Returns on cash remain a fraction of their pre-crisis levels, despite the 0.25 per cent rise in base rates in November. At the same time, inflation is at a five-year high, and is expected to continue to exceed the returns available on low-risk investments, and the stock market has also lost its attraction for new income seekers as inflated share values mean yields are low.
This difficult scenario has fuelled interest in alternative assets, such as infrastructure, that compensate investors for their illiquidity with a higher rate of return. For example, HICL Infrastructure Company Limited (HICL) is fairly typical of listed infrastructure companies in offering a 4.5 per cent yield, ahead of that of the FTSE 100 index.
With such a dearth of other obvious yield opportunities, investors have been piling into infrastructure trusts in recent years; as a consequence, many now trade at double-digit premiums to the value of their underlying assets, a sign of overheating in the market. However, attractive returns are still expected over the next few years, as governments in many developed nations are renewing state investment in infrastructure in an attempt to stoke domestic growth.
In the European Union, for example, government investment in digital and transport infrastructure is currently at a 20-year low, according to the European Investment Bank’s annual investment report. In the US, president Donald Trump’s proposed corporation tax cuts should also benefit infrastructure and the rail sector in particular.
‘Infrastructure is an interesting theme, as the baton is clearly being passed from central banks supporting growth monetary policy by creating more money and keeping interest rates low, to governments becoming more active in economic management through fiscal policy,’ says Jason Hollands, managing director at Tilney Group. ‘Across the globe – from the Trump administration in the US to Shinzo Abe’s government in Japan – we are seeing governments pledging to increase infrastructure investment to help improve economic efficiency and stimulate growth.’
He continues: ‘Infrastructure projects typically involve long-term contracts of 20 to 30 years and these contracts often include an element of inflation-proofing, so that revenues rise incrementally in line with inflation. These provide investors with a relatively secure and predictable revenue stream that is less sensitive to the economic cycle.’
Investors should scrutinise the underlying assets and schemes when selecting funds. Some will be invested in just a few major new projects, while others could be invested in longstanding companies such as utilities. An exchange traded fund (ETF) might be the better option for most retail investors, as these tend to be broadly based and will also rise in response to any positive sentiment to the sector.
Looking ahead, however, there is the risk that a Labour party government would bring private finance initiative (PFI) contracts ‘back in-house’, which would impact contracts for UK public assets such as hospitals, schools and transport. A de-rating for infrastructure holdings could also be expected if the Bank of England raises interest rates rapidly, as this would make returns on competing lower-risk investments such as gilts begin to climb.
Tilney’s preferred fund in this space is the Lazard Global Listed Infrastructure Equities fund, a 25-stock portfolio that includes toll road operator Atlantia, which operates 5,000 km of toll motorways, and US rail freight firm Norfolk Southern. John Husselbee, head of multi-asset at Liontrust, recommends VT UK Infrastructure Income, which invests in listed vehicles and is managed by Gravis Capital Partners. Some investors will be familiar with the company’s other offerings in asset backed lending and student accommodation.
Technology goes mainstream
The technology sector has done well in recent months, with many of the tech giants reporting excellent trading, including Facebook and Amazon, which lifted sales in the third quarter by 49 per cent and 34 per cent respectively.
Of course, the big tech companies are on astronomical price/earnings (p/e) ratios – Amazon has been on a forward p/e of over 100 for five years, for example. However, the positive narrative remains intact: use of mobiles and the internet will continue to grow globally as emerging market consumers come on stream. For example, currently advertising contributes only a fragment of Amazon’s total revenues, but Morgan Stanley analysts predict that the company’s advertising business could generate $5 billion in revenues by 2018 and $7 billion by 2020, and other analysts have come up with similar forecasts.
The challenge for many investors looking at this sector is one of diversification as the so-called FAANG stocks (tech giants Facebook, Amazon, Apple, Netflix and Google, now Alphabet) are well represented in many broad funds that investors already own. Thus, the popular Scottish Mortgage trust holds 7.7 per cent in Amazon, and 4.2 per cent in both Alphabet and Facebook.
Darius McDermott, managing director at FundCalibre, recommends AXA Framlington Global Technology, which invests in well-established tech companies and avoids ‘blue sky’ companies that may have good ideas but zero income and burgeoning development costs. ‘By waiting for companies to fully develop their products, the fund is more likely to avoid the pitfalls that affected tech funds in the early 2000s,’ he says.
