Log inMarket Update from Jilly Mann
The last couple of weeks have seen quite a blizzard of announcements coming our way. We had US unemployment data causing woes, AstraZeneca’s possible vaccine causing highs, company reports leading to analysts downgrading their forecasts and Rishi Sunak’s warning of a “recession like no other”. One might be forgiven for looking at portfolio valuations with some trepidation on the back of all that, but over the last week alone, markets are significantly up.
It’s time for me to repeat the mantra that we will keep going over bumps on the road to recovery, so we must remain pragmatic about any short term rises and falls. Undoubtedly there is a more cautious tone amongst economists and market forecasters at the moment, but it remains true to say that stock markets generally lead the economy, that is to say that the global economy could be in a parlous state for some time to come, but markets tend to rise, or fall, well ahead of hard and fast economic data being published.
Looking at some of the funds within the portfolios, the JPM Natural Resources fund is up around 18% over the last month alone and the JPM Emerging Markets fund which we reintroduced to portfolios last month, is up just under 7% over that time period, outperforming the FTSE All Share fund whose allocation we reduced in turn. We foresee this upwards trend from commodities continuing over the coming months and undoubtedly this will also help Emerging Markets whose economies are largely linked to the price of oil. Interestingly, whilst gold is the usual poster child of precious metals, the price of silver has risen over 40% in US Dollar terms since mid-March so we are now seeing a general recovery in broader resources stocks as the world starts to recover from the depths of global lockdown. There will come a point when this theme has run its course, but for now, we still see plenty of upward opportunity.
To continue the theme of commodities, we are introducing the Gravis UK Infrastructure Income fund into portfolios. The fund has been around since January 2016 and has now reached a size whereby we feel comfortable investing into it. This is essentially a UK equity fund. We will divert some of our FTSE All Share Tracker exposure into this Infrastructure fund, which should provide a little more downside protection than the index tracking fund as we move into an environment where the initial pick up in markets has happened and now the focus turns to stock picking and selecting the sectors which are likely to recover from this crisis quickest.
The Gravis fund is quite different to our other holdings and also to most infrastructure funds, which are generally global in nature or heavily biased towards the US. The Infrastructure Income fund invests just under 40% of the portfolio in renewable energy assets for example. The fund aims to generate a yield of 5% per annum net of fees and even in spite of the challenges which Corona Virus poses to business, 91% of the fund’s investments have confirmed that they are maintaining their dividend yield. This is quite different to the 40% yield cuts we have seen in more traditional UK equity stocks. The fund also offers some inflation protection through the nature of the contracts it invests into, although we don’t anticipate inflation rising hugely in the short term, we do need to be prepared for it as the economic dynamics are there for inflation to emerge quite quickly. We remain positive on UK equities, but this fund diversifies our position in that it aims to invest 75% of its assets in Government backed fully operational assets where income and return comes from long term contracts such as GP surgeries or hospitals or even Crossrail. In essence, projects and assets which will still operate and provide a boost to employment post Covid 19.
Touching briefly on inflation, when inflation returns will largely depend on Government action in individual countries. There are worries that as soon as we reach the end of June where the worst of the economic data is in the public domain, public spending will stop, and taxes will soar. I’m not convinced it will happen that quickly. If we think back to 2008 and the Global Financial Crisis, interest rates of 7% were available on savings account, which fell to nigh on 0% in the blink of an eye. Inflation was seen as the natural next step, interest rates had to rise, borrowing had to be repaid, but very little of that happened for quite some time with only really austerity in more recent years coming though to reduce public debt. It was simply that soaring inflation, taxes and interest rates would cause more harm than good. Mortgages would default and not be repaid, the cost of living would go through the roof as wage inflation was stagnant to name but two reasons. The measures taken by Governments so far indicate an acceptance that getting an economy back on its feet, returning people to work and taking the hit on the money pumped in to get through the crisis is more important than immediately ramping up taxes and inflation. That is not to say that we won’t see some steps in that direction, but I doubt we will see much in the very near term, at least not whilst we lack a proven vaccine for the Virus to ward off a likely second wave later in 2020. The threat of the second wave to Government policy and stock recovery shouldn’t be underestimated and further explains our wish to remain invested, but more selectively.
