Biotech, banks and roads: rosy prospects for 2017


Governments around the world - in the US, UK, Canada, Indonesia, Peru and the Philippines, to name a few - are calling for more spending on infrastructure to boost their stalling economies, as many start to move away from monetary easing to fiscal stimulus.

For governments, a big attraction of stoking the economy by building infrastructure is that borrowing costs are low; for investors, these assets offer steady yields that are less volatile than returns from the stock market, and indeed have little correlation with bond and equity indices.

For example, investment trusts with holdings in infrastructure pay yields of 4-6 per cent. However, the average premium of an infrastructure investment trust is now around 13 per cent, so investors are overpaying for the underlying assets.

Three infrastructure funds for income seekers


In fact, in recent history these trusts have only moved to a discount during the financial crisis. For most investors therefore, open-ended unit trusts offer better value, as they do not trade at a premium or discount to asset value.

'I really like infrastructure, particularly at the moment as it is ticking a lot of boxes,' says Darius McDermott, managing director at Chelsea Financial Services. 'The sector tends to be less volatile than the wider market.

'This is because infrastructure assets tend to provide core services and facilities, from large-scale projects such as power networks, railways and roads, to smaller but equally essential structures such as GP surgeries. Importantly, they generate cash flows that are not dependent on wider economic conditions.

'Earnings are typically resilient and predictable, so there is some protection from inflation - which has just started to pick up - and the yield can be very attractive, an important element when cash savings rates are being slashed.'

He likes the First State Global Listed Infrastructure and Legg Mason RARE Global Infrastructure Income funds, which are both diversified internationally, and VT UK Infrastructure Income, which invests in UK projects only. All three yield around 5 per cent.

McDermott says infrastructure assets are traded so rarely that it is difficult to value them, and discounted cash flow is often used instead, which involves making a judgement call on the risks of the investments versus what the managers think when they value them.

'These vehicles are seen as high income payers and safe, as they are often government-backed investments,' he says. 'The clear risk is of changes to government policy and the withdrawal of support for projects, but this is unlikely in the present climate.'

The Institute of Fiscal Studies recently questioned the headlong rush into infrastructure, however, and pointed out that nine out of 10 large projects go over budget.

'The sweet spot for most investors is investing when the project is complete, as this is the safest part,' warns Mark Dampier, research director at Hargreaves Lansdown.

'Infrastructure is being portrayed as a risk-free asset class, but investing at the start of a project is actually quite dangerous.'

A more cautious alternative is to invest in debt issued by infrastructure projects, which yields around 6 per cent.

GCP Infrastructure Investments fund invests in Private Finance Initiative debt, effectively funding public projects with private money, which is a very conservative business. The fund's premium has fallen from 23 per cent to 16 per cent in November.

Similarly, SQN Asset Finance Income has substantial holdings in renewable projects, while Starwood European Real Estate is a Guernsey-domiciled closed-ended company with real estate debt investments in liquid sectors, which is on a smaller premium than much of the market.


The biotech sector has also been boosted by the prospect of Trump in the White House, as the president-elect has a more relaxed attitude to drug price inflation than adversary Hillary Clinton, who planned to curb the pharma industry's 'egregious' pricing practices.

While large pharma companies with undifferentiated products in the crowded therapeutic categories face challenges in driving real growth from volumes as opposed to price, there are better opportunities among the riskier mid- and smaller-cap companies, which just so happen to be those that have been sold down most heavily over the past 18 months.

Thus International Biotechnology Trust recovered 30 per cent on 9 November, the day after the US election. Biotech Growth IT and Polar Capital Biotechnology fund have also recently reached 52-week highs.

Trump's promised repatriation tax should also boost the large pharma sector, allowing companies to pay just 10 per cent tax if they bring home money that has been parked overseas.

For example, Pfizer chief executive Ian Read has said he will repatriate over $80 billion (£65 million) earmarked for deals.

M&A activity in pharma is expected to lift off following this influx of foreign cash and improved stock valuations. Smaller biotech firms may now also be bolder in raising money themselves, particularly those that delayed investment during a weak equities market.


The long-unloved financial sector is enjoying a similar Trump-surge. Low interest rates have wrought havoc, compounded by ever-tighter capital adequacy and other banking regulations, but high hopes have been pinned on the president-elect's expansionist policy and relationship with the Federal Reserve.

footsie-world-versus-footsie-world-financials-performanceAlmost as soon as Trump was elected, the indicators for US inflation started to tick up. Ironically, a hike in inflation was something central bankers have been trying (and failing) to engineer themselves for years through quantitative easing.

A rise in inflation boosts the prospect of rate rises, which would lift profitability in the financial sector.

'For the last few years, there has been a high level of uncertainty over negative rates and close to zero rates in some markets, which has been detrimental for banks and the financial sector,' says Guy de Blonay, manager of Jupiter Financial Opportunities fund.

'Regulations have led to constantly higher capital costs, and apart from cutting costs there has not been much banks could do to offset the lower interest-rate environment.'

Previous potential inflexion points in 2012 and 2013 proved short-lived, and even though inflation expectations have slowly been creeping up, no one believed inflation was sticky enough to make the Fed raise rates as aggressively as it liked to suggest it might.

Post-election, however, 10-year Treasury yields rose from 1.5 per cent to 2.2 per cent in a single week, as bond investors showed their concerns over rising inflation eroding the value of fixed income payments.

Trump's promise to cut taxes and potentially lighten regulation such as the Dodd-Frank Act (regulatory legislation enacted in response to the financial crisis) have been welcomed by the financial sector.

In particular he favours weakening some new regulations covering fiduciary standards for providers of investment advice, which will help firms with armies of brokers, such as Morgan Stanley or Bank of America.

'A lot of the good news is priced in, but what is not priced in is the belief that it is actually going to work and that we are entering a new bull phase.

'Banks will want to see how Trump's policies materialise. Should the first 100 days of the new administration deliver few pro-growth signs, then the excitement in US share prices could reverse quickly,' adds de Blonay.

In addition, there are plenty of detractors who point out that anti-establishment, anti-EU parties threaten market stability across Europe and the European Union itself.

Importantly, many mainstream active funds now have quite high allocations to biotech and/or financials, so you may be in danger of duplicating your stock holdings.

To give just one example, 36 per cent per cent of the Woodford Equity Income fund is in healthcare and 28 per cent is in financials.


There are three established exchange traded funds that track global infrastructure indices - SPDR Morningstar Multi-Asset Global Infrastructure, iShares Global Infrastructure and db X-trackers S&P Global Infrastructure.

The first two use physical replication to track infrastructure-related stocks, while the X-tracker uses synthetic replication.

iShares Global Infrastructure pays dividends, while as its name suggests, SPDR Morningstar Multi-Asset Global Infrastructure also invests in bonds issued by infrastructure companies such as Transport for London.

Other more specialist plays are PowerShares Emerging Markets Infrastructure Portfolio ETF and Guggenheim S&P High Income Infrastructure ETF.

Source Nasdaq Biotech ETF was launched in 2014 as Europe's first exchange traded fund to track Nasdaq. In the financial sector, the SPDR Financial Select Fund offers exposure to large financial firms.

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