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It is becoming increasingly clear that travel is a winner-takes all market. In the future there won’t be separate online hospitality companies in every country, just one dominant global player – Airbnb
I was sitting behind Brian Chesky, the chief executive officer (CEO) and co-founder of Airbnb, at a conference in Arizona in November 2011. Chesky was due to speak the following day, but he was still working on his slides, shuffling things around. I was thinking, “Who is this guy? This is a big event tomorrow, and he’s not even finished his presentation yet.” The following day, I sat and listened to Chesky. We didn’t invest. Later, I came across an interview with Jeff Jordan, a venture capitalist at Andreessen Horowitz and former CEO of OpenTable. He was talking about listening to Chesky at that same conference, and how the penny dropped for him that Airbnb was going to be the eBay for hospitality. It was going to be massive. Jordan went out and led a round of funding that valued the company at $1.3 billion. I listened to the same presentation, but I didn’t see the magic. The penny didn’t drop for me until July 2015, when we invested. By then the company was worth 20 times as much. Often the biggest mistakes we make are not investing early enough in companies. I’ve stayed in Airbnbs on my extended visits to San Francisco and with my wife when she ran the London Marathon earlier this year. Our Airbnb apartments were generally a little more comfortable and luxurious than the airbed accommodation originally rented out in San Francisco when Airbnb began in 2008. Its great attraction to users then was that it was cheap. Airbnb created a new kind of accommodation that has displaced cheaper hotels and bed and breakfasts: home rentals. At the same time, it built up an inventory of underutilised assets – rooms or second homes – and created income for the people who rented them out. Since then, an ecosystem has sprung up around it, with individuals and companies managing over 5 million properties listed with Airbnb. Today Airbnb has more bookable listings than any major hotel group and is in 81,000 cities and over 191 countries around the world. Travel is a global market, by its very nature. And it is becoming increasingly clear that travel is a winner-takes all market. In the future there won’t be separate online hospitality companies in every country, just one dominant global player – Airbnb. Airbnb has created a marketplace. We like marketplaces, because they don’t require much capital to add another component.
When Tom Slater first came across Airbnb’s Brian Chesky, he didn’t spot the magic. Here the joint manager of Scottish Mortgage Investment Trust explains why he changed his mind.
Room for Growth
Amazon is a classic example. It started with books and has expanded into selling multiple other product lines such as music, apparel, consumer electronics and groceries. Marketplaces create value on both sides, in Airbnb’s case not just for travellers, but for hosts too. Marketplaces can be scaled up, because the more users you have, the more suppliers you get. The more suppliers you have, the more users want to use your service. There is a competitive dynamic highly skewed towards the largest provider. The returns on scale can be huge. We believe that Airbnb is thinking about growth in a similar way to Amazon in its ideas about expanding the travel experience, by creating different categories of accommodation, including luxury homes and boutique hotels and unusual spaces that aren’t homes such as yurts, treehouses, boats and igloos. It’s offering experiences, from Beatles tours to hunting for truffles, with local guides who get an income from them. At the same time Airbnb has stayed focused and avoided expanding into lower margin and non core areas such as flights. By acquiring an inventory of each trip, Airbnb is at the hub of all the data, which it can use to support profiling and marketing. There are some parallels with Amazon. And underpinning both brands is the customer’s trust. Airbnb has run into some challenges with local authorities and regulators, but we have been impressed by the proactive way in which it has dealt with these. Chesky was very young when he started Airbnb, but he has consistently demonstrated that he can learn and grow. Anybody who goes from nothing to running a business at this scale is a unique individual. I only wish we had spotted the magic earlier.
IMPORTANT INFORMATION Investments with exposure to overseas securities can be affected by changing stock market conditions and currency exchange rates. The trust’s risk could be increased by its investment in unlisted investments. These assets may be more difficult to buy or sell, so changes in their prices may be greater. For more details on the Scottish Mortgage Investment Trust, including the Key Information Document, please see our website at www.bailliegifford.com This article does not constitute, and is not subject to the protections afforded to, independent research. Baillie Gifford and its staff may have dealt in the investments concerned. The views expressed are those of Tom Slater, are not statements of fact, and should not be considered as advice or a recommendation to buy, sell or hold a particular investment. If you are unsure whether an investment is right for you, please contact an authorised intermediary for advice. Baillie Gifford & Co Limited is authorised and regulated by the Financial Conduct Authority (FCA). The trust is listed on the London Stock Exchange and is not authorised or regulated by the Financial Conduct Authority.
