There are some attractive opportunities around currently, says Darius McDermott, investment adviser to the VT Chelsea Managed Fund range.
Just when investors think they’ve found the answers, the Bank of England (BoE) has once again changed the direction of travel for markets in these uncertain times. I can’t quite believe how quickly things have changed in the past few months. In a previous update, I said UK interest rate expectations could reach an “unthinkable” peak of 4.6% – we’re now at 5% with expectations it could reach 6%.
That has changed everything apart from one key factor – inflation – which remains stubbornly high at 8.7% in the UK. I’m certain the BoE would’ve expected it to come down much faster than this (hence the expectation rates will now reach 6%) but I am also certain the BoE is ready to throw the kitchen sink to get inflation to a more manageable level quickly – particularly as the pressure on the mortgage market cranks up.
The quick return to alternatives – changing allocations in the Chelsea Managed fund range
The consequence of this changing environment is the funds in the range have had to be incredibly nimble, with opportunities arising quickly. This has been the case with alternatives, an area the funds have started adding to once again. The simple reason for this is that some of them are as much as 50% cheaper – we’ve almost gone back to the crazy days of peak Covid, where investment trust vehicles were being unreasonably exposed to market sentiment. In 2020, trusts relying on the sun shining and the wind blowing quickly found their feet again – but on this occasion we’ve not even had a liquidity squeeze act as a catalyst to damage sentiment.
A good example is Supermarket Income REIT – it’s been a big position across the VT Chelsea Managed Cautious Growth, Balanced Growth and Monthly Income funds. It offered a good yield of 5% and investors were getting exposure to real assets – backed by the likes of Tesco’s and Sainsbury’s primarily. By contrast, if you were trying to buy a Tesco bond, it was yielding circa 2%.
Then Q1 happened. Rates continued to rise and, all of a sudden, Tesco bonds were offering a more attractive yield. By contrast, the Supermarket Income REIT’s yield had fallen. This rate rising environment has also seen the share price of Supermarket Income REIT go from 130p in June 2022 to 71.8p as of writing*. The trust has seen its share price fall over 30% since the start of February alone, while over the same period the trust has moved from a 9% premium to a 26% discount**. It went from having a 4% position a year ago to a low of 0.5% earlier this year – now it’s back at 2-3% across the fund range.
There is more to do
The reality is this is just the tip of the iceberg. A vast number of investment trusts in property and other alternatives are now trading at wide discounts – and when interest rates went up 0.5% in June, they fell rapidly. That might make them look like a bond proxy, but the average bond fund is flat this year. Supermarket Income REIT is down almost 30% – in my view it is a proxy on interest rate rises rather than bonds.
That tie to rates could impact future cashflows – but the discount is attractive over the long-term. Supermarket Income REIT and Target Healthcare are both property vehicles with real assets behind them. The latter is the UK’s first care home REIT – people live or rent those properties – the case is solid for rent and potential rental growth.
The reality is there are a lot of specialist trusts out there at distressed levels. We are familiar with them, have owned them in the past and find them attractive at these prices. Another example of that is Assura, a specialist property company that buys GP surgeries. All of the additions to the alternatives space have come from new monies raised and trimming back the equities allocation – not from fixed income, where we continue to see the long-term attraction.
The funds have also been adding to their core UK corporate bond positions in Man GLG Sterling Corporate Bond and Artemis Corporate Bond. UK corporate bonds are the easy choice at the moment – spreads are historically attractive on fixed income, but not at the levels we saw on the back of the Global Financial Crisis or Covid, when interest rates were at record lows. As of writing the two-year gilt stands at just over 5 per cent***, so you should be looking for around 7 per cent from a UK corporate bond (2 per cent above the risk-free rate).
Positioned for anything – but opportunities need to be taken advantage of
Equities also offer opportunities, but you have to be careful, particularly as the strong rallies in the likes of the S&P 500 and the Nasdaq thus far in 2023 do seem a little extreme. The funds have always had an overweight to Japan, and a decent weighting in Europe – both of which have worked this year. They remain underweight the UK versus other fund of funds.
But we simply cannot ignore those alternative opportunities – beyond property they are also prevalent in the likes of infrastructure and renewables, both major long-term themes with levels of protection from inflation (particularly in infrastructure’s case).
If alternatives are the opportunity – then fixed income is the ballast. The markets are telling me rates are going up another 1%, but as the re-mortgaging market starts to feel the bite (people come off fixed rates) that will cause a further slowdown.
I think the BoE should be looking to pause at 5% interest rates – but if inflation remains stubbornly high they’ll have no choice but to keep going. In this scenario – or even one where rates plateau at this level – attractive high single digit yield returns from UK corporate bonds look both realistic and attractive in the next couple of years.
*Source: Google Finance
**Source: Association of Investment Companies
***Source: MarketWatch
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested. The views expressed are those of Darius and do not constitute financial advice. Valu-Trac Investment Management Limited is the authorised corporate director (ACD) and investment manager of the VT Chelsea Managed Funds. Valu-Trac is authorised and regulated by the Financial Conduct Authority (FCA). Valu-Trac’s FCA registration is 145168. Chelsea Portfolio Management Services Limited is the investment adviser for the VT Chelsea Managed Funds.
