Where else to invest, beyond company shares?

Wednesday, 14th August 2019 15:38 - by David Harbage

In the last blog, three weeks ago, the author considered the immediate prospects for the UK’s financial markets following the appointment of a new prime minister – anticipating sterling weakness, higher volatility for risk assets (such as equities), in the second half of 2019 - and some potential hedges against likely market turbulence. The latter included reference to switching from highly valued stocks (citing Unilever as an example) or equity markets into more attractively valued domestic ones, as well as looking at other areas of investment – such as gold (the physical metal and the extractors), smaller value UK priced technology, global utilities and infrastructure.

Following subsequent enquiries from readers seeking alternatives to company shares for their long term savings, this article takes a closer look into some of the available assets and options. The intuitive first choice for most personal investors would be to retain monies in Cash, but history shows us that this asset does not usually deliver real returns in sterling terms: UK interest rates are typically lower than domestic inflation – last month the 12month Consumer Prices index (CPI) rose to 2.1% and the Retail Price index (RPI) is closer to 3% - meaning that the real value or purchasing power of money is being eroded by being retained in cash.   

A natural extension of Cash, and the logical choice for institutional investors – who are often charged with owning assets that will match or cover a specific future liability or need – are Bonds, which can be viewed as longer term interest rates. In UK, sterling terms, the risk-free HM Government conventional (paying a fixed rate of interest) variety offer very little to the buyer today: the current ten year gilt yields (covering annual returns to redemption) just 0.5% per annum – again a negative real return. Owning a corporate bond or fund investing in a diversified portfolio of company bonds will normally provide a higher income – dependant on how much risk the investor is prepared to take. Lower quality businesses, in particular featuring weaker balance sheets, offer higher income (as they have to pay more for capital) but are at greater risk of defaulting on their debt.

Based on distribution yields currently being paid by low cost exchange traded funds (ETFs) that invest in corporate bonds, the level of income which an investor might expect to receive from investment grade quality (rated BBB or higher) global or domestic sterling corporate bonds is 2.4%. The actual total return over the longer term is likely to be lower than that figure as the current portfolios of both the overseas currency denominated and the sterling issued bonds is relatively short dated (duration is circa 6 years and 8 years respectively), but more particularly features weighted average coupons considerably above current distribution yields – implying significant prospective capital erosion, unless interest rates remain on their current downward trend.

With rates close to zero in the UK and most other developed markets, there is limited scope for high quality (UK government or near equivalent) fixed interest bonds to appreciate further and, unless one wishes to own higher yielding bonds inevitably issued by lower quality corporate issuers (in the belief that their delinquency rates will fall and credit status improve), the balance of risk versus reward in corporate bonds, as an asset class, has limited appeal to longer term investors.

Choosing a bond whose return (the income coupon, as well as ultimate redemption worth) is linked to inflation offers more potential, dependant on one’s expectation of where prices are set to go. The valuation of such investments will be determined by reference to an assessment of the current price of an equivalent duration conventional bond allied, according to the terms of the bond, domestic or global inflation. Like mainstream fixed interest bonds, inflation linkers have performed well of late but, looking forward, performance will depend on inflation.

In domestic terms, there has been a pick-up in wage inflation (annual growth of, a higher than expected, 3.9% was announced yesterday) and the weakness of sterling is likely to import more inflation in the immediate future.  Current distribution yields on global inflation linked government bonds is 1.5% for a sterling UK gilt and 2% for a global fund (again via low cost, index tracking exchange traded funds - ETFs – featuring duration of 22 years for sterling and 12.5 years for international issues). Two less popular or liquid forms of bond investment - floating rate notes and convertible bonds - could also be discussed in this blog, but the income available on each, relative to Cash or equity (as far as convertible issues are concerned), renders them as somewhat unattractive or peripheral alternatives.      

Beyond bond investments, property remains a favourite area for private individuals’ long term savings – be it via owning, (and probably letting out), a second home or buying into a fund which invests direct into residential or commercial  property - producing, as it does, a reasonable level of rental income with the prospect of capital appreciation. While UK taxation treatment of second home or Buy-to-Let property has become tougher in recent years, and house price inflation has eased partly in response to demand from such landlords (but also due to Brexit-induced economic uncertainty and a decade of an easing in real wage growth), this ‘see and feel bricks & mortar’ investment may appeal to some investors as a means of procuring income growth in retirement.

Those seeking more active management of a property portfolio may wish to consider funds such as the Picton Property income investment trust. This company has a full listing on the London stock exchange and, with a market capitalisation of £480m, is a member of the FTSE250 index. Investing in commercial property across the UK, the managers seeks to provide investors with an attractive level of income (the shares currently yield 4%) and the potential for capital growth as management acquire, develop and either retain or sell individual properties. The portfolio is focused on industrial (capturing the strong trend towards online shopping) and regional office properties (by contrast: no exposure to retail centres). The quarter ended 30 June 2019 showed further growth in net asset value (NAV) to 93p and activity featured 7 lease renewals, 4 new lettings and £1m refurbishment spend to boost future income.  