The value of your investment and any income from it can go down as well as up and as a result your capital may be at risk.
As I write, in the middle of December, the FTSE All-Share is down nearly 8% year to date and that’s measuring the benchmark on a total return basis with dividends from London-listed companies included. Excluding those the index is down over 11%. In the aftermath of the EU referendum investors continue to do better outside the UK with international markets up an average of 3%, according to the MSCI World ex-UK index, but that modest gain has largely been driven by the weakness of the pound against the dollar. The US stock market, incidentally, has gone sideways, in dollar terms. UK investment trusts focused on smaller and mid-cap stocks have generally done poorly with their shares down an average of 11% and 17% respectively. Equity income trusts both in the UK and overseas have also struggled as rising interest rates and industry changes have made some dividend stocks, like tobacco companies, look very un-defensive indeed. With Asia, other emerging markets, Japan and Europe all down in sterling terms, the few obviously good places to have had your money this year were infrastructure, biotechnology and healthcare and student accommodation with average investment trust sector total returns of between 7-10%. Despite this bruising experience, investment trusts have not suffered a wholesale de-rating and a widening in their shares’ discounts to net asset values. Nevertheless as the experience of some trusts whose bubbles did burst this year shows, it’s important to be aware of discount risk if the market turbulence continues next year, as Rob St George explains. While some caution is warranted as we near the end of the bull market, it’s also sensible not to be too despondent. For long-term investors one bad year is a blip. Besides, as this year’s turnaround in social infrastructure funds shows, when investors become too bearish there will always be other investors willing to take advantage. It’s interesting to read Danielle Levy finding professional investors who are eyeing the UK stock market whose cheapness may attract more buyers whenever we get Brexit clarity of one form or another. While investment returns have been poor, it’s been a good year for investment company launches. Jennifer Hill’s article and timeline shows how 19 closed-end funds have to varying degrees defied the gloomsters and listed on the London Stock Exchange to raise £2.9 billion from investors. True, Terry Smith’s global smaller companies trust Smithson generated more than a quarter of that alone with its blockbuster £822 million flotation. That’s further proof – if more were needed – that investors like a trusted guide through these uncertain markets. ♦
‘The few obviously good places to have had your money this year were infrastructure, biotechnology and healthcare and student accommodation’
Absent a late Santa rally, 2018 is going down as a tough year for investors. Political and market turbulence has made for a volatile 12 months, with the ‘Red October’ sell-off starting a punishing fourth quarter.
The lessons of a tough year
The bright side of Japan's labour crunch
As Japan’s population declines, it has been left with a glut of about 8 million abandoned homes, known as ‘akiya’, across the country. Katitas, held in Baillie Gifford Shin Nippon, buys up such houses, renovates them and sells them at an affordable price – rejuvenating communities and giving young families a start. Katitas is a compelling example of the opportunities to be reaped in what looks like an alarming demographic picture – often cast as condemning Japan to long-term decline. One of Japan’s most pressing issues is an acute labour crunch as its working age population, which peaked in 1997, continues to shrink. There are currently about 160 job openings for 100 applicants, the tightest labour market since 1974. One-third of Japan’s construction workers are over the age of 55. Many all-night restaurants in Japan are closing because they cannot find enough staff. And Yamato Transport – Japan’s largest parcel delivery company – is mulling an exit from Amazon same-day deliveries because of a lack of drivers. Yet there is another way to look at labour shortages that points to a brighter future for Japan’s economy. Outsourcing and labour-saving technologies are the stellar growth drivers in the labour crunch. One company that is benefiting from this structural tailwind is the specialist staffing company Outsourcing Inc, which both Baillie Gifford Shin Nippon and the Baillie Gifford Japan Trust hold shares in. During Japan’s long period of stagnation, companies began to rely heavily on contract workers over permanent staff to rein in costs. The government subsequently introduced legislation that requires companies hiring staff working on temporary contracts for more than five years to employ them as permanent employees. Outsourcing’s business model effectively hires such workers from major corporations as regular employees – providing them with the benefits of permanent staff – and leases them back to the company from which they originally came. The client pays an annual fee to Outsourcing and also pays the workers’ wages.
