3 months on!
It seems a long time ago, but we commenced the start of the first quarter of this year in a reasonably buoyant mood with strong hopes of a global recovery from the pandemic. Tempering this optimism was rising inflation and signals from Central Banks that interest rates could rise quite quickly.
Just over 3 months on and the picture looks somewhat different.
However, whilst the world is looking far from certain, it’s important not to be caught up in the negative news flow. I know, my last couple of commentaries have been far from upbeat but, of course, it’s also important to address the issues facing us all. If we thought that there was no point in investing, we would recommend you disinvest and move into cash.
The problem with this strategy however is that you are guaranteed to lose money. Even if you can obtain a savings rate of 1.5% per annum, you are effectively guaranteeing that you will lose money in real terms with UK inflation now at 7%. Simple maths tells you this isn’t good!
When investing, there are no guarantees on the open market but there are low risk strategies which will enable your money to grow in a much better way. The key, of course, is choosing the right approach for you and your risk profile. Whilst for those investing in broader or more specific strategies there are significant opportunities, it is worth reiterating once more that most equities are in positive territory since the invasion of Ukraine.
I spoke to a friend and client today, and reminded him of what he said in April 2020 after listening to Radio 4 and a representative of the International Monetary Fund (IMF) talking about the likely impact Covid-19 would have on the global economy. Basically, he said to me “we are stuffed, we might as well lock the door and throw away the key”.
We all know how the markets responded then! One of the best prolonged stock market performances in recent years.
So, what are the IMF saying now?
Unsurprisingly, they are not deliriously positive about the global economic outlook this time either. Before we explore the possibilities, let’s understand their sentiment:
The IMF has predicted that the global growth forecast will fall to 3.6%. The IMF Chief Economist Pierre-Olivier Gourinchas suggested that emerging economies would underperform even more in 2022 and 2023 than advanced economies because commodity importers would suffer most from higher prices.
They warned that their view of a strong recovery from the pandemic has been turned around this year and now they only expect global growth of gross domestic product (GDP) to be 3.6% this year, down from the 4.4% they estimated at the start of the year. This is 1.3% lower than they forecast 6 months ago!
They recognised the difficulties the war in Ukraine has caused and expect that this will have a bigger impact on European growth, which in turn may mean that interest rates may not go up as aggressively, with concerns about tipping economies into recession.
The US is in a different position because the economy is much stronger and can bear the brunt of frequent rising interest rates.
What do our investment partners think?
If you haven’t already done so, make sure you get a glass or mug of something you fancy as this is a quarterly investment overview and there is a lot going on! Here’s how our strategic investment partners see the outlook:
Undoubtedly the main success story amongst our portfolio suite since the invasion on the 24th February 2022 is our Infrastructure portfolio managed by Foresight. I thought we would provide a deeper dive than normal in these uncertain times and reinforce that there is always somewhere positive to invest. The holdings are spread across three different funds, their Global ‘real’ Infrastructure fund, their UK Infrastructure fund and Global Sustainable Real Estate fund. Foresight is a sustainably led alternative assets and SME manager (small/medium sized companies) which focuses on investing in physical assets.
Global Real Infrastructure Fund
The fund returned a notable 9.07% in March 2022, with a strong performance from each of the fund’s sectors, particularly renewable energy. A key attraction of infrastructure is its criticality to everyday life – many of the fund’s holdings own and operate assets which societies rely on every day. This is heightened during times of uncertainty.
Infrastructure is its critical to everyday life.
The fund’s renewable energy investments have benefitted from increased cash generation in recent months driven by high power prices. The Investment Team maintained their conviction to the sector in early 2022, with 34% of the fund’s portfolio invested in renewable energy holdings. The Investment Team assessed the sector as undervalued and positioned for a period of strong performance. The share prices of renewable energy companies rose strongly in March 2022, driving fund performance.
