This week’s investment soundbite from FundCalibre is with Alexandra Jackson, manager of the Rathbone UK Opportunities fund. She comments on the impact of Silicon Valley Bank’s failure on UK start-ups and discusses the wide range of opportunities to be had in the UK equity market.
(Podcast pre-recorded 30 March 2023)
Can you give us your views on Silicon Valley Bank [SVB], and the impact this has had on some of the UK’s most creative companies?
There is definitely some second-round impact that we need to think about in the UK. I don’t think this is a systematic issue that we need to get extremely nervous about, because of the way that the Fed has reacted and because of the signs that I’ve seen in bank lending since. But SVB had a very impressive Rolodex of relationships with US tech firms, but also a lot of UK tech firms, and during that era of very low interest rates, those tech startups increasingly banked with Silicon Valley Bank.
SVB was taking a big share of those deposits and those loans and they were attracting more deposits than they could lend out.But those deposits weren’t particularly sticky because they were effectively current accounts for very cash-hungry, loss-making startups. So, with short deposits on one side, and then the assets that they had on the other side of the balance sheet being very long duration bonds, it basically became an asset liability mismatch. This is banking 1-0-1. And when short rates started rising,and long rates didn’t really move, SVB was very long duration, during one of the most violent yield curve inversions we’ve ever seen. You get huge losses and then a depositor base which gradually and then very suddenly noticed that a) they could get a much better rate on their money somewhere else, and b) were able to pull their money, just with a very quick swipe on the app.
But note, it wasn’t the asset quality that was the problem, and it wasn’t the quality of the loan book that was the problem; it was just a simple case of balance sheet mismanagement. That’s reassuring because I think it demonstrates that it’s idiosyncratic,rather than systemic credit issues.
I spoke to the CEO of one of our portfolio holdings just after SVB UK was taken over by HSBC. Molten Ventures [Molten Ventures VCT plc], the company we own, is a UK-listed venture capital firm, and they have stakes in around 70 private, early-stage, consumer tech businesses. Their view is that there will be more strain in this kind of startup part of the market, and that some business models really only worked because of the era of free money.
But the companies that they [Molten] invested in their core portfolio are fully funded for 18 months, so they don’t need any more cash in order to realise their growth forecasts. These startup companies are growing very rapidly as well – we’re looking at 60%+ a year for some of these companies – so they’re not really the areas that you’d be worried about. But nonetheless,Molten have been asking their businesses to cut their costs where they can, to reduce that cash burn, so that they’re doubly surethat they don’t need extra cash, without harming the long-term growth. And actually, what he said was that the end of free money raises the bar for success. So, weaker players will fall by the wayside and the strong will get stronger. He thinks that plays to his portfolio. I know that it definitely plays into our investment style, which focuses on high quality, category leaders,best in class.
I read a commentary from you from 1 January this year, where you said 2023 would be a year we’d start to feel the chill from monetary policy. Is now the time to spot some of the stronger from the weaker firms?
Yes, this should be a really good time for stock picking, and valuation will be the key. When you get this very rapid tightening cycle, strange things happen, for example, cryptocurrency frauds and bank runs. But more prosaic things happen as well. For example, companies have to spend more money paying their interest bills, funding might not be as plentiful; we’ve had supply chain issues, labour shortages, all of those things, which mean companies potentially have to downgrade their revenue and profit expectations.
And when you get downgrades, valuation becomes essential because, for share prices to move forward, you need to be in areas that have already priced that in. And actually, the UK does score really well there as the cheapest developed market out there – the UK trades on around a 40% discount to global equities now
The portfolio has a reasonable weighting invested in the FTSE 250 and also in AIM-listed companies. Are the clouds lifting for the FTSE 250, for these midcap companies?
I think a lot of the headwinds that really weighed on the FTSE 250 last year are slowly lifting or maybe even reversing. Politics has been one of the strongest upside surprises in recent months, with the current government having achieved some success with the Windsor framework.
Gas prices are back down below levels they were before Russia invaded Ukraine which is a really nice boon for consumers and for businesses. It means hopefully that inflation has peaked and therefore interest rates are probably pretty close to peaking. And sterling has bounced really nicely, and these are all really good predictors of midcap outperformance.
Can you give us an example of a midcap holding?
Keyword Studios plc is a really interesting UK midcap. They are a video game outsourcing business. Although we really like the video game space, we’re never sure exactly which game is going to do best and exactly which console, which area, which niche etc. So, we would rather go one stage back and buy the outsourcers. Keywords does game design, game support, game translation, all of those things for almost all the AAA manufacturers.
Regarding your AIM weighting, are you having to meet management a bit more, to really get under the bonnet, even perhaps more so in this environment?
Yes, for us it’s about raising the bar again in terms of the quality, the accounting focus. We are becoming stricter all the time about finding those signposts in the accounts that suggest that all is not what it seems, usually around the same things: cash, accruals, and working capital. We have also raised the size limit a little bit in AIM, and that seems to help a bit.
But our AIM weighting has come down a lot in recent years, partly because a few companies have been taken out, have been bid for, we have sold a couple of companies, and then lots of companies are moving from AIM to the main list, which is an interesting development. For years, having said “there’s nothing wrong with AIM, we’re happy here”, actually now people are saying we need to demonstrate that we have the most stringent corporate governance and accounting and all of those factors. And one way to demonstrate that is to move on to the main list.
Can you tell us a little bit more about UK companies that can benefit from US infrastructure spending?
That’s a really interesting theme running through the portfolio at the moment. It’s not just the Inflation Reduction Act, the IRAthat’s behind this theme; it’s also the CHIPS Act, the JOBS act, … there is a lot of stimulus around infrastructure spending, which is percolating through the US economy which is being translated into actual dollars on the ground now, which is something I think people often worry about with infrastructure spend – that you actually never see the dollars, and that the companies never really benefit from it. Actually, it’s happening now. So, companies that we invest in, like Ashtead [Ashtead Group plc] and CRH [plc], which are both in the FTSE 100, and then Hill & Smith [plc] also, which is a FTSE 250 business, are variously involved in different parts of the infrastructure space.
So, CRH does aggregates and cement, and so is very involved at the very beginning of building roads and bridges and things like that. Hill & Smith, they galvanise steel, and so would be more involved towards the end of building a bridge or similar.Ashtead rents out the equipment that you need during that whole process. This means all three companies are benefiting from that US infrastructure spend, just at slightly different points of that cycle.
Give us your view for UK investors and why now might be an extremely good time to go into UK equities.
Firstly, it’s about valuations. There is a margin of safety, this great cushion, that means we can absorb some of these downgrades. I thought it was really interesting that, during February, when the US market sold off because of all theseconcerns about a harder landing and recession, and during that time period, the UK market was up a little bit. I think that’s a good pointer for how this year could potentially play out.
Secondly, we are beginning to see some of those headwinds disappearing around politics, interest rates, sterling weakness. It’s also good to recognise that the stock market is not the same as the UK economy. So, if you can stay active and be quite selective in the names that you own, so, for me, if you can really focus in mid-caps – which is where the alpha comes from – if you want to outperform in UK assets, you need to own FTSE 250 businesses, not just the FTSE 100. And if you can stay in quality, you can try and outrun some of those potholes that can hinder performance. And, if there is a recession, these type of companies in the mid and small cap space tend to be the ones that lead recoveries as well.
You can listen to the full interview below:
[Main image: Jack-emily-wang-P84Q6CTSIT8-unsplash]
