division on Brexit may not be resolved by the seemingly inevitable (given the current Government’s lack of a meaningful working majority) general election and a second referendum may eventually be required to achieve closure.


Global prospects have dimmed, largely due to a fall-out from the US-China ‘tariff wars’ which has prompted a reduction in both private and public sector investment - leading to a marked slowdown in economic activity. Intuitively, one might expect the US administration to adopt a softer stance in order to publicise progress (if not achieve a complete resolution) of the ‘Put America First’ campaign. However, Donald Trump is not a regular president and, while he has delivered fiscal benefits to corporate America, he may continue to play ‘hard ball’ in trade negotiations rather than settle for an interim ‘peaceful solution’ ahead of next year’s US elections.


More encouragingly, the anticipated change in policy direction by the US Federal Reserve has materialised with two cuts in interest rates being made since late July. The mid-September quarter of a percentage point cut is likely to be reinforced with another reduction in November or December - which is likely to maintain a reasonable level of real growth in the world’s largest economy in 2020 and into 2021. This has been complimented by other central banks – noting, for example last month, further quantitative easing (in the form of asset purchases) by the ECB and another rate cut in Australia.


While there is typically a 12-18 month lag before rate cuts have a real economic impact (to say nothing of when corporate revenues or profits may be influenced), the immediate yield-based valuation of fixed interest instruments and company stocks should be favourably impacted. Current consensus expectations are for US and UK listed firms’ earnings to rise by 8% over the next twelve months – with a similar figure applying to global company profit growth, albeit a little lower in the Eurozone. That level of growth may surprise some readers, but universal reductions in direct corporate taxation and foreign exchange translation benefits for UK quoted, but non-domestic, businesses are providing tailwinds.


UK politics remains as difficult as ever to call, despite frenetic levels of activity and unprecedented developments. While Prime Minister Johnson’s resolve that the UK leave the EU on 31 October 2019 remains undimmed (despite opposition, to say nothing of defectors, within his own party) his ‘plan A’ - to invite public endorsement via a general election - will not take place before the critical ‘B’ date, and so the uncertainty continues. Having said that, although sterling warmed to the receding prospect of a ‘No Deal’ in September, by appreciating from US$1.207 to reach 1.256 on the 19th, cable slipped a couple of cents by the month-end in recognition of the opaque landscape.  



Analysis of risk and reward, perhaps prompted by the inverted yield curve (higher rates of interest available at the short, rather than the more normal mature, end of the available universe), has featured the traditional Growth versus Value discussion in equity selection. Heightened debate that the cycle might be moving from favouring businesses demonstrating superior Growth, (often accompanied by quality or reliability factors), towards lower-priced Value companies, (regularly featuring ‘fallen angels’ as well as smaller ‘yet to be recognised’), has taken place in research houses on Wall Street, in London and across European bourses.


The author has an unashamed bias towards Value – so perhaps missing out on very highly rated/priced stocks in futuristic high-growth industries such as technology. Such investors would prefer to persevere in owning potentially unloved assets, whose business or operational model is simpler to comprehend and believe in, and which offers the prospect of enjoying a positive re-rating emanating from consistently beating (probably low) expectations. In terms of individual company shares and collective funds mentioned within the blog, this Value orientation – frequently featuring a bias towards smaller or medium sized UK equity and domestic business sectors – is evident.


Over the past few weeks a number of research houses have speculated (and published their findings) on the likely impact of a ‘No Deal’ Brexit - as well as an ultimate cancellation of Brexit - on sterling’s relative worth, the level of the FTSE100 index and domestic sectors of commerce. Most market strategists agree that the pound will fall further should the UK leave without a ‘Deal’ (also anticipating the Bank of England cutting interest rates - to offset any loss in consumer or business confidence and stimulate economic activity). This, in turn, would be supportive of the largest multinational-dominated firms (that feature in the FTSE100) as the translation of overseas currency would be flattered in accounting terms.