Gravis also run a specific Clean Energy fund, which solely invests in renewable energy sources. This fund will be added to our ethical strategies. Both Gravis funds have a core focus on investing to benefit from decarbonisation and the electrification of heating and transport as traditional forms of generating power need to reform. The JPM Natural Resources fund provides us with exposure to traditional forms of resources which provide us with a tactical opportunity to benefit as the markets recover from unsustainable lows, whilst the Gravis funds allow us to look ahead and take a position in what are fairly mainstream ways of investing for environmental change. To be clear, in the past stocks with such a focus on the environment were often niche and returns were too reliant on one or two factors coming good, so the risk reward balance was out of sync with less confidence on the returns. Those stocks still exist today and I believe the phrase is “blue sky thinking” which is all well and good if it comes off, less so when it is based on hope not evidence. In Gravis and the Liontrust Sustainable Global Growth funds, we have two funds centred on real assets and real investment management who have proven themselves in difficult market conditions.
The Liontrust fund is a familiar staple of our ethical strategies, but the fund has performed really well during this crisis and so we are adding it to our growth strategies as well. It is not alone amongst Socially Responsible funds in having avoided the worst of the recent falls. Socially Responsible funds typically do not invest in sectors which have been hard hit amongst mainstream funds, such as banks for example. The story runs deeper than that though as it not just about what they didn’t invest in, on the positive side of the coin they do invest in innovative stocks focused on healthcare and new technology, many of the beneficiaries, if we can term them as such, of this crisis. The Liontrust fund owns around 44% in technology and 18% in healthcare, but there is no Facebook or Amazon amongst the top ten holdings, so the very technology stocks which we are concerned remain highly overvalued don’t feature in this fund, but we do gain exposure to the broader sector which will form the backbone of the global economy in the years ahead.
I wrote last time about the potential issues facing the Eurozone as the German courts battle with the European Central Bank over the validity of the Corona Virus rescue package. I mentioned that there was still some upside to come in Europe and we have seen a further uptick in returns, but we are increasingly worried that there is increasingly less cohesion between European states in how to recover from this crisis. The French and Germans have stepped up in recent days to provide further stimulus, but when the tide turns to more worrying news than good before we even mention the dreaded Brexit word, we feel it is time to look for better opportunities elsewhere.
Japan is an interesting one as the economy has been one of the few positive lights during 2020, even when Japan was in the midst of the virus. The Japanese healthcare system has held up well to the threat of Corona Virus not least as they have over 4 times as many hospital beds available per 1,000 inhabitants as either the UK or the US. Despite their aging population and the density of cities such as Tokyo, Japan have suffered less than 1,000 deaths as a result of the virus. Nearly 56% of the non-financial companies listed on the Japanese Topix stock exchange have surplus cash on their balance sheets i.e. they have more cash than debt. This compares to just over 15% on the S&P 500. Investors are sold the dream of Japan year on year and it rarely plays out, but when looking at economies that could withstand a second wave both medically and financially, Japan stands out amongst its peers.
The JPM Japan fund has been consistently strong in recent years, interestingly it isn’t a portfolio full of the “usual” Japanese names, there is much more of a domestic focus to its holdings and so the overall strength of Japan will be a key factor in how well the fund does rather than it relying on imports, exports or the currency which is usually a trap with Japanese funds. One of its current themes is automation for manufacturing processes. It is difficult to see how that wouldn’t be a positive trend, post Covid 19. As we think about the structural problems facing the Eurozone, it is interesting to see active engagement between the UK and Japan for finalising a Free Trade Agreement, something which has seemingly only stalled due to the virus breakout and the additional weighting to the Asia Pacific region represents our view that increasingly Asian countries will rely more on each other and less on the West, specifically the US. Globalisation faces challenges in the coming years and as regions close ranks on travel and trade, Asia may well benefit from being home to some of the world’s new powerhouse economies, leaving some of the West in their wake.