During the period, the Foresight team selectively trimmed exposures where share price performance outpaced underlying growth, while maintaining conviction over the long-term prospects for the sector. Since the start of the year the fund has increased its allocation to Cellnex, a European owner of telecommunications infrastructure. Cellnex’s share price had decreased materially through 2021, despite continuing to post significant growth in earnings. The Investment Team viewed the company as attractively priced for long-term growth, with the UK Competition & Markets Authority review of the company’s purchase of 6,000 telecoms towers, weighing on the share price. In March 2022, this review ended favourably for the company and its share price rose 8.41%.
The portfolio remains diversified across attractive sectors of the listed infrastructure market, the tailwinds for which remain strong. The cash balance at month end is expected to be selectively deployed, with heightened volatility providing investment opportunities.
UK Infrastructure Income Fund
The fund delivered a positive performance of 4.36% during March, which was supported by positive contributions from all sectors. The continued hunt for inflation ‘linked’ income by investors, broader energy and infrastructure policy momentum, and the macro-economic environment, all support valuations across the infrastructure sub sectors.
The fund has participated in several capital raises and over £20 million of capital was deployed into equity placings over the month at levels that were at a discount to pre-announced secondary market prices. This capital will eventually be deployed by the companies into real economy investments across a range of infrastructure projects. The fund participated in the placings announced by SDCL Energy Efficiency Trust (SEIT), The Renewables Infrastructure Group (TRIG) and Greencoat Renewables PLC (GRP). Given the supportive power price backdrop, and increasing focus on energy security and efficiency, these companies took advantage of the positive sentiment towards their shares and issued equity to fund pipeline opportunities.
During the month the fund also participated in Northwest Healthcare REIT’s (Real Estate Investment Trusts) equity offering which marked the first overseas placing in which the fund has participated. Northwest Healthcare (NWH) launched its placing programme to fund near term investment opportunities in the US medical office building sector. Over the period, the Lead Manager also visited the management team at NWH in Toronto and toured a medical office building and hospital assets owned by the company. The visit highlighted the critical nature of the healthcare infrastructure provided and the collaborative relationship between the company and its tenants.
The rising interest rate environment remains a key risk across the infrastructure landscape, however this is cushioned by the potential for dividend growth and the potential for further risk minimisation, given the flight of capital towards the sector. The real assets sector remains a good alternative to cyclical equity income or risky fixed income as it continues to offer good inflation linkage and the prospects for uncorrelated dividend growth. The renewable energy, core infrastructure and healthcare sector, remain structural growth areas and are cornerstones of the fund. The Investment Manager also remains optimistic about the fund’s other sectors such as digital infrastructure and energy efficiency, as they complement the core allocations.
Sustainable Real Estate
Mark Brennan, the Fund Manager, stated that real estate is a critical piece of the puzzle when it comes to sustainable investing. The building environment is responsible for about one third of all carbon emissions globally. Foresight see a very strong connection between sustainability and financial performance. Read more here.
Real estate is a critical piece of the puzzle when it comes to sustainable investing.
The fund returned 5.21% during March, the strongest period of monthly performance since the fund’s inception. Heightened political risk reinforced the value of real estate in a balanced portfolio, with the fund’s holdings continuing to perform as expected.
The drivers of the fund’s performance were widespread, with almost all the holdings finishing the month in positive territory. Notable performances came from companies that had suffered from poor share price performance at the start of 2022 stemming from fears of interest rate hikes. The team viewed the share price reaction for many companies as overdone. Crown Castle International, a US owner of telecommunications assets and Prologis, a US logistics REIT, returned 10.81% and 10.72% respectively, after consecutive periods of negative performance in January and February. Both businesses continue to perform well operationally and their earnings benefit from a high level of inflation linkage.
The portfolio remains well protected against inflation, exemplified by Supermarket Income REIT (SUPR), a landlord to the large UK grocers. 85% of the company’s rent is directly inflation linked, with rents primarily reviewed annually. In its most recent results, SUPR reported a 6.35% year-on-year increase in rental income, driven by this inflation linkage.