However, making a call on how the domestic (often medium or smaller sized, non-exporting) companies of the stock market would perform is a more difficult judgement. Consideration would be less focused on foreign exchange translation and more on pertinent trading prospects and rather subjective issues – such as those surrounding investor sentiment. Financial markets are often criticised for being too short term in their assessment of investment opportunities – even though many mathematical assessments of future growth (over decades, rather than a year or two) are applied to reach fair values of the present day worth of those future cash flows – but the immediate emotive fear (of the unknown) and greed (if only in the form of a relief rally) factors are likely to make a major contribution to short term returns.


As an example of such a domestic industry, the share capital of house builders is typically lowly valued as compared to the overall UK equity market. Perhaps much of the depressed sentiment and rating is caused by the perception that a No Deal Brexit (i) could inhibit prospective purchasers from buying a new home, and/or (ii) would lead to a collapse in house prices (and, with it, profit margins). Further reasons to worry or be cheerful about the industry could be proffered, but the reader can be spared an inexhaustive list of threats or opportunities. The reality of the past three plus years since the EU referendum is that, almost without exception, the major new home providers in the UK have been trading very well in actuality. However, by contrast with the steady progress in delivering higher profits from increasing revenues (completing more homes at higher margins), replenishing the land bank with ease (increasing cash balances, after distributing higher dividends),  share price performance has been turbulent.


Placing a fair valuation on cyclical industries (that is: those which are more sensitive to the ups and downs of an economic cycle) at any point in time will logically be more difficult to achieve – as demand for their product or service will vary much more than a staple product (such as a water company). For instance, economists will always argue about where we are in the cycle and research analysts will debate how accurately the market has ‘priced in’ a particular industry prospects or an individual firm’s position in the cycle.


In terms of specific company shares, we would encourage investors to take a longer term view and prioritise income over capital appreciation when assessing total returns (as most of equity’s historic superior performance comes from the growth in – and the reinvestment of – its dividends). Previous blogs have often focused on the relative attraction of equity investment by reference to their earnings (the price-to-income multiple, known as the PE ratio). The proportion of such profits paid out as dividend income – and expressed as an income yield – will often come to the fore, when comparison is made with the interest, property rent or other income which can be earned on other assets which compete for a long term investor’s savings.     


Another metric which a professional investor uses when assessing the merit, and the fair valuation, of a company share listed on a stock exchange – or indeed the overall equity market - is a firm’s asset worth or ‘book value’. In theory, where the book value exceeds the share price that company could sell all its assets and shareholders would be left with a surplus. The reality is that most listed company shares are priced at a significant premium to the worth of their assets, as the majority of businesses focus on earnings – and sharing those profits with their owners (in the form of dividends) – rather than concentrating on achieving appreciation in their asset worth.


Having said that, a focus on a business’ balance sheet (with its assets and liabilities) is a fundamental part – along with investigating Profit & Loss and Cash flow statements - in assessing an equity investment. The reader might be interested to learn that the UK equity market appears attractively valued – as compared to US or global listed stock, as well as by contrast to the historic valuation of UK shares - by reference to price:book value (P/B ratio). Looking at the FTSE100 index’s Price to Book multiple since the turn of the millennium, the average level of that index’ prices has been 2.25x of its book value. It reached a high of 3.2 times in 2007, just ahead of the Banking crisis, before reverting back towards the trend level in 2011.


The ratio ‘progressed’ further to exceed 2.5 in 2015, but currently UK share prices are significantly below the post year 2000 median at just 1.7 times book value. Along with a much lower price-to-earnings ratio, (and a higher dividend yield compared to cash or gilt yields) than has historically applied, this reinforces the wish to retain an overweight exposure to UK equity notwithstanding the very real global and local concerns that will impact the shorter term pricing of company shares.      


Institutional investors are seemingly, by nature, bearish (by contrast with the published research views of broking houses – known as the Sell side) and survey evidence from both the United States and Europe bear this out. Please note that this attitude can apply irrespective of the level or valuation of a market; for instance, US institutions are currently underweight their own domestic equity, even as the Dow Jones Industrial index reached new highs in the third quarter. Incidentally, the more representative US equity index - the S&P500 – reached an all-time high of 3026.1 on 29 July, but nearly challenged that again last month (at 3022.7 on 13th September).