About 40 per cent of Katitas’s workforce is female and the company is proactive about bringing them into management. Last year, all five top salespeople on Katitas’s staff were women
Not only are they providing this large pool of experienced workers to companies that need them, they are also hiring these contract workers from their clients and employing them as their own full-time employees, giving them all the associated benefits such as pensions, insurance and wages commensurate with their experience and expertise. This arrangement removes a potentially expensive staff overhead for clients. Meanwhile, Japan’s world-leading expertise in robotics gives it natural advantages in "labour-saving" strategies. Cyberdyne is a company in the Baillie Gifford Japan Trust’s portfolio that makes a robotic exoskeleton, enabling the physically disabled to walk. Now its technology is being used on construction sites to help workers perform heavy lifting. Other labour-saving technologies exploit inefficiencies in Japan’s economy – a system of middle-men and legacy relationships that push up costs for consumers. Infomart, for example, allows restaurants to place orders online from suppliers, in an industry greased by personal contact. Broadleaf runs a platform for garages to shop around for auto parts online. Both companies, which are in Baillie Gifford Shin Nippon’s portfolio, challenge cherished practices that serve as social binders but hold back an urgent need to boost productivity. And Katitas – the company that renovates abandoned homes – is a pioneer in promoting Japan’s most important neglected labour resource of all: its women. About 40 per cent of Katitas’s workforce is female and the company is proactive about bringing them into management. Last year, all five top salespeople on Katitas’s staff were women. And unusually for Japan, the company extends generous maternity leave – without any career setbacks to be expected upon return. Kumar believes that, contrary to the downbeat commentary you see in the financial press and elsewhere, there is a brighter side to Japan’s labour crunch both for investors and for society at large.
Innovation is often born out of necessity. Praveen Kumar, manager of Baillie Gifford Shin Nippon and deputy manager of the Baillie Gifford Japan Trust, tells journalist Joji Sakurai that Japan’s staff shortages have sparked creativity and investment opportunities.
IMPORTANT INFORMATION The value of a stock market investment and any income from it can fall as well as rise and investors may not get back the amount invested. Investments with exposure to overseas securities can be affected by changing stock market conditions and currency exchange rates. Investment in smaller companies is generally considered higher risk as changes in their share prices may be greater and the shares may be harder to sell. Smaller companies may do less well in periods of unfavourable economic conditions. The trusts’ exposure to a single market and currency may increase risk. For a Key Information Document please visit our website at www.bailliegifford.com This article does not constitute, and is not subject to the protections afforded to, independent research. Baillie Gifford and its staff may have dealt in the investments concerned. The views expressed are those of the manager, are not statements of fact, and should not be considered as advice or a recommendation to buy, sell or hold a particular investment. If you are unsure whether an investment is right for you, please contact an authorised intermediary for advice. Baillie Gifford & Co Limited is authorised and regulated by the Financial Conduct Authority (FCA). The trusts are listed on the London Stock Exchange and are not authorised or regulated by the Financial Conduct Authority.
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Banerjee expressed more caution. ‘It is not unusual to see discounts in private-equity funds remain relatively wide when there are fears about a long cycle coming to an end. These discounts could persist for a while so one shouldn’t expect a sharp contraction of discounts.’ Nevertheless he acknowledged that those winding themselves down and returning capital could be attractive on wide discounts. Liberum’s Myrto Charamis believed private-equity discounts were too wide, but felt that that did not necessarily make the sector appealing. ‘Discounts were wide and now they are a little wider,’ she said. ‘This may be expected given sentiment, such as fears over Brexit or trade wars and also how high valuations of private assets have been. Realisations have been great and a lot of these funds have done spectacularly well, but now most people – including myself – would expect profitability to come off a little bit for the next few years.’ Charamis hoped to see more action from private-equity boards in the future, recognising that some steps have already been taken to tackle persistent discounts. NB Private Equity Partners (NBPE) hiked its dividend for this purpose in July, for example, and Pantheon (PIN) simplified its share structure with the same objective. ‘Private-equity funds may put in place more quickly what they were already thinking of doing anyway, but I have to say I am not sure investors’ sentiment will change’ Charamis supposed. NB and Pantheon both still labour under discounts greater than 20%, after all, compared with 12-month averages in the high teens. With ‘vanilla’ property, on the other hand, Murphy was confident enough to be patient. ‘Yes, you have some question marks about where valuations will end up, but there is a healthy sense that the dividends will continue,’ he said. ‘It is a case of looking and buying something that isn’t too levered.’