During the month, members of the team visited a recently acquired office and laboratory asset held by Life Science REIT PLC. The Rolling Stock Yard has 58,000 square feet of lettable area with 43% leased to Gyroscope, a subsidiary of Novartis, that focuses on gene therapy. The asset is located in the heart of the St Pancras Knowledge Quarter in London, which remains an upcoming life science and technology hub. Management have identified asset management opportunities that will convert vacant space on the first and second floors from traditional office space to purpose-built laboratories allowing the company to capture above market rents in a sub-sector of the market that remains undersupplied.
The fund’s lead manager also visited Dream Industrial REIT in Canada during the month, viewing logistics assets in the Greater Toronto Area where rental growth and low vacancy remain strong drivers of financial performance. Active management is central to the investment process and the team intend to continue asset visits throughout 2022.
Note that ‘Vestra’ has now been dropped from the name which probably makes it easier for all concerned!
I’ve covered off most of their broad points in previous commentaries in terms of what will determine the possibilities to be moving forward. However, we use LGT’s model portfolios for both mainstream investments and Sustainability, both of which have had their challenges of late.
LGT Wealth as an investment house have dialled back some of their risks and have reduced some of the growth aspects of their portfolios. The backdrop is because of the elevated recession risk I spoke about a couple of weeks ago. LGT however were keen to state that other indicators suggest less concerns about a recession. They were at odds to point out that whilst they’ve tempered their bias towards growth over the last few months, they retain their focus on quality companies with strong balance sheets, within the portfolios.
They retain their focus on quality companies with strong balance sheets.
We had a discussion about Europe and at the start of the year the economy was expected to recover sharply from the pandemic, helped by loose monetary policy from the European Central Bank (ECB), compared to the US and UK. Now Europe’s relatively high dependency on Russian oil and natural gas, in addition to Ukrainian wheat and sunflower oil, is threatening to dampen the recovery as the outlook for households has worsened.
As oil and gas supplies from Russia remain constrained by sanctions, the food and energy sectors are likely to remain a source of inflation, even as interest rates rise. Any resolution to the war in Ukraine will undoubtedly be positive, but a swift roll back of sanctions appears unlikely. Given the squeeze on real incomes, Central Banks could lose their nerve in tightening policy.
Of course, Europe is watching the French election dramas very carefully with the final round of voting on Sunday. From an equity perspective, the hope is that Macron is re-elected.
There is no doubt in the western world that it is inflation and interest rate rises which are front and centre of investors’ thinking, but LGT were keen to reinforce that what matters most is the ability of companies to grow their earnings. This is one of the best predictors of share price performance over the longer term and with earnings season just around the corner, a great deal of attention will be paid to companies’ pricing power in the face of growing recessionary risks.
What matters most is the ability of companies to grow their earnings.
Phoebe Stone, the Head of Sustainability and a partner at LGT Wealth spoke about how China’s zero tolerance towards Covid has created enormous disruption with its stop/start approach. As the second biggest economic power in the world, the impact on elevating inflation cannot be overlooked.
I thought a client summed it up nicely the other day when he said “sustainable assets may be struggling price wise right now, but this is the future and money will begin pouring back into this space when the conflict has found a resolution. In fact, there will be even more awareness of the need to protect our environment after the damage this conflict has done”.
There is no doubt Sustainable investments have had a rocky time as sentiment has switched, in many cases back to the old traditional businesses which have been accused of not being environmentally friendly – mining companies being a case in point. Phoebe did however mention that they have recently invested into a Canadian mining company which, unusually, ticks all the boxes with regards to Sustainability. This is an encouraging move and whilst positive impact companies are desirable, it shows the importance of the need to be flexible and adaptable when events take a turn for the worse.
Phoebe spoke about how the sudden change around in monetary policy and the invasion has caused disruption across the Sustainable model portfolios. Of late they have increased their cash position awaiting further buying opportunities but also to protect against further weakening of sentiment in this area due to recessionary concerns.