While the ‘bull market’ on Wall Street has exceeded ten years, the prospect of US fund managers becoming more positive - in allocating more of their assets to equity - is an encouraging one. Survey data has been mixed, with the PMI evidence no doubt influencing the Fed’s decision to cut rates. However, the subsequent industrial production report was more encouraging, and the prospect of a further boost to sentiment as a consequence of President Trump pronouncing some sort of a ‘win’ in the trade wrangle with China should not be discounted.


As seasoned stock market observers will appreciate, US equities normally enjoy a strong rally in the year of a Presidential election. That equities often enjoy a strong burst in the final leg of a bull market is also a truism which argues for investors ‘keeping their nerve’ despite a lack of obvious good news and, indeed, an apparent deterioration in global economic data.           


The writer makes no excuse for reiterating that history shows that markets ‘fall on negative rumour, and rally on fact - even if adverse’ and therefore attempting to correctly time entry or exit points in the stock market is nigh on impossible. Bounce-backs occur so quickly that only a fortunate few benefit from what are often double-digit share price jumps in such an aggressive trading environ. Owners of stock market listed companies should always be taking the longer term view – with a minimum retention period of five years or ten years, but perhaps more probably ‘an indefinite, foreseeable future’ should be considered as the appropriate time horizon.


The 2019 version of the Barclays Equity Gilt Study, which reviewed the performance of prime financial assets from 1899 to the end of 2018, found that in considering every 5 year period, UK company shares beat a higher rate deposit bank account on 76% of occasions. The probability that shares outperform cash rose to 91% when assessing the respective total return (of income, plus or minus any capital movement) over every 10 year time period.


It is appreciated that most UK private clients will focus on the local landscape, rather than on global prospects – notwithstanding the fact that as much as three quarters of the revenue and profit earned by the constituent firms of the FTSE100 index arise overseas. Although it is to be hoped that investors are taking the long term view and are likely to retain their stock exchange investments for a decade or more (to ride out economic cycles, as well as unexpected natural disasters or dramatic geo-political events), it is only human nature to have concerns about the immediate future. The investor has to ask him or herself if the prospects are under or over ‘priced in’ by the market, by assessing the likely future performance from different kinds of asset – as well as the magnitude of the threat to those returns.


One should look at the relative attraction of the various investible assets – from cash (sterling versus other currencies) to bonds (longer term interest rates or loans of varying duration), through to equity (company shares, listed on the London and overseas stock exchanges, as well as well as private, unquoted equity) – in terms of potential returns over the next year or so.


In our previous quarterly report, we flagged the following issues as being most influential in affecting investor sentiment and, as previously intimated, little seems to have changed from:

United States-instigated action to address imbalances with its trading partners, China in particular, has produced a slowdown in global economic activity.

The rise in populist politics, reversing a trend for greater globalisation in trade, is acting as a drag on business and consumer confidence - as well as raising unhelpful tensions between, and intra, nations.

Speaking of tensions, any resolution on the obvious domestic issue, Brexit – to say nothing of making any meaningful judgements on its likely impact – seems as distant as ever. Boris Johnson is determined to exit (potentially without a deal) the European Union – if Parliament allows. In the absence of that outcome, the prospect of a general election looms; the recent EU elections, which featured strong showings for the Brexit and the Liberal Democrat parties, flag the difficulty in calling a winner.

Risk assets, such as equity, which sold-off in the last three months of 2018 - as investors succumbed to fear – recovered from that oversold valuation and have consolidated after the first quarter of 2019’s bounce-back.

A risk-averse environ remains evident with negative real (after taking account of inflation) interest rates – in overnight money, but also across government and many investment grade (BBB or higher credit rated corporate) debt issues.

As global economic growth appears to have peaked last year, the prospect of interest rate hikes have receded, and been replaced by cuts – in turn reinforcing the relative value (as compared to other asset types) of credit and equity.

Corporate earnings growth, aided by lower rates of taxation, was exceptional in 2018 – but, while profit and dividend progression ahead of inflation is forecast for the current year, the prospect of slowing economic activity in 2020 is likely to mean that the pace of growth in company earnings will weaken. Analysts will be making downward revisions, beginning with the most economically sensitive sectors; logically, highly rated listed businesses are most susceptible to investor disappointment.

