This year has been disruptive to markets, with previously neglected sectors emerging to the fore and other collapsing. With unpredictability as a key word, some investors might be wondering which of their falling assets are set to rebound – and which not.
Expectations for a forthcoming recession have gained ground and James Yardley, senior research analyst at Chelsea Financial Services and investment adviser to the VT Chelsea Managed Monthly Income fund, is worried that the downturn of UK and Europe assets is going to be a deep one.
In face of these developments, Yardley discussed which sectors are unlikely to recover and have been expunged from VT Chelsea Managed Monthly Income, and why.
Subordinated bank debt
The first area that Yardley thought is probably best avoided is subordinated bank debt. The current base case view among the investment advisers is that the UK and Europe will head into a deep recession and this will cause credit spreads to widen, which makes subordinated bank debt far less attractive, explained Yardley.
“Heavy regulation post the global financial crises has stopped banks from making much in the way of profit but has also made them much safer and almost turned them into utilities,” he said.
“We sold them because the trade had largely played out. Spreads on subordinated bank debt had tightened significantly, the risk reward was no longer as good, and de-risked banks are still highly geared and vulnerable to a recession.”
A key sector to help the transition to renewables and net zero, Chelsea decided to sell out of battery storage trusts for numerous reasons.
Firstly, trusts in this sector went to a very high premium, which is one reason Yardley gave for why they were sold. Secondly, there were concerns about low barriers to entry and unstable cash flows, which made it hard to guarantee consistent dividends. Lastly, new batteries are likely to be better in the future, and as existing batteries degrade, they need to make a lot of cash quickly to justify themselves.
“In hindsight we probably got this one wrong,” said Yardley.
“These trusts have been huge beneficiaries of the volatility in energy prices and the country is simply desperate for this type of infrastructure given the huge expansion in renewable energy. The greater need for battery storage doesn’t look like changing any time soon. However, we still don’t think this is a ‘buy and forget’ investment as there are risks.”
According to Yardley, residential housing will be highly impacted by the upcoming recession, which, combined with higher energy and food bills, will mean that people will also find it harder to pay their rent, threatening the income of trusts in this sector.
"As a team we think higher interest rates will cause the housing market to slow and then fall. Higher rates will limit the amount new buyers entering the market are able to pay. This will force prices down across the board,” he said.
“We also think the UK is heading for a combination of a deep recession and higher interest rates which will likely be very negative for the housing market. Housing is already very expensive as mentioned as a proportion of people's income and needs to fall."
Chelsea gave up on student accommodation pre-Covid, on the basis of its low yield and of rent increases which were perceived as unsustainable in the long term.
"After Covid and Brexit there was also a concern that far fewer students would come to study in the UK, reducing a significant amount of demand for student accommodation, while people had other alternatives to expensive accommodation, such as potentially attending lectures online."
Despite the high demand for social housing, problems between the regulator and the housing associations prompted Chelsea to sell its position in the asset class.
“In addition, cash generation was weak and there were concerns about the sustainability of rent and that cash generation would not allow for sustainable growing dividends in the long term and whether the level of the current rents were justifiable or sustainable,” said Yardley.