We differ from market consensus in that we expect interest rates to remain low for the foreseeable future; at the moment the investing public believes that the current low level of interest rates is a temporary, rather than structural, phenomenon. Once the collective penny drops that this situation will last for years rather than months, dependable sources of revenue will become sought after.
Many investment trusts which chose to focus on defensive equities endured a difficult 2009. This has dented sentiment towards them and as a result it has been possible to acquire these on relatively wide discounts. This provided a useful entry point and as a result we have started to build a position in Perpetual Income and Growth, a trust managed by Mark Barnett.
Other increased positions within this theme include Greenwich Loan Income, PSource Structured Debt and Tetragon. These are all debt specialists which, for one reason or another, have been prevented from paying the intended level of dividends and their share prices have been hurt as a result. Once these payments recommence, the running yields will be both high and sustainable.
Following different themes - funds identified by Nick Greenwood
Source: Financial Express Analytics
We continue to favour funds where the managers have a substantial personal investment. Currently 14 of our portfolio positions have a significant percentage of their equity owned by insiders. Backing investment trusts where managers own a significant stake is not dissimilar to following directors into the shares of industrial companies. It exposes investors to situations where there is high conviction demonstrated by those involved. There are two distinct types of situation. On the one hand there are vehicles such as Establishment Trust, Artemis Alpha and Jupiter Second Split which were always designed to be a vehicle for their managers own wealth. More recently we have been adding to situations where those close to trusts have reacted opportunistically following a slump in the open market valuation of their funds and bought aggressively.
In relation to pharmaceuticals we knew that there was bad news on the horizon and this caused significant under pricing and uncertainty. Traditionally healthcare margins are much higher in the US than in other geographical areas. This allows companies that operate there to make disproportionate profits. In our view, prices fell too far and were unlikely to recover until the extent of the bad news was clarified, and they would not correct until certainty returned to the market. Obama’s healthcare reform bill aims to tackle the distribution and insurance side of the healthcare market but not the actual costs (pay for your drugs/doctor). In this respect prices in the sector have risen and we believe that the theme has come close to maturity.
Generally speaking bank balance sheets must continue to deleverage. The cause of the credit crunch lies in the fact that over the last decade, these became steadily more bloated. The authorities will need to continue to encourage banks to deleverage further. Despite our government investing in the equities of Lloyds and Royal Bank of Scotland and committing £200bn towards a programme of quantitative easing, more will have to be done. Therefore achieving a stable environment depends on the government’s ability to continue to tap the global credit markets. The process of deleveraging is deflationary as for every billion pounds retired from the balance sheet of a bank which is 35 times geared; £35bn evaporates from within the real economy. This sum is no longer available to invest in assets or buy goods and services.
The scenario is not necessarily all doom and gloom. The last time state debt had to be paid down on this scale was in the fifties. Whilst that decade was austere and by all accounts not an exciting one to live through, equities did well and that period saw the development of the reverse yield gap. In an environment where returns from cash are close to zero, a company which can generate earnings growth of, say, 7 per cent and further 3 per cent or so in dividends is a highly attractive prospect. It is distinctly possible that in time investors will pay a premium for such returns and push some share prices higher.
A side effect of the deleveraging process is likely to be a continued rise in the value of the dollar. This is because much of the debt has been drawn down in this liquid and low cost currency. This would not be good for commodities which are usually priced in dollars and also Asia which would become less competitive as many local currencies are linked to the greenback in some way. The whole process may be accelerated should Obama’s banking reforms succeed. These would cut many proprietary trading desks access to funding from the Fed window, pushing their cost of capital significantly higher.
On my recent round of presentations and updates to potential shareholders, I failed to meet a single bull. A background of ubiquitous bearishness combined with the fact that equities have declined over the past ten years would be an unusual setting for a savage bear market.
Looking at our sector, it should be remembered that the aftermath of a new issue boom has been historically a good time to invest. Many launches from the 1993 to 1995 vintage languished on substantial discounts towards the end of the nineties, a landscape similar to today's. Most of these proved successful investments as their discounts narrowed either because they fell prey to corporate activity or their asset class came back into favour.
Nick Greenwood Manager of the iimia investment trust and CF Miton Select Assets Fund. The views expressed here are his own. No recommendations are implied.