Some might say that today’s big tech stocks have had their glory days, and their great success should not mask some of their failings. For instance, it is easy to overlook the relative failure of Amazon’s smartphone, credit card reader and movie-streaming products.
At any rate, even more exciting growth could come from artificial intelligence (AI) and robotics, where practical applications are beginning to proliferate. Many experts say that artificial intelligence and the Internet of Things (IoT) are poised at the beginning of product explosions similar to the era when smartphones first came out, the PC market was dominated by Microsoft and Intel, and the smartphone was the new big thing.
An ETF that specialises in this sector, such as ETFS Global Robotics and Automation, which tracks the ROBO Global Robotics and Automation UCITS index, is a good way to access a broad church of tech companies. It has 20 per cent in computer processing and AI; 15.2 per cent in manufacturing and industrial automation; 14 per cent in actuation and the remainder spread across areas such as logistics automation and sensing.
Babyboomers fuel healthcare
Another exciting theme is healthcare – not just traditional pharmaceuticals, but cutting-edge biotechnology and medical devices. While this market is not expected to grow much in the near term, fabulous growth of as much as 45 per cent is expected two or three years out as demand rises for new drugs for the ageing babyboomer generation, who will have to cope with multiple co-morbidities. Hollands’ favoured option here is the Worldwide Healthcare Trust (WWH), although it typically trades at a premium to net asset value. He also likes Syncona (SYNC), formerly BACIT (The Battle Against Cancer Investment Trust), a multi-manager trust with high exposure to hedge funds that also generates revenues for cancer research charities.
Following a tie-up with the Wellcome Trust, Syncona is transitioning into a life science investment company with a portfolio rich in cancer tackling early stage companies, such as Blue Earth Diagnostics, a medical imaging company which helps detect prostate cancer; Autolus Limited, which develops advanced cell therapies to treat blood cancers; and Achilles Therapeutics, which uses DNA sequencing technology and cancer immunotherapy to create personalised medicines for late-stage cancers.
Financials in recovery
Insurance is an often-overlooked sector, which has been sold down with financials but possesses different qualities. Many insurance businesses are capable of generating high single-digit returns, and are an attractive proposition in today’s environment as the sector is not heavily exposed to the economic cycle. All our experts suggested one particular specialist fund: the £900 million Polar Capital Global Insurance fund.
‘The financial sector is typically a main component of any equity index,’ explains Jason Broomer, Head of Investment at Square Mile Investment Consulting and Research Limited. ‘The largest companies are either banks or life companies, which are complex businesses that require considerable resources to analyse effectively. Property casualty insurers often have similarly difficult-to understand accounts and many have a reputation for being poorly run.
‘As a result we suspect that investors often choose to steer away from this small sub-sector. However, there are a number of well-run organisations in this area that have generated impressive returns for investors over many years. It is no accident that the core holdings in Warren Buffett’s Berkshire Hathaway company are these types of businesses.’
Meanwhile, banks and other financials are still dealing with a raft of challenging regulations such as the Markets in Financial Instruments Directive, or Mifid II, a 1.4 million paragraph rulebook coming into effect in January 2018 that is designed to protect investors with greater transparency; and the Basel III regulatory framework, developed to enhance the stability of the financial system through imposition of more stringent capital requirements.
Major players such as Deutsche Bank, Barclays, RBS and the French banks have been pulling out of the critical US market because various regulatory constraints around unencumbered cash and risk ratios are raising their service cost basis to uncompetitive levels, and the scale of their businesses has shrunk generally. Banks are also under pressure to update their legacy systems and invest in emerging technologies for greater efficiencies, competitiveness and cyber security.
Commodity prices have been erratic since September, with industrial metals such as nickel rising and falling as expectations fluctuate about Chinese demand – but overall commodities and energy in particular look good value.
‘We believe there are three good reasons to re-consider investing into commodities,’ says Jeremy Baker, senior portfolio adviser at Vontobel Asset Management. ‘The first is that excess supply has created downward pressure on commodity prices. However, lower prices will lead to the curtailment of future supply growth, leading to imbalances across the commodity markets and creating the foundation for higher prices in the future.