While the pace of top-line revenue growth may be slowing, company balance sheets appear robust (in the absence of any significant rise in the cost of servicing debt) and, for the most part, dividend cover is encouraging. In such an environment, financially strong firms will seek to grow their businesses via acquisitions and re-engineer their balance sheets (bringing down the cost of capital by low coupon bond issuance) as well as also consider boosting earnings by buying back their own shares. 

Disappointingly, the bounce-back in investors’ appetite for risk has been half-hearted as the current sources of uncertainty, (notably US-China trade talks and Brexit, which optimists expect to be resolved in the second half of 2019), remain a drag on economic activity and sentiment.

Finally, a catalyst (in the form of depressed sterling) for sparking corporate merger and acquisition activity – which could come to the rescue of mispriced assets (often at times of heightened volatility, uncertainty or emotion) – is making a belated appearance. Many expect the de-rating of domestic stock exchange listed companies to rebound upon any resolution of Brexit; even being forced out on 31 October, without a trading deal with the EU, is likely to be a ‘low water mark’ for this unloved equity segment. Meantime overseas, especially dollar-denominated, buyers are viewing the universe of investor-neglected UK company investments as an opportunity to acquire assets cheaply.


The current consensual view is that global economic growth will still be reasonably robust this year - forecasting real GDP growth for 2019 at 2.6% - but notably lower than the 3.1% we predicted at the beginning of the year. Essentially, that means we expect gross domestic product to rise by 2.6%, after inflation, compared to 2018’s higher expansion pace of 3.2%. Looking forward, the previously referred to trade tariffs remain at best a significant unknown, but we anticipate unchanged levels of economic activity in both 2020 and 2021 forecasting global GDP growing at a rate of close to 2.5%. Anticipating such an environ, over the next twelve months interest rates hikes will become a rarity - with local inflation typically exceeding nominal rates to deliver negative returns to holders of cash.


For instance in the UK, cash rates of 0.75% lags inflation – targeted at 2.0% - although measures, such as the Retail Price Index (RPI) suggested almost 2.8% this summer. The same scenario applies in the US, Japan and in the Euro zone. In such an environment, to hold large sums of one’s liquid, long term savings in Cash is unappealing and conventional government bonds struggle to offer real (inflation beating) returns, especially after deduction of income tax. The current gross of tax yield to redemption of a ten year conventional British Government stock is just 0.5%.


By contrast, inflation-linked bonds provide some relief, as they offer the prospect of appreciation in capital - and growth in income. No longer expecting a hike in US interest rates over the next year (Federal Funds rate is likely to fall to 2.0%) slower, below-trend economic growth in the UK and the Eurozone will not prompt central banks to hike. UK Bank rate and Eurozone rates are unlikely to move from their current respective 0.75% and 0.0%, but there is a prospective outlier: a soft Brexit resolution, which could see our base rate rise to 1.0% (a step towards ‘normalisation’). By contrast a ‘no deal’ exit would almost certainly prompt the Bank of England to stimulate the domestic economy by cutting interest rates to 0.25%, (prompting further weakness in sterling).


The writer’s prognosis for equity performance is unchanged from that espoused previously that, after the first quarter’s significant rebound, investors can expect to see equities make further, albeit limited progress over the remainder of 2019 – with an approximate 5% uplift in capital terms, enhanced by income distributions. This is based on the current macro factors (notably international trade disputes and Brexit uncertainty) continuing, close to their current ‘state of play’. Any major positive breakthrough on the US-China trade talks could see markets achieve that 5% advance overnight, and then progress further.


While a positive outcome on Brexit would benefit domestic businesses most, the FTSE100 index’s multinationals would be less affected (as anticipated foreign exchange translation benefits disappear with any marked recovery in sterling). It probably does not need to be reiterated, but new negative ‘news’ or protracted uncertainty on the political front (for example the announcement of a general election in the UK which could bring a less business friendly government), or on trade, would not be well received by financial markets.


