Investors should consider increasing exposure to assets that are uncorrelated to the business cycle as the short-term upside potential for most developed equity markets is limited, according to Stockdale Securities, which highlights an investment trust looking attractive from this point of view.
After stock markets were hit with heavy losses in the opening weeks of 2016, things have been looking better since mid-February with the S&P 500 currently up 3.08 per cent year-to-date and the FTSE All Share gaining 1.83 per cent.
Performance of indices over 2016
Source: FE Analytics
Stockdale Securities analyst Saumya Banerjee, however, argues that the rally means further progress from here could be difficult to achieve.
“With the S&P 500 near the top of its trading range, we believe that markets have limited upside potential from current levels in the short term,” he said. “Equally, with the recovery in oil prices, the continued strength of the US employment data and accommodative monetary policy globally, we see limited downside risks in the short term.”
Balanced against these positives, though, are “many” short-term headwinds that threaten to overthrow the current bull run.
These include the likelihood that the Federal Reserve will raise short-term interest rates in June/July, the looming remain/leave referendum on the UK’s membership of the European Union and mounting debt-to-GDP ratios in China.
Against this backdrop, Banerjee says investors could consider using the current rally to lift exposure to non-cyclical assets with a high covered yield.
He highlights Primary Health Properties, which is a real estate investment trust (REIT) that invests in UK healthcare properties. More than 90 per cent of its income stream comes from the UK government or related sources and it operates in an area that is set to expand.
“Primary Health Properties has a high covered dividend yield while deriving virtually all its income from the UK government. Given the length and structure of the leases that Primary Health Properties has we believe that it is an ideal candidate for both long-term steady returns and for protecting one’s portfolio in turbulent times,” the analyst said.
As shown in the table below, the REIT has had a low correlation to UK and global equity markets over the past five years, as well as having a negative correlation to UK government bonds.
Source: FE Analytics
Banerjee adds: “Indeed, the faith of the market is exemplified by its historic beta to the FTSE All-Share index (0.53). We believe that, while this is a useful number, it does not fully capture the downside protection and optionality that Primary Health Properties provides despite its relatively high loan-to-value ratio.”
“In our view, the potentially asymmetric nature of returns that we might experience in the short term makes Primary Health Properties an excellent candidate for capital protection, while capturing most of the upside potential of the FTSE All Share index.”
FE Analytics shows that the REIT actually had a higher maximum drawdown that the FTSE All Share during the global financial crisis, at 50.81 per cent (in total return terms) compared with the index’s 41.09 per cent drop, as well as being more volatile.
This might not be surprising, however, given that the financial crisis was based on problems in the property space.
Over the past five years, on the other hand, the portfolio’s maximum drawdown has been just 6.45 per cent (compared with the FTSE All Share’s 14.50 per cent) while it has been slightly less volatile than the market at 9.93 per cent.
Performance of trust vs index over 20yrs
Source: FE Analytics
It is also outperforming the over one, three, five and 10-year periods; over the past 12 months it’s made 11.83 per cent while the FTSE All Share is down 7.03 per cent and over three years it’s up 53.80 per cent while the index has gained 8.354 per cent.
Stockdale Securities believes the trust, which owns 267 completed primary healthcare properties and has six in development, offers a “strong combination” of current income and future growth.
It has consistently grown its dividend over the past 20 years and the number of patients it serves is still only around 5 per cent of the total population, despite owning properties worth a combined £1.12bn, suggesting strong growth potential.
“With NHS England’s Five Year Forward View reaffirming list-based primary care as being the bedrock of the NHS, it is set to invest more in primary care,” Banerjee said.
“With more than 50 per cent of the current GP practices in residential conversion being more than 30 years old, there is a continued need for modern properties that can deliver extra services, more training and education and be able to deliver the 24/7 GP access model that the government is targeting by 2020.”
“Primary care spend is projected to rise 4-5 per cent per annum. The NHS is starting to approve new developments and the pace is likely to increase. With well-established links to GP owner-occupiers, we believe that PHP is poised to continue to grow.”
Furthermore, the REIT is expanding into the Republic of Ireland. The Department of Health in Ireland plans to widen access to primary care and Primary Health Properties intends to get involved with the new large, modern, integrated primary care centres that have been built or are being constructed.