Seven Investment Management (7IM)
Although we don’t use 7IM very much these days, I respect their opinions and was interested to hear their views. Strategically, they have always taken pride in their tactical approach and their focus in using alternative assets.. They appear to have a stronger proposition now and hence I was keen to hear what Martin Surguy, their Chief Investment Officer and Ben Kumar, a Senior Investment Strategists (someone we have worked closely with in the past) had to say.
In a similar way to Blue Sky, they reinforced that they like to take a clear view of the world, understand where they should position their assets and then identify investments which will help in this environment.
I found their engagement interesting, and I have to say they were quite upbeat, probably because they believe that alternative assets are now coming into their own which suits their investment style.
I liked their comment about the markets “financial markets don’t need an economic boom to do well and nor is it the case that a recession is bad news for equities”.
Financial markets don’t need an economic boom to do well.
Ben spoke about inflation and reminded us that essentials are not a large part of spending, with food and beverages typically less than 10% of household expenditure here in the UK. Giving context he was suggesting that inflation in this way will, on its own, not create a crisis.
He spoke about how markets are functioning, despite shortages and price rises. Ben also made an important point in that price rises tend to create more investment because it makes investment more viable because of improved margins and sentiment can shift quite rapidly. As more companies enter a sector, this can ease supply chains and prices then begin to weaken. Ben was keen to point out that such examples are unfolding in all sectors across the globe, whereby companies are searching for solutions to their challenges. Timber prices were cited as an example. The price last year nearly quadrupled but the response was to open timber yards for longer, cut down more trees and seek wider supply chains.
It is for such reasons that 7IM aren’t pre-occupied with longer term inflation and believe that inflation will eventually settle back to the 2% target set by the Bank of England. They accept it may settle at slightly elevated levels.
Two thirds of most major market economies are based on consumer spending. The US consumer loves to spend and their economy appears strong enough to cope with short-term lofty inflation and rapidly rising interest rates.
It worth noting that the US government, in the depth of the pandemic, passed money to the consumer and coupled with reduced spending, the amount American’s have in savings is way above long-term averages.
Governments have packed away their reliance on austerity.
Governments will be more on the front foot with regards to spending, particularly in the UK where they have packed away their reliance on austerity. Fiscal policy and spending will do the heavy lifting and help the economic recovery. Ben also talked about how business spending will help drive economies. Many businesses have a lot of capital they are waiting to deploy.
Positioning for the next party!
They referred to the top companies by capitalisation in 1999 compared with today, the relevance being what is a driving force today may not be the driving force down the line. Microsoft being the only constant.
1999: Walmart, Intel, Cisco, GE and Microsoft
2021: Apple, Amazon, Alphabet, Facebook and Microsoft
Today’s fashion is tomorrows tank top.
The point is, as Justin Urquhart Stewart used to say at our investment seminars, “today’s fashion is tomorrows tank top”. This doesn’t mean that the companies aren’t worth investing in, but they might not deliver the equity returns that have been enjoyed to date. Is Netflix a prime example having just had its worst trading day in two decades?
7IM highlighted the importance of the Asian story and how the landscape is changing. The establishment of the Pacific Trading Bloc was a major development. The Regional Comprehensive Economic Partnership (RCEP) was signed on 15th November 2020. This trading bloc is now the largest in the world by both population and economic size, exceeding both the European Union and the US-Mexico-Canada Agreement. The RCEP accounts for 30% of the world’s population and 30% of global GDP.
Hot off the press: UK moves closer to joining one of the largest and most exciting free trading clubs in the world!
It was announced last night that the UK had passed the first stage of the accession process for the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP… what a mouthful!). The Department of Trade claims membership will be worth £8.4 trillion. Britain hopes to join before the end of 2022 as part of its wider foreign policy agenda to deepen ties with the Asia Pacific region.
Anyway, back to 7IM and their views on Asia. They stated that circa one third of Asian exports go to the west and the rest serves domestic demand. With regards to spotting trends for the future, the Pacific region was cited as having a huge part to play in embedding Environmental, Social, Governance (ESG) into their economies. It is estimated that by 2025 ESG assets will amount to one third of all global assets!