With limited appetite to own bonds at their current low yielding valuation levels or cash, company shares continue to offer more appeal as a long term investment. The ability of well-managed businesses to adapt and prosper, even in difficult or uncertain economic circumstances, encourages selective but diversified ownership – especially in recognition of their ability to increase dividend pay-outs.


For similar reasons surrounding the prospect of income growth from higher rent rolls, real asset ‘bricks & mortar’ in the form of commercial property retains its appeal. Geographically, the domestic market has limited space, especially in the south east of England; accordingly, well-located assets are likely to appreciate over the longer term. Offering a rising rental stream and the prospect of exceptional capital appreciation, as a result of landlord or management improvement, property merits a position in portfolios. Some readers, owning one or more residential homes and their own business premises may be loath to commit more of their savings or retirement wealth to commercial property, but it is important to own differing kinds of asset to achieve diversification and reduce one’s risk profile (in particular, not to own too much equity).


Turning to potential trading activity which the author considered in the third quarter of 2019, concerns about the heady valuation of US company shares, ahead of the Q2 reporting season, may have prompted the disposal of JP Morgan Global Growth & Income investment trust. This investment trust has 58% of its net asset value (NAV) in US equity and had performed well with its share price reaching a new high and, more significantly, achieving a near 3% premium over NAV.


Herald investment trust is an interesting vehicle which aims to deliver capital appreciation through investing in lower value global technology, media & telecommunications stocks (typically under US$2bn market capitalisation, rather than the highly valued, better known American tech giants). Geographically, the £890m market cap fund is primarily invested UK 51% & US 19%, and has delivered strong returns (+21%, +74% and +98% over past 2, 3 and 5 years) outperforming both UK & World equity benchmarks. The shares of Herald investment trust currently appear attractive as its discount to NAV has widened to 18% and the underlying portfolio features a lot of UK stocks which appear likely to be acquired by overseas buyers. Recent merger and acquisition M&A activity included technology-rich firms Entertainment One and TT Management being bought by overseas predators on one Friday in August and encourages ownership of £ priced/listed technology counters.


Another asset which has captured retail investors’ attention, in recognition of its safe haven status, has been gold which could be owned via i shares Physical Gold Exchange Traded Commodity (ETC). Although cash also offers no real income, precious commodities such as gold or silver have some defensive merit with US $ and interest rates set to fall, global economic activity easing (the IMF’s forecasts for global GDP growth have been reduced to 3.2% for 2019 and 3.5% in 2020) and the prospect of geo-political tensions increasing (notably freedom of movement in international waters & atomic capability issues impacting in Iran, Russia and South Korea & Georgia, China and Australia - at the time of acquisition).


Some view gold as a contrarian investment, and it could be argued that choosing to own UK mid cap and UK small cap businesses ahead of a potential ‘No Deal’ Brexit is a bold call. As regular readers of this blog will know, the writer is a fan of both Henderson Smaller Companies investment trust and the Mercantile investment trust increasingly so, as their relative attraction, in valuation terms, compared to the global mega caps has widened. This in turn, we believe, will lead to more merger and acquisition activity from overseas buyers who perceive sterling priced assets to be cheap. While listed companies outside of the multinational-dominated FTSE100 index have outperformed the overall UK equity market over most ten year periods, the prospect of Brexit has dampened sentiment towards domestic and smaller companies. Something we expect to reverse over the medium term. 


Prudent investors should not ‘buy & forget’ but ‘watch, buy & watch’ each constituent of their portfolio of investments. This monitoring should extend beyond individual company shares to assess on-going suitability of both passive index tracking and actively managed collective investments - considering their relative attractions as compared to the respective peer group. This will take the form of watching short term performance of the underlying portfolio, versus its defined benchmark and the universe of similarly investing funds or trusts, as well deciding if the market’s valuation (comparing price to net asset value in the case of investment trusts) is fair. Such action might have prompted profit taking on Capital Gearing and the Harbourvest Global Private Equity investment trusts this summer following stronger than expected performance in both share prices over the previous six months or so.