Wide discounts
04
Conversely, in these sectors where discounts can be more volatile there is theoretically more opportunity for value-minded investors in search of a bargain. UK property trusts, for instance, began 2018 with an average premium of 5.6% but plummeted to an average discount of 3.3% in November. The average private-equity discount has increased from 13.5% to 19.9% through the same period. Even 3i (III), the £8 billion private equity giant, has suffered in this latter category, its premium softening from a peak of 45% earlier this year to a low of 2% in November as trepidation set in over Brexit. This kind of overreaction could be an entry point. ‘The businesses that are going to drive its NAV forward aren’t really Brexit related at all,’ said Murphy. ‘They have some holdings engaged in cross-border trade, but they aren’t massive.’ More broadly, though, there is no firm consensus on private equity. Murphy is bullish. ‘I think the market undervalues its return profile,’ he contended. ‘The discounts have anticipated any downside, and more, that might happen in the year-end portfolio valuations. The way these guys make their money is by growing earnings; ignore all the other noise, it’s basically an earnings-growth story and they’re very good at getting their companies to grow a lot faster than everybody else.’
PE lessons
03
Key Points:
European disappointment
02
All quiet on the discount front
Discount risk - the danger of investment trust shares trading a long way below their net asset values (NAVs) - is a key talking point among investors after a volatile year.
Fortunately, the market declines in February and October have not led to a wholesale widening in discounts although that is not to say it couldn’t happen if we experienced a prolonged crash after the bull market of the past nine years.
In this article analysts explain the factors that have protected investment trusts so far and how investors can avoid falling into discount traps.
From a febrile February to ‘Red October’, volatility has returned to stalk financial markets in 2018. It has been just the type of environment that sceptics of the closed-ended structure would expect to expose weakness in investment trusts: the potential double jeopardy of declining net asset values (NAVs) and plunging discounts as investors panic. But that is not what has happened: discounts have been remarkably stable during this turbulent year. Numis Securities analysts noted that having entered 2018 with a historically tight market-cap-weighted average discount of 4.7%, the average equity-focused fund’s discount was barely moved at 4.5% in the middle of October’s correction. According to Liberum, discounts among the 363 listed funds it watches have widened only marginally from their one-year average of 5.9% to 6.3% by late November. ‘The lack of volatility in discounts, relative to the volatility in markets, has been interesting,’ observed Saumya Banerjee at Stockdale Securities. ‘In the past, when you have had volatile markets you have had discount volatility on top of that. The retail shareholders seem to be investing with a longer-term perspective in mind, so when markets fall they are not necessarily rushing to sell. If anything, they are looking to buy the dip as of now. ‘Whether that changes in a full-fledged bear market, should it occur, remains to be seen but we would expect discount volatility to rise if the correction in equity markets intensifies.’ Panmure Gordon’s Charles Murphy credited the tranquillity to discount-control mechanisms (DCMs) – typically whereby boards buy back shares to protect their trust’s valuation – but also wondered what would happen in a harsher climate. ‘DCMs will work for really quite a long time, until they don’t,’ he said. ‘Everyone has a caveat in their DCM about normal market conditions. Although 2018 may have felt pretty choppy at times, the actual daily moves have not been much more a few percent backwards or forwards. There hasn’t been a breakdown and panic.’
At the other end of the spectrum is TR European Growth (TRG), which abandoned a strict DCM in 2010 and has drifted from a premium to a 10% discount amid disappointing NAV performance this year after strong returns in the previous three years. Monica Tepes at finnCap reckoned the two key ingredients for a steady discount were strong performance and a flexible and active buyback and issuance policy. ‘In the absence of these two elements, yearly or more frequent 100% redemption opportunities should also be effective,’ she stated. ‘However, if performance disappoints too much or for too long, these funds could quickly shrink to unviable levels.’ All of this, of course, is much easier with liquid underlying assets like equities. ‘When you’re looking at the listed space, panics will be resolved quite quickly,’ Murphy commented. ‘When you get into the unlisted areas, whether that is property or lending or private equity, people will start wondering whether the assets need to be re-priced,’ he added.
