A cautious investment approach should be taken against a backdrop of economic uncertainty, says JOHCM UK Opportunities Fund.
A sharp rise in mortgage rates in recent months could see fixed-term mortgages taken out during the pandemic and due to expire shortly skyrocket from 1.5% to over 6%, while UK inflation has remained stubbornly high despite energy prices falling.
JOHCM said the numbers are “large, unpredictable and not what businesses or consumers have been used to” and urged investors to adopt a cautious investment approach, especially regarding financial leverage.
The Fund, run by fund managers Rachel Reutter and Michael Ulrich, said it will continue to own businesses which can self-fund their growth through cash-generative business models and avoid those where profits don’t convert into cash or the business holds inappropriate amounts of debt for its business model.
In a statement, the Fund said: “We remain sceptical on suggestions that global economies will smoothly negotiate higher inflation, higher interest rates and the heightened tension between Western liberal democracies and much of the rest of the world. We increasingly expect a bumpy ride for businesses with poor cashflow and excessive leverage.
“We have continued to tilt the portfolio towards stable and resilient cashflows, whilst maintaining our focus on growth that is more structural than cyclical.”
JOHCM believes there will be opportunities in “transmission” assets which connect electricity generation to towns and cities. UK electricity transmission assets are split into three companies, with two (National Grid and SSE) listed on the London Stock Exchange. Both reported strong full-year results during the quarter.
A lack of transmission connections risks deterring the development of new renewable energy and pressure is growing to accelerate the pace of investment in the electricity grid, particularly in the wake of the war in Ukraine, JOHCM said.
The attraction of owning transition assets is that they receive a guaranteed and ongoing return on the infrastructure they build. The return comes directly from consumer bills; however, infrastructure remains a small part of overall costs, which are dominated by energy consumption. Regulation also serves to protect the profits from inflation, giving a “fast growing, visible and defensive profit stream”.
JOHCM expects National Grid’s electricity transmission assets to grow 40% by 2027 and another 40% by 2032. The company’s UK assets sit alongside its US electricity assets that are subject to the same growth tailwinds.
Growth at SSE is likely to be even more significant given the abundance of wind in places like the Shetlands, and the distances that need to be covered to get it to large populations.
SSE now expects earnings to grow between 13% to 16% every year until 2027, and JOHCM assumes a similar level of growth out to 2032.