‘Secondly, low commodity prices, especially when compared to the high valuations of equities and bonds, offer attractive relative valuations for investors. And thirdly, the valuation discrepancy provides useful diversification benefits to investors.’
Precious metals are primarily a hedge against stock market falls; as McDermott puts it: ‘Investing in gold is basically insuring against central bank mistakes – so in these unprecedented times we think a small allocation is sensible.’
Companies with solid environmental, social and governance (ESG) credentials should be better able to weather a correction, as they tend to have sustainable business plans and long-term horizons. ESG investing has grown by more than 97 per cent globally in the past 20 years, according to a report from Merrill Lynch Bank of America, ‘Capitalism and the Rise of Responsible Growth’. Harvard even teaches its students categorically that companies with a sustainability-based approach to their businesses are more profitable over time and deliver better returns to their shareholders.
Emerging countries are well-represented in the sustainability-friendly digital technology, fintech and renewable energy sectors, providing an additional layer of diversification and also access to the growth of the Asian middle classes. The MSCI EM ESG Leaders index has outstripped the MSCI EM benchmark consistently since the 2008 financial crisis, and is a good choice for a sustainable Asian market tracker. iShares for example offers the MSCI EM ESG Optimized ETF.
Russ Mould, investment director at AJ Bell, recommends the £580 million Kames Ethical Cautious Managed, which follows strict ethical criteria. ‘This does limit the range of investments from which this multi-asset fund can pick, but managers Audrey Ryan and Iain Buckle have proved adept at delivering attractive long-term performance within the constraints of their mandate, which caps equity exposure at 60 per cent at all times,’ he says.
And some to avoid
Finally, which sectors should investors avoid at all costs? According to Alan Steel of Alan Steel Asset Management: ‘The herd is still piling into GARStype funds (GARS refers to Standard Life’s Global Absolute Return Strategies absolute return fund), which have under-delivered big style over the last three years. They are also chucking their money into “cheap” trackers and exchange traded funds, which they don’t realise are momentum plays just like the late 1990s over-buying of mega-caps in cap-weighted indices.’
Steel also warns investors to stay well away from US Treasuries, traditionally considered to be one of the safest investments available. If the Federal Reserve raises interest rates faster than anticipated, bonds of all descriptions will be hit. ‘The key thing is to avoid following the herd,’ he adds. ‘2018 could be another nicely surprising year if you manage to do so.’
Specialist fund and trust tips
JPMorgan Russian Securities (JRS) (adventurous growth and income)
SPTR 1 year 8.1%, 3 years 61.2%, discount -15.6%, yield 4.7%
JPMorgan Russian Securities has outperformed the volatile MSCI Russia index over most periods since Oleg Biryulyov became manager in 2002, but it has been a rollercoaster ride. Energy companies account for 40 per cent of the trust’s portfolio, so the oil price is important, and materials and financials account for around 20 per cent each. John Newlands is attracted by the trust’s wide discount and respectable yield, but warns: ‘This is a “fasten your seatbelts” type of investment trust, best judged on a medium-term view.’
BlackRock Gold and General (tactical pick - growth)
TR 1 year -2.5%, 3 years 33.4%, yield 0%
For bearish investors, or indeed even for those at the other end of the spectrum, reserving a small part of a portfolio to gold is widely viewed as a sensible insurance policy. BlackRock Gold and General is the experts’ preferred route to gain exposure to the precious metal, with Rob Burdett pointing out that BlackRock is the world’s largest investor in the sector, so is therefore well-placed to ‘add a layer of skill investing in the best gold and other mining companies’.
VT UK Infrastructure Income (income)
TR 1 year 3.8%, 3 years n/a, yield 3.8%
At the time of writing in late November, inflation stood at 3 per cent, well above the Bank of England’s 2 per cent target. In order to try and keep a lid on inflation, interest rates were restored back up to 0.5 per cent, and there could be further increases to follow over the coming year. Infrastructure has monopolistic pricing power, which has historically helped the sector to act as an impressive long-term hedge against inflation.