DCM portent
01
Should such a sell-off transpire, how can investors insulate themselves from the worst of it? Most obviously, shareholders will need boards prepared to implement a DCM assertively. For Murphy, their ability to do so will hinge on two factors. ‘To run an active and fairly robust DCM, you need to have a big trust with liquid assets,’ he argued. ‘Otherwise, if you stand in the market when it is all going horribly wrong, you just end up owning everything and the portfolio manager is required to sell into a falling market.’ As a positive example, consider Scottish Mortgage Trust (SMT). James Anderson and Tom Slater’s FTSE 100 giant could buy back half its stock and still be a £3 billion fund, while the liquidity of its large-cap holdings means it need not conduct a fire sale to raise money. It has indeed also acted decisively, reining a 6.4% discount in February back to a 3.5% premium in November thanks in part to spending more than £42 million on buying back its shares over the past year, primarily early on.
Monica Tepes: performance key
Myrto Charamis: cautious
Brexit uncertainty is a big risk
05
Debt doubts
He was more anxious about high-yield debt, where some funds still trade at a premium despite NAV losses this year. ‘We don’t know exactly where we are in the cycle, we don’t know how much longer it will last, we don’t know what effect Brexit will have, and if there is going to be a crisis we don’t know where it will come from,’ summarised Charamis. ‘This is a time for people to be cautious, and discounts aren’t the only thing that matters. You have to understand what you are buying, why it is at a discount, and whether there is a catalyst for re-rating.’
The headline figures also mask a difference in the hit rate. Only one conventional trust, Utilico Global Income, failed to get off the ground. Investor nervousness over emerging markets forced the trust, which would have focused on utilities and infrastructure companies with a 60% exposure to emerging markets, to shelve its launch in June. Despite offering a 5% target dividend yield, the company was unable to secure commitments anywhere close to the £100 million it sought to raise. At least six alternative IPOs, many of them real estate investment trusts – Core Industrial Reit, Fundamentum Supported Housing Reit, Horizon Housing Reit and The Multifamily Housing Reit, as well as Blue Ocean Maritime Income and Global Diversified Infrastructure – were among a string of failed launches. A host of other trusts in both conventional and alternative sectors went ahead having raised half or less of their fundraising targets. ‘I think it’s understandable given the large number of funds that have been launched over the last six years or so and the sizeable follow-on issuance,’ said Monica Tepes, investment companies research director at finnCap. ‘Many investors have been increasing their holdings in existing funds, reducing demand for new launches and making it necessary to come to market with something new, given that the most popular sectors, like renewables, direct lending and the specialist property sectors, have grown to have at least two or three constituents each,’ said Tepes. QuotedData, the investment trust research company, expects many new launches to do well from here. James Carthew, its head of research, said: ‘Many of this year’s new issues are a bit on the small side, but it has been notable how much money has been raised to expand existing trusts and, if that trend continues in 2019, a few of these could grow. Indeed, a couple already have, most notably Baillie Gifford USA [USA].’ Our timeline details 20 IPOs of 2018, how they fared and what investors might expect from them.
String of failures
2018 Review: what the year’s 20 new trusts offered investors
Lots of new investment trusts and investment companies braved volatile stock markets and investor caution to launch this year.
Although many of their initial public share offers (IPOs) did not raise as much as hoped, nevertheless a total of around £2.9 billion flowed into newly-listed closed-end funds on the London Stock Exchange.
We provide a timeline and analysis of all the main launches so you can see which might be useful to you.
