The Fund Calibre team delves into the dynamics of investment trusts – including the substantial discounts some are trading at – with Niall highlighting the potential for mergers and acquisitions in this space.
Niall finishes with his outlook for 2024 and the polarised nature of a potential recession in the UK.
Listen to the full interview here:
Why you should listen to the interview: Listeners can gain a deeper understanding of the current economic landscape, the potential for interest rate changes, and how different investment opportunities are affected. The key takeaway is the importance of considering the impact of inflation on investments and how to navigate these challenges.
Interesting points within the interview:
UK mortgages
“So, although effectively this mortgage rate increase has been baked into the cake for a while, we haven’t really yet seen the economic impact of it. People whose mortgage will be refinanced towards the end of next year, I don’t think their spending patterns will really change until maybe the middle of next year. So, the economy hasn’t slowed as much as you might have expected it to yet. And that’s really where we see the lags come through.
Likewise with companies refinancing debt, a lot of companies with fixed rate debt – if you’ve got five year fixed rate debt, you know you’ve got a problem in the future, but it’s not really showing up in profits for now, for instance.”
Round Hill Music
“It’s one of the two investment companies in the UK that invests in writers’ music rights. The other one is Hypnosis Songs fund. So Round Hill is the smaller one. We preferred it from a quality perspective. As the economy grows and as more people consume music – global music consumption goes about up about 8% each year at the moment – you’ve got a rising revenue stream.
And it traded to a very, very big discount. I think it got to 51% discount at one point because what we’ve really got in the investment trust space at the moment is a buyer strike. People are just buying government bonds because they’re looking at a government bond and saying, I get 5% risk free and I lost a lot of money last year, I don’t want to take any risk. So, as a result of that, you’ve seen redemptions, outflows from open-ended funds that hold investment trusts.
Nobody really wanted to own an investment trust and hence it went to a 51% discount. And then it got bid for at a 67% premium to the previous day’s close – that was still an 11% discount to its net asset value so, I think sort of everyone’s a bit of a winner there; the shareholders get a 67% uplift; the IPO price was a dollar and we’re being bought out at $1.15 and a half, and we’ve had dividends along the way, the shareholders are happy and the acquirers are happy as well because they’re buying some assets at a slight discount to net asset value. And it was our third biggest holding, so, it’s been a real win for us and vindication of our investment process and philosophy as well, I think.”
More M&A?
“I was just having a look through our holdings and the discounts are, I mean, I’ve never seen them so wide to be honest. So, I looked through our fund and if you looked at investment trusts where you could pay a 30% premium to the current share price and still end up paying less than NAV – and a 30% premium is a sort of typical buyout premium – but you still get them at less than net asset value ie. less than the actual value of the company, then 30 of our holdings fall into that category.
That’s 30% of our whole fund you could have takeover of. And I think you’re absolutely right, US private equity must be having a look, particularly with the strength of the dollar recently. It makes UK assets look very cheap. But I’ve never seen a situation where we’ve got so much of the fund you could bid for.”
Government bonds
“So the thing is, if you’re buying a government bond at the moment, you’re getting around 5% return. So, if you’re buying a one year government bond, you’re going to get 5% come hell or high water. The problem is, CPI is 6.7%, so it is all very well if you invest £100 in a government bond, now you’re going to get £105 in a year’s time, but the price of everything will be £106.7. So, in real terms, you’ve lost money, you’re actually walking backwards here.
I think people just haven’t got acclimatised to the fact that the price of everything is going up and hence your required returns are higher. If you look through a lot of our investment trusts now, the dividend yields are sort of 11% or 12%, whereas, you know, they would’ve been 6% or 7% before because everything has gone up 5%. And, as a result, we haven’t invested in government bonds.”
Polarised recession
“Because only about a third of people have mortgages and I think this recession, let’s call it, there kind of will be a recession, but it’s going to be a strange one because if your mortgage has gone up £1,000 a month, you are kind of personally in a recession already. You’ll be cutting back on, you know, £1,000 a month, that’s £12,000 a year, that’s way more than a family holiday, so you’ll already be feeling as if you are in recession.
So, we’re going to end up with a very polarised recession, where some people won’t notice it at all and other people are going to be feeling it. And I think again, it depends a lot on income deciles. If you’re in the very bottom deciles with benefits going up with inflation, it’s not great, but you’re not the worst off. If you’re in the top two or three deciles, your assets have appreciated, so you’re probably okay. But somewhere in the middle, you’re going to be feeling economic times are quite hard. And you know, as well, I think the job market will weaken a little bit as well. But again, you know, we’re seeing good pay rises, we’re seeing 7%-8% pay rises at the moment in the UK. So it won’t be a deep recession but I think some people will feel like there is one.”
Conclusion: This interview serves as a call to action to stay informed about macroeconomic trends and carefully assess their investment portfolios. It encourages them to diversify and consider alternative assets, such as short-dated index-linked government bonds, and to be mindful of the impact of inflation on real returns. It’s a reminder to continuously monitor the market, evaluate risk versus reward, and consider the potential for mergers and acquisitions in various sectors.
Listen to the full interview here:
Main image: alice-yamamura-iAVTikZXqR0-unsplash