In terms of property assets, the writer’s favoured industry segment remains the big warehouses being used to fulfil the explosive growth in demand for online grocery and most other areas of retail. The £2.4bn market capitalised Tritax Big Box real estate investment trust is one such operator: owning 58 London-biased properties and development land worth £3.4billion, its asset value rose 12.6% in the first half of 2019 (equating to a NAV of 150p per share) and its dividend distribution represents an income yield of 4.7%. As at 30 June, the company’s weighted average unexpired lease term was 14.3 years and 99% of the properties within its investment portfolio were either let or pre-let. It may not surprise the reader to learn that the global online retailer Amazon is the trust’s biggest tenant – accounting for 13.6% of this REIT’s rental income last year.

Taking the appropriate longer term view, commercial property rental income should rise, leading to dividend progression and an upward revaluation of the asset’s capital worth – but, as most of Britain’s High Streets will testify, investors need to be selective. The UK’s largest stock market listed residential landlord is Grainger a £1.4bn market worth business which owns 8,400 rental homes and has plans to acquire a further 8,200 homes. Half year results to 31 March 2019 featured major expansion via the acquisition of GRIP (1,700 rental homes in London), a link with Transport for London to develop 3,000 new homes across the capital and strong lettings performance at the recently developed Clippers Quay in Manchester. Overall like-for-like (comparable with the previous period) rental growth was 3.7% and the NAV, post a cash raising rights issue of new equity, stood at 271p. As the business model has changed from a passive ‘buy with tenant, eventual sale with vacant possession’ to becoming a more active developer, the shares currently yield 2.1% - but dividend hikes are confidently forecast to take the income yield up to 3% by the September 2020. 

Beyond property, the author has viewed diversified closed ended investment trusts which the industry categorises as Flexible, as being interesting alternatives to stock exchange listed company shares. They are termed ‘flexible’ in part because the asset managers can invest in a wider range of different asset classes, and also because often because the performance benchmark is an absolute or actual return (as compared to beating an equity index, such as the FTSE100’s, return). Most personal investors will share these asset managers’ wish to preserve capital (at least in real, inflation-beating, terms).

The desire to incorporate other alternative assets in a stock exchange based, long term savings plan or portfolio also prompts consideration of the market’s valuation of such investments – by reference to the difference between the share price and the net asset worth (NAV) – as well as their flexible strategies in choice of asset type. Caledonia investment trust is such an example, as its £2bn portfolio of assets is currently priced at a 17% discount (3050p share price and an estimated 3686p NAV). The latter is difficult to value, because it features unquoted private companies (an area where management can manage with less interference or influence – something that can be viewed both positively and negatively, in respect to time horizon and other factors), along with other types of asset. The trust is currently invested: Unquoted investments & Funds 41%, Quoted equities 30%, Debt & Cash 29%; its assets are primarily located: UK 34%, North America 28%, Europe 20%, Asia 14% and the shares currently offer an income yield of 1.9%. Caledonia aims to grow assets and dividends while avoiding permanent loss of capital (which, no doubt again, fits with many of our readers’ objectives), as it seeks to beat both UK inflation and the total returns produced by the FTSE All Share index. The trust has managed to do this over the past ten years – achieving annualised returns of 9.5% (NAV 9.9%), as compared to the benchmark RPI’s 2.7% and the All Share’s 9.8% to 13 August 2019.

Another flexible (as defined by the Investment Management Association) investment worthy of consideration and further investigation by investors seeking alternative assets is the smaller £133m Henderson Alternative Strategies investment trust which aims to outperform the FTSE World index, via a diversified multi-strategy portfolio using specialist funds including hedge and private equity. It has a strong focus on absolute returns and, managed by Peter Webster and James de Bunsen, over the past 5 years it has achieved annual returns of 5.5% over the past five years, with only one negative return (NAV of -1.7% in year to 30.6.15). The shares are currently priced at an attractive discount of just over 19% to net asset worth, which is towards the bottom end of their annual range and is likely to tighten in 2019. This trust has been likened to a ‘one stop shop’ for investors looking for assets which are not co-related to equity. Currently the trust’s largest exposures (typically effected via funds rather than individual securities) include Cuban property, global private equity, a long/short hedge fund, Russian private equity, German commercial property, commodity and an unlisted energy investment – most of which are managed by well-regarded managers. In geographic terms, Western Europe (31% of asset worth) and North America (30%) dominate with the largest industry or sector segment being property at 15%.