This year has seen investments trusts of all sorts make their market debuts, many of them in new asset classes or sectors. There were 20 notable initial public offerings (IPOs) during the course of 2018, just seven investing in conventional equities, or shares, with 13 investing in alternative strategies, both types raising a total of £2.9 billion. ‘Overall 2018 has been a tale of two halves, namely conventional versus alternative IPOs,’ said Markuz Jaffe, an analyst at Cantor Fitzgerald. While the sums raised might not look that different – £1.3 billion for conventional trusts versus £1.6 billion for alternative ones – the mega launch of Smithson (SSON) skews the conventional total. Star manager Terry Smith’s new investment trust accounted for almost two-thirds of funds raised by equity funds investing in the UK, US, India, Japan and wider emerging markets. It attracted £822.5 million, smashing the £800 million record that Neil Woodford raised for his Woodford Patient Capital (WPCT) investment trust three years ago and taking the crown as the largest IPO ever for an equity-focused trust. ‘Investor appetite within conventionals has appeared to favour concentrated strategies that are clearly differentiated from their respective markets or benchmarks, which seems logical given the need for asset managers to prove their actively managed status in a world where passive investing is becoming the base case for many investors,’ said Jaffe. Investors were given an eclectic mix of opportunities within alternatives, in contrast to recent years when high-yielding propositions drove the vast majority of launches. The return of private equity and private equity like strategies – Augmentum Fintech (AUGM) and Merian Chrysalis (MERI) are tapping into the better growth potential of private companies versus public ones – and activist investors like Trian Investors (TI1) was balanced with commercial property and infrastructure-based strategies. Hipgnosis Songs (SONG) brought music rights and royalties to the investment company world; Gore Street Energy Storage (GSF) and Gresham House Energy Storage (GRID) opened up Britain’s energy revolution by allowing investors to support a network of industrial batteries in which renewable energy can be stored; while Yellow Cake (YCA) gives investors an ETF-like opportunity to directly access a single commodity, namely uranium. ‘Some of the most interesting [launches] from an investment company fan’s point of view have been ones like these that involve new asset classes,’ added Jaffe.
Terry Smith’s Smithson was the blockbuster launch
Markuz Jaffe: year of two halves
Emerging markets
Further afield, emerging markets are also on Gilligan’s radar for 2019. Although 2018 has been a tough year for them, he hopes to see a reversal in their fortunes, particularly as they have become difficult to ignore on a valuation basis. Here he likes Mobius (MMIT) investment trust, the new entrant to the Global Emerging Markets sector, which although it trades on on a narrower discount of 3% compared to a peer group average of around 15%, is run by the seasoned team that was behind Templeton Emerging Markets (TEM): veteran Mark Mobius and his former Franklin Templeton colleagues Carlos Hardenberg and Greg Konieczny. ‘You have got very experienced individuals and a concentrated portfolio. There is every reason it should do well,’ said Gilligan. Mobius raised £100 million at its flotation in September ahead of October’s sharp sell-off. The share price has fallen since its London listing, creating an attractive entry point, he said. ‘That is not to say the discount won’t widen, but I still think the investment trust looks attractive on a long-term view,’ Gilligan added.
Investment trust ideas for a nervous 2019
The next 12 months look particularly fraught with uncertainty. However, investors with genuinely long-term horizons can afford to take a dispassionate look at the opportunities this creates.
In this article we speak to wealth managers, fund managers and analysts about the investment trusts on their watch lists as they look for over-sold or underperforming markets and funds to bounce back in 2019.
The UK is in focus as a result of Brexit fears but emerging markets, property and infrastructure are mentioned too.