Law Debenture investment trust is something of an unusual hybrid within close-ended funds and merits closer investigation. A value-focused investment, the share price’s discount to NAV had reached 12% (as compared to a single digit norm) and the trust’s move from a Global to UK equity bias (because the manager anticipates best value, and future returns, reside here) might also attract the reader’s attention. The Law Debenture investment trust seeks to deliver capital appreciation through investing in a wide range of investments (equity, unlisted companies, cash, short term loans, bonds, debentures and derivatives but, unusually, the £820m market cap trust's income arises 85% from a closed-ended fund and 15% from a separate financial services business. The underlying portfolio features low costs, a 40 year record of dividend growth (or, at least, maintenance) and impressive outperformance of UK peers over the past 1, 3, 5 &10 year periods.


Heightened geo-political tensions and a counter-intuitive weak oil price since the middle of August might have prompted a second look at the energy-oriented Blackrock Energy & Resources Income investment trust (BERI). The shares appear undervalued, by reference to its discount to NAV widening from circa 7% to 12%, as big oil & gas companies would appear to be neglected by the wider market. BERI aims to produce a high income, along with capital appreciation over the long term, via securities of companies in the mining and energy sectors. The £80m trust is currently invested: US, UK & Canada 29% each, Switzerland, Australia & Brazil 4% each, Mexico 1%; and by product: minerals 52%, energy 48%. Last, but not least, the shares offer an attractive yield of 5.8%.


Rising concerns about political protests in Hong Kong, (which could yet bring retaliatory measures from China) might prompt reconsideration of one’s exposure to that region. The passive tracker Vanguard Asia Pacific ex-Japan ETF has 23% of its assets invested in Hang Seng listed securities.


As highlighted by the 0.5% gross return to maturity of ten year UK conventional gilts, the risk-free rate has appreciated strongly over the past year but at this level now appears to offer very little value. The prospect of higher debt issuance, announced in early September’s public Spending Budget, could lead to profit taking on i shares UK inflation index linked gilt ETF. Following publication of better than expected domestic GDP, the £ might be expected to rebound from a Brexit-induced nadir. Recognising this, together with the fact that the rate cutting cycle has limited scope to extend further, one might expect the extreme risk aversion which has driven non-UK inflation linked gilts to abate. Such a perspective might lead to lightening exposure to i shares Global inflation government bond ETF.  


The performance of Edinburgh investment trust has been a disappointment in 2019, with a number of its larger exposures (like Burford Capital) and sector calls (such as tobacco) struggling. Investors might wish to consider reinvestment away from a large cap-focused UK equity collective into a different category of investment trust known as flexible assets - which tends to be less volatile than quoted equity – such as Pantheon International investment trust. This FTSE250 constituent, private equity-biased vehicle features a £1.4bn portfolio and its shares stand on a 20% discount to NAV. Pantheon manages US$43.5bn investing across all stages of PE development & geography, as well as infrastructure, real assets and debt. The track record is impressive in absolute terms, (to 30/6/19: NAV +12.9%, +13.7%, 15.1%, 13.5% over 1, 3, 5 & 10 years respectively), comfortably ahead of the FTSE All Share and MSCI World indices.


It might be helpful to indicate how the writer would currently allocate assets taking the appropriate longer term perspective – mindful that actual weightings would depend on an individual’s circumstances, appetite for risk and objectives:

Underweight bonds - owning government, risk-free inflation linked domestic and international bonds (but having no exposure to conventional gilts) across all maturities, along with investment grade (BBB rated or higher) sterling-denominated company bonds and global higher yield corporate bonds. The latter in expectation of the continuation of higher economic growth in emerging economies, allied to the prospect of falling delinquency rates in developed markets. Probably best achieved by the use of relatively low-cost tracker ETFs in order to gain diversification and minimise default risk. Mindful that interest rates are low, as compared to history, and have limited scope to fall further - but that while inflationary pressures appear to be easing, there could yet be upward surprises.


Underweight property – owning commercial and residential property funds, featuring active management and sector specialism (to overcome ‘flat spots’ like retail). Mindful that ‘bricks & mortar’ assets enjoys a scarcity, supply-demand benefit in the UK, but that demographic and cultural change casts uncertainty over the ability of landlords to raise rents (notably in retail, and away from central London) at historic rates in the short term.           