Another stock exchange listed investment vehicle, Capital Gearing investment trust, with a similar benchmark of beating UK inflation (by reference to the Retail Price index), aims to preserve shareholders' real wealth by achieving an absolute total return over the medium to longer term. As at the 30 June 2019, its £400m portfolio (managed by Peter Spiller since 1982, Alastair Laing since 2011 and Chris Clothier since 2015) is invested: 56% in £ assets, 29% US$, 6% Euro and 9% in other currencies. Index linked government bonds account for 32% of assets, conventional gilts 10%, preference shares & corporate debt 18%, collective funds & equities 33%, cash & gold 7%. The trust has comfortably outperformed the MSCI UK equity index and the 3 month LIBOR cash rate since 1 January 2000 (annualised return +8.4% v +4.2% MSCI, +2.8% cash), with the maximum drawdown fall since 1.1.2000 being -9.0% versus MSCI -41.3%.

Another alternative investment worth closer inspection is Harbourvest Global Private Equity investment trust again designated’ Flexible’ within the industry’s categorisation – although focused, per its title, on one particular class of asset. A well-regarded financial institution based in Boston, Massachusetts, with more than 100 staff managing US$55 billion out of offices in nine countries, the group has a strong track record of growth - notably in progressing net asset value. Perhaps surprisingly, the shares of this £135bn market capitalised, FTSE250 constituent stand at a 13.5% discount to NAV – having recently improved from a 20% discount earlier in 2019. By contrast the shares of the better known (at least to UK investors), FTSE100 private equity group 3i are priced at a premium to their asset worth. The trust aims to produce long term capital growth and its portfolio of unquoted businesses is well diversified – both by reference to the stage of these companies’ development (invariably firms are acquired in their infancy or when distressed, close to being broken and improved to the point of being sold or re-floated on the market), geography and industry.

Finally, in this article seeking to review alternatives to stock market company shares, the long term investor may wish to look beyond the value of recently highlighted precious & industrial metal Gold, to consider other valuable commodities or the owners of such assets. Blackrock Energy & Resources Income investment trust aims to produce a high income, with capital appreciation over the long term, via the securities (equity and bonds) 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%; (split: minerals 52%, energy 48%), its shares are currently priced on an attractive 12% discount to NAV and offer an income yield of 5.7%. In part, this might reflect the fact that institutional investors have tended to overlook oil & gas in particular – in an expectation that demand will ease in a slowing global economy.

However, owning scarce assets (albeit ‘in the ground’ rather than being readily accessible ‘off the shelf’) will appeal to many personal investors, who may subscribe to the belief that the faster pace of growth - in infrastructure & transport in particular - within emerging economies could offset any decline in developed countries’ appetite for oil and industrial metals. The largest individual exposures will be well known to many readers: BHP Group 9.6%, Royal Dutch Shell ‘B’ 7.3%, Rio Tinto 6.7%, Glencore 5.7%, Exxon Mobil 5.2%, Teck Resources, Vale, Chevron and BP 4.8% each, and ConocoPhillips 3.8% . The fund’s benchmark is the US dollar denominated MSCI World Energy index, which it has matched over the past three years, (but underperformed wider global equity indices), and the trust charges an annual management fee of 0.95%.

Another fund from the same Blackrock ‘stable’ which shares an investment in valuable, by reference to its limited supply and difficulty in discovery & extraction), raw materials is Blackrock World Mining investment trust – an actively managed investment in mining and metal assets worldwide, with the objective of maximising total returns. The £645m trust primarily investing in listed companies, but can also incorporate royalties derived from mineral production, up to 10% in physical metals and a maximum of 20% in unquoted investments. Managed by industry guru Evy Hambro and Olivia Markham, the trust has the EMIX Global Mining (£ based with income reinvested) index as its benchmark. While the fund managers’ prime aim is to achieve capital growth, the trust has a balanced approach to risk-reward although, akin to the sister trust Energy & Resources Income, it takes high conviction positions, evident from the fact that the top ten holdings represent 74% of the portfolio.

Many of these companies have mines around the world (63% of assets are owned by global businesses), but in terms of country specific positions, 10.6% of the portfolio is in Australasia and also in Latin America, with 6.6% of assets domiciled in Canada and 6.3% located in Africa. The £800m portfolio’s sector allocation is currently: diversified miners 49%, copper 21%, gold 14%, silver & diamonds 8%, industrial 7%, with the largest individual company exposures being BHP Billiton 13.3%, Rio Tinto 12.7%, Vale 12.4% and Glencore11.0%. The trust yields 4% per annum, distributes income quarterly and has an on-going annual charge of 0.8% per annum. The trust pays an income yield worth 5%, the shares discount to NAV is an attractive 14% and over the last three years to 30 June 2019, this trust has delivered 20%+ returns to outperform its benchmark.

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.