UK equity income picks
Looking ahead, however, the Hawksmoor team is monitoring Edinburgh (EDIN) managed by Invesco Perpetual’s Mark Barnett, Neil Woodford’s successor. Although the £1.2 billion UK equity income trust has struggled in recent years, it stands to benefit if we get a better exit deal than is currently priced in to markets. Its shares trade on an 8% discount to net asset value (NAV) wider than its sector average of 3%, making it cheap and ripe for a re-rating if markets turn. The UK is also on the radar for Nigel Moore, a senior wealth manager at Pilling & Co Stockbrokers. ‘I expect a recovery in flows into the UK market and a pick-up in sterling, once greater clarity on the future relationship with the EU is delivered early into 2019,’ he said. Moore highlighted Lowland Investment Company (LWI), a rival £370 million UK equity income trust, run by veteran, contrarian stock picker James Henderson on a 5% discount. More broadly, Mick Gilligan, head of fund research at Killik & Co, believed that the ‘value’ investment style of buying undervalued, high-yielding stocks could shine again after 10 years in which paying up for high ’growth’ companies has dominated. ‘At some point you’d have thought this would change. The differential between value and growth is as extreme as it was in the tech boom of the late 90s,’ he said. For a third trust from the AIC UK Equity Income sector, Gilligan pointed to Temple Bar (TMPL), managed by deep value fund manager Alastair Mundy, highlighting its attractive 3.6% yield and 4% share price discount to net asset. For something a bit different in the UK, Gilligan pointed to Woodford Patient Capital (WPCT) to watch in 2019. The investment trust raised £800 million in a blaze of hype in 2015 to invest in early-stage technology companies, frequently in healthcare and life sciences. After a good first year, a number of setbacks have seen the shares consistently trade below their flotation price. However, Gilligan believed things were starting to look up with Patient Capital’s NAV up 12% this year although its shares lagged with a gain of under 5%. ‘I think we are well through the J-curve,’ he added, referring to the shape of returns from new companies, which are low initially but ramp up as the businesses mature, which Gilligan thought boded well for a recovery.
Next year is shaping up to be a significant 12 months for investors: central banks across the globe continue to tighten interest rates and monetary policies, there are growing trade tensions between the US and China and the UK’s exit route from the European Union (EU) in March remains disturbingly unclear. The good news is that because of these headwinds there are plenty of opportunities in investment trusts, particularly in unloved markets such as UK equities. Daniel Lockyer, an enthusiastic buyer of investment trusts at Hawksmoor Investment Management in Exeter, believes that domestically-focused companies look attractively valued having been overlooked by investors as a result of Brexit risk. Investors are concerned that if we have a no deal or hard Brexit, which would see the UK give up full access to the single market and customs union, domestically-focused companies will be hit the hardest. ‘We have no view on Brexit,’ said Lockyer. ‘All we can analyse is what valuations are discounting. Even if there is a bad exit, the prices and valuations on offer for these types of companies are already discounting a bad Brexit - so any positive outcome would be beneficial,’ he explained. Lockyer and fellow fund managers Ben Conway and Richard Scott have increased UK equity exposure in the MI Hawksmoor Distribution fund from 10% at the beginning of the year to 15% today. This has mainly been through open-ended funds.
Daniel Lockyer: eyeing Edinburgh
Infrastructure back
The trust selector also highlighted infrastructure investment companies. The high-yielding, alternative income sector has experienced a difficult 12 months after shadow chancellor John McDonnell threatened to cancel hundreds of private finance initiatives (PFI) at the 2017 Labour party conference. This sparked a sell-off and the sector then took another hit in January after the collapse of contractor Carillion. However, in spite of these issues, trading statements within the listed infrastructure sector have been robust – and Gilligan believes that some investment companies had been oversold. ‘If they were forced to come out of contracts early, the financial impact would be fairly limited and they’ve also reiterated dividend guidance because of the level of confidence they have in their cash flows,’ he explained. His favoured investment companies are HICL Infrastructure (HICL) and 3i Infrastructure (3IN).
Inflation watch
Looking ahead to next year, Moore cites the return of inflation as a theme to look out for. In the US, wage inflation has increased – something the Federal Reserve, its central, is watching closely. Meanwhile in the UK, he says pressures are mounting as a result of materially higher council tax rates. ‘Pension auto-enrolment rates have also risen this year and will do so again in 2019, stoking further wage inflation in the UK to combat these outlays. I am mindful of the inflationary risks next year and will seek to protect portfolios accordingly,’ he said. With this in mind, he points to the benefits of alternative income strategies – and recently added to Real Estate Credit Investments (RECI) via a share placing. ‘The fund invests into secured real estate debt via loans and bonds, principally in the UK, and offers a 7% yield,’ he explained. In addition, Moore likes that the portfolio has the potential to provide some inflation protection. Lockyer also favours alternative income strategies and has added to the MI Hawksmoor Distribution fund’s real estate investment trust (Reit) allocation, which currently stands at 20%. ‘When you compare some of the returns we should be getting from our Reits exposure. They are yielding 6%, which are covered so we feel confident the income is secure. And there are rental growth opportunities, especially in the industrials and warehouse sectors,’ he added. He chose Warehouse Reit