Overweight UK equity – recognising that UK company shares enjoy an unprecedented income yield advantage, relative to the perceived ‘risk-free’ returns offered by government bonds and cash. Brexit-recession fears have driven significant dispersion in industry valuations, with domestic industry sectors and especially smaller companies appearing particularly inexpensive.

Underweight overseas equity – preferring UK listed multinationals, which can provide the investor with exposure to the world’s higher growth economies and typically represent better value (based on earnings and asset backing). The prospect of a rebound in a seemingly oversold sterling also persuades for this position.

Overweight Flexible assets – primarily investing via undervalued investment trusts (by reference to share price at a discount to underlying asset value). One is entrusting these fund managers to select the appropriate, sometimes alternate, assets to deliver to their capital preservation perspective.

Neutral cash – given the low absolute return on offer compared to the other selected assets. Mindful, as mentioned previously, that retaining a cushion of liquidity can enable the diligent investor to take advantage of buying opportunities as they present themselves. In extremis, the low yielding inflation-linked government bonds could also provide a further source of funds should an exceptional opportunity to add to another (probably equity) investment arise.  


Finally, the author takes a look at the shorter term capital performance of a typical portfolio’s constituents and proffers a few comments on the returns they produced in the third quarter of the year:

i shares UK Inflation-linked government bond ETF maintained their strong progress in 2019 to date, as the price moved from 18.9p to 20.3p in the quarter period under review.

i shares Global Inflation-linked government bond ETF delivered similar strong absolute progress in the year to date - rising from 127.7p to 134.4p in the last three months - as further US rate cuts are anticipated.

i shares UK Corporate Bond ETF extended its 2019 year to date progress – advancing from 148p to 151.8p in the latest quarter, aided by hopes of a monetary stimulus in the event of a No-deal Brexit.

i shares Global High Yield Corporate Bond ETF progressed from 76.3p to 76.4p, aided by forecasts of rate reductions in many regions or of basement levels continuing in Europe and Japan.

Picton Property investment trust regressed from 98p to 87.6p, perhaps as June’s placing and mixed industry news flow caused some short term indigestion. The company have been particularly active in the last quarter – via 20 asset management initiatives, which resulted in a 4% annual uplift in related rent compared to 2018... 

i shares UK Property ETF advanced from 568p to 590p, recovering a new 52 week high as investors focused on the asset’s income attractions rather than retail tenants’ difficulties which has captured media headlines.

Tritax Big Box REIT retreated from June’s 154.3p high point to 147p, despite a well-received update on its recently acquired dedicated logistics developer Symmetry – the latter introduces  speculative development to a portfolio of 58 assets which are 99% let or pre-let, with an average unexpired lease term of 14 years.  

Mercantile investment trust advanced from 205.4p to 210p, as its FTSE250 biased businesses benefitted from predatory M&A activity and, more widely, improving sentiment towards medium sized UK companies.

Henderson Smaller Companies investment trust also enjoyed a recovery in investor sentiment towards domestic businesses (its portfolio of investments typically range from £50m+), the shares rising from 842p to 855p.

Barclays marked time, its shares stable at 150p after paying an interim dividend and despite a major surge in PPI claims ahead of the 29 August deadline. Sentiment towards banks is weak in a slow and rate easing environment, but the stock’s value is clear: PE of 6.2x, yield 6.3% on brokers’ consensus forecasts for calendar 2020.

Bellway bounced from 2785p to 3360p, reaching a 52 week high. Investor sentiment has been helped by political unanimity on the need to build more homes and an appreciation that the domestic economy is more resilient than is often portrayed.

GVC Holdings enjoyed another strong quarter of share price recovery, jumping from 652p to 746p, as investor focus moved from the fixed odds betting terminal hit towards an emergence of transatlantic (as US liberalises) industry consolidation.

Prudential, by contrast, fell from 1716p to 1460p in the third quarter of 2019 as a number of concerns adversely impacted. These included troubles in Hong Kong, the demerger of M&G, Regulator fines and its blocking of a £12bn annuity transfer.   