Impax Environmental Markets (IEM) (growth)
SPTR 1 year 22.1%, 3 years 74.4%, discount -7.3%, yield 0.8%
IEM has much the best three-year returns in the small environmental/ alternative energy sector. Its managers invest for growth in companies involved in areas such as alternative energy, waste management and water management. The US dominates the portfolio at 44 per cent, and only 8 per cent is in the UK. Tim Cockerill says: ‘Impax Environmental specialises in an area we expect to continue growing as the world addresses many major environmental issues.’
Polar Capital Global Technology (adventurous growth)
TR 1 year 36.3%, 3 yrs 100.9%, yield 0%
Technology stocks are partying like it’s 1999 all over again – only this time the consensus is that the rally has legs because it is built on solid foundations, as businesses across various industries become more efficient in adopting cutting-edge technology. ‘The next stage of innovation is best pursued through established technology funds where the managers have the knowledge and experience to sort the wheat from the chaff ,’ says John Husselbee.
Woodford Patient Capital (WPCT) (adventurous growth)
SPTR 1 year -7.4%, 3 years n/a%, discount -8.7%, yield 0.3%
Launched in April 2015, Woodford Patient Capital seeks long-term capital growth from a portfolio of mainly UK-quoted and unquoted companies. Managed by the highly regarded Neil Woodford, supported by a well-resourced Oxford-based team, over half its holdings are in healthcare, including biotech, and a number are university spin-off s. Results so far have been disappointing, but various experts including Peter Hewitt believe it will eventually do well. ‘Some holdings will have big events next year,’ Hewitt says.
Worldwide Healthcare Trust (WWH) (core growth)
SPTR 1 year 19.1%, 3 years 45.7%, premium 0.7%, yield 0.9% WWH invests in a globally diversified portfolio of pharmaceutical, biotechnology and related companies for capital growth. Its managers OrbiMed are considered world leaders in their field, and the trust has trounced the MSCI World Healthcare index over the past five and 10 years, with less volatility than the biotech specialists. Tim Cockerill expects it to continue to benefit from the rapid global growth in demand for healthcare products. Peter Hewitt says: ‘Healthcare can be volatile but valuations are not high, and lots of new products are coming through, which should boost returns.’
Polar Capital Global Insurance (tactical pick – growth)
TR 1 year 10.6%, 3 years 64.8%, yield 0%
As the name suggests, this fund specialises in the insurance industry. According to Rob Burdett, the sector’s correlation with equities is low. He adds that the manager Nick Martin argues it is at an interesting point in the cycle, as rates for insurers have gone up significantly following the unusually large number of hurricanes in 2017. Jason Broomer, who also tipped the fund, adds: ‘Although the insurance industry can be highly cyclical, enjoying periods of feast and famine, the manager of this fund focuses on the steadier and more mundane parts of the business.’
Polar Capital Global Financials (PCFT) (growth and income)
SPTR 1 year 16.1%, 3 years 49.6%, discount -4.4%, yield 2.7%
PCFT invests globally in financial companies for growth in capital and income. Its NAV total return has pulled a little ahead of the MSCI World Financials plus Real Estate index since launch. Nearly 40 per cent of its portfolio is in North America and over 60 per cent is in banks, headed by JPMorgan, ING Group and Bank of America. Charles Murphy expects the financial sector to be a signifi cant benefi ciary of economic growth and rising interest rates.
P2P Global Investments (P2P) (income)
SPTR 1 year 11.9%, 3 years -14.4%, discount -18.6%, yield 3.3%
P2P Global Investments was the fi rst trust to invest in what many describe collectively as “peer-to-peer” loans. Over its fi rst three years its shares soared to a premium before diving to a wide discount, in part on regulatory worries. John Newlands says: ‘The portfolio currently contains US, UK and European income funds, fl oating rate bonds, real estate loans and money market funds. It has new management in place, is reducing its US exposure and off ers an attractive yield.’
ICG Enterprise (ICGT) (growth and income)
SPTR 1 year 23.6%, 3 years 50.9%, discount -13.2%, yield 2.5%
Jean Matterson is also sticking with ICG Enterprise, formerly Graphite Capital, a private equity fund of funds which has regained its momentum since joining the ICG stable in 2015. ICG’s contacts have widened the trust’s investment opportunities, helping it to become more fully invested, increasing its US exposure and raising the proportion managed in house. She says: ‘ICGT has taken the unusual step for a private equity company of targeting annual dividends of at least 20p a share.’ This has helped close the discount.
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