ESG assets will amount to one third of all global assets by 2025.
In many ways, the biggest risk for investors is not seeing the ESG opportunities, despite recent pullbacks in share prices. The health care sector they see as being really attractive, along with the Thematic sector and climate change opportunities.
Legal and General Investment Management (LGIM)
LGIM were similarly bullish to 7IM in believing that supply chain disruption will ease, and inflation concerns will begin to dissipate towards the end of the year and into 2023.
Francis Chua, a Fund Manager at LGIM and a regular commentator, discussed with me the strong consumer confidence in the US and whilst there are elements of this in the UK, the consumer here is far more sensitive to rising energy costs.
I haven’t mentioned much about government bonds in this report but Francis reinforced that their emphasis on bonds was more orientated towards Australia, New Zealand and Canada. They operate in a similar way to the UK, Europe and the US, but investors are getting paid more for their participation.
We spoke about India and how their stock market is performing well of late, whereas many other emerging markets are struggling. As the biggest democracy in the world, it offers attractive opportunities, but it is notoriously difficult to navigate but there is no doubt that there are significant opportunities. Conversely, as India is recovering from Covid, China still has many regions in lockdown which is naturally resulting in weaker economic growth.
Francis spoke about what they see as attractive in hedging against inflation; that is REITS, commodities and infrastructure. All assets which feature independently within our in-house portfolios, as well as within LGIM’s multi assets funds.
The ESG story for infrastructure is very compelling.
With regards to infrastructure, valuations look attractive and like us at Blue Sky, they believe that the sustainable element is enticing. Our in-house holdings are of course with Foresight as we identified earlier, one fund being focused on sustainable real estate. With regards to ESG, LGIM are expecting companies now to realign themselves more quickly to the themes coming down the track, which reinforces our view that events can unfold and change very speedily. Francis re-iterated that the ESG story for infrastructure is very compelling. Currently, only 25-30% of infrastructure is aligned with ESG and of course this is where Foresight really excels.
We discussed the various waves of fluctuating investor sentiment towards Sustainable assets and the likelihood is that as Sustainability become more embedded, such swings will be less marked.
Every crisis is an opportunity.
Never more so than in Artificial Intelligence (AI). LGIM last year tempered their exposure to large cap technology stocks in the US and have focused more on AI. This is a divergence play on technology, but they can see a huge potential in this space. AI companies also typically have strong balance sheets and lower wage costs which in an inflationary environment, makes them look more attractive than many other stocks. We have a holding of AI within our in-house Momentum portfolio.
Deglobalisation is being discussed at length in various quarters, but one thing is for sure, there is going to be a huge commitment in terms of capital expenditure from businesses and governments alike. Technology should fare well in such an environment.
If you worked your way through all that in one go, I would be mightily impressed. If you read it in dispatches, I don’t blame you! Regardless, I hope you found it interesting.
As usual, it’s all about perspective and its worth remembering that there is always somewhere positive to invest. In volatile markets it can be very difficult to retain conviction around certain assets. Of course there are risks, but there also opportunities.
With many stock-market indices quite a way lower than their 52 week highs, stocks don’t look expensive. Diversification is important but too much diversification can weaken returns in periods of high inflation, hence why we recommended switches in our in-house portfolios when we bought a commodity fund and bought a FTSE 100 tracker. We already have a good proportion of infrastructure holdings which have come into their own of late and we may well introduce more infrastructure holdings into some of our other portfolios when we meet for our quarterly investment review next week.
Hope I didn’t frazzle you too much!
Have a great weekend.
Gary and the Blue Sky Investment team
Please Note: This communication should not be read as giving specific advice regarding your personal circumstances. This would only be given following detailed assessment of your individual needs. The value of investments may fall as well as rise; you may get back less than invested. Past performance is not necessarily a guide to future returns.