Royal Dutch Shell was also weak, its shares retreating from 2581p to 2400p, despite investing US$2.75bn in buying back its own shares. The half year results fell below City expectations and profits are set to fall 15% this year before bouncing back 24% in 2020. Dividend is maintained, covered 1.3 times by earnings and, of 28 analysts publishing a view on the stock, 17 say Buy, 11 Hold with no Sellers.

i share FTSE100 ETF gave up a little of the previous quarter’s gains, slipping from 733p to 728p, with cable (US$ versus £) being a prime driver in daily volatility - in the absence of progress on US-China trade talks or Brexit.

Edinburgh investment trust struggled as a number of its larger holdings reported disappointing news – over the quarter period, the shares fell from 581p to 535p mid-August before ending September at 590p.

Law Debenture investment trust began the quarter at 600p, falling to an August low of 550p, but the shares ended the quarter at 570p.

JP Morgan Global Growth & Income investment trust progressed from 333.5p to 345p in mid-July, before retreating to end the third quarter at 339p.

Blackrock Energy & Resources Income investment trust began the quarter at 73p, slid to 69p before recovering somewhat to ended the period at 71p.

Herald investment trust began the quarter at 1338p, slid to 1275p and ended the third quarter period at 1301p.

Vanguard All World High Dividend ETF progressed from 4331p to 4428p, as value-biased equity began to return to favour.

i shares MSCI Europe ex-UK ETF rose from 2868p to 2890p, despite evidence of economic slowdown. However, many of its largest holdings are truly global (like the UK), and the region offers more value (evidenced by a 3% income) than the US.

Vanguard Asia Pacific ex-Japan ETF had a turbulent quarter – as investors worried about political developments in Hong Kong and the fall-out from the US-China trade ‘wars’. Beginning the period at 66.8p, the price fell to 61.8p in August, before ending the quarter at 64.9p.

Caledonia investment trust gave up some of its 2019 gain, slipping from 3055p to 3005p – despite announcing a 3689p NAV. In July the group announced a £89m investment for a 36% stake in Stonehage Fleming, the largest family office in Europe.

Capital Gearing investment trust progressed from 4240p to 4355p in July - meaning its discount to a NAV of 4226p had gone, and ending the period at 4350p. 

Harbourvest Global Private Equity investment trust also performed strongly (1345p on 1.1.2019), rising from 1614p to 1732p in July (NAV was 1968p) before ending the quarter at 1750p.

Henderson Alternative Strategies investment trust by contrast with those flexible investments, disappointed as the shares fell from 286p to 272p - notwithstanding a 19% discount to NAV of 332.4p.

Ecofin Global Utilities & Infrastructure investment trust made further progress, from 141.5p to 159p, in the third quarter. NAV grew to 175p reflecting the strength of long duration infrastructure assets at the later stages of an economic cycle.

Pantheon International investment trust began the quarter at 2140p, rose in July to 2335p, easing to 2190p in August before strengthening to end September at 2320p.

i share Physical Gold ETC began the quarter at 2160p, rising to a high of 2510p on 3 September before profit taking left the period end price at 2335p.

Cash was unchanged, producing no income worthy of mention.


Previous blogs have commented on the higher risk-reward inherent in individual company shares and this has been borne out in this quarter, with the weakest capital return came from Prudential which fell 14.9%. The two best positive performances were Bellway and GVC, with capital returns of +20.6% and +14.4% respectively during the reviewed period. By contrast, almost all the diversified collective or pooled investment vehicles - many of which incorporate hundreds of individual securities, as they seek to track an index or a particular asset class – delivered single digit returns over the past three months. However, the bright and dull double-digit spots included Ecofin Global Utilities & Infrastructure investment trust (capital return +12.3%) and Picton Property investment trust (capital return -10.6%).


Finally, it should also be noted that the above mention of performance takes no account of income – most of the investments (including the above mentioned Ecofin Global Utilities & Infrastructure, GVC, Picton Property and Prudential holdings), have produced income in the quarter period - which will be significant on the higher yielding assets, in particular the corporate bond ETF, the property and the UK equity investments.



The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.


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