As I write this there has been an uptick in tensions with China, as the Communist Party have passed a national security law to tighten controls on Hong Kong. This in turn has started the wheels in motion with further rumours of US/China trade tensions. Immediately, looking at the fallout of this decision, markets have reacted with some concern and one would anticipate some fairly threatening tweets to appear from the US fairly shortly. The tensions with Hong Kong last year certainly caused some uncertainty within markets and this will have a similar effect, but it wasn’t long term and it didn’t affect all Chinese stocks. There will be movements in currency markets and we would expect forecasters and analysts to immediately predict the worst, but we still believe that the Chinese exposure we have within portfolios is largely immune to the political situation within the country and is much more dependent on the domestic and regional market beyond Hong Kong.
To continue the theme from above, we have also increased allocation to Healthcare and Asia in our higher risk strategies. There is a danger that Healthcare becomes something of a bandwagon, which then falls off as soon as Covid 19 is under control, but looking at where investment is likely to be made in the future, with Governments being caught short on Healthcare provision, science and new technology which has the ability to employ bright minds to fix an urgent problem isn’t a position any Government is going to want to find themselves in after this crisis abates. When we talk about now being the time for stock picking, it is these themes which we have in mind, perhaps more than traditional stocks which have been hurt quite badly in recent times.
We have been tempted by some deep value stocks, basically stocks or funds which have lost 40-50% of their value, but in developed markets we still don’t feel that the massive fall represents a buying opportunity. We think some of those stocks may have a recovery of sorts, but our preference at the moment is for quality names with a viable business model, not just cheap for cheap’s sake. It will take quite a lot more Government intervention for us to feel confident in the long term story for some of those stocks.
I wanted to touch on Property on this update. The Property sector has been rather unfairly hit during this pandemic. Certainly, the funds we own have no liquidity concerns at all, which is usually the reason for property funds being hit hard by investor redemptions during global crises. The BMO UK Property fund is sitting on 22% cash at the moment. Of the underlying assets, around 77% of the businesses which trade from property which the fund owns are likely to recommence trading relatively quickly as lockdown eases. All property funds were ceased from trading as surveyors were unable to accurately provide valuations with trade shut down. This is known as a Market Uncertainty Event and hasn’t happened on this scale before. BMO are confident that they will be open relatively quickly once the restrictions ease. They have already received 78% of the rent due for the quarter, with a further 9% on its way, so they are factoring in a worst case scenario of 13% of the quarter’s rent being deferred. I wanted to reference this fund, because I don’t expect most property funds to be in a position to reopen as quickly as the BMO UK Property fund, nor do I expect them to have maintained such a healthy rental yield through a period where the economy effectively stopped. This fund is hugely selective about the assets it owns, it avoids shopping centres for example and where it owns an out of town retail unit, the fund has applied for pre-planning permission to convert the site into residential housing for example, so there is an inherent value to the asset rather than it becoming another dormant retail unit.
The fund is also planning ahead for a more flexible working environment in the future which is either desired by employers to reduce the cost of fixed working space in lieu of increased working from home or is potentially necessary in the event of a second wave of the virus resurfacing in the future. As I have said before, I don’t think the Virus will fundamentally change everything about the way we live and work, but I would rather be invested in funds which can adapt to changing requirements with relative ease. We have avoided the behemoth property funds with huge assets in the City for quite some time now, be that hotel chains, funky Docklands office units. The BMO fund is quite boring, it has an overriding exposure to industrial units which have been in great demand thanks to online shopping and no big Central London units which will sit in the fund potentially dormant if we do see a shift in working patters and flexibility. It is important that we provide balance in these updates and it would be easy for us to not comment on property and the issues facing the sector, solely focusing on all the positives, but we believe that as property finds its feet again, this fund will recover strongly whilst many of its peers are left languishing with huge assets which simply cannot be either repurposed or put to work in the near term.
Our overall view of the markets at the moment is that we want to maintain equity exposure, but we want to be much more specific about where we invest. We still feel that a market recovery will be forthcoming, albeit not a straight line recovery, but we want to build in some defences to portfolios so that we can benefit from the upside, but hopefully also protect some on the downside as the post Corona Virus phase 1 (dare I say that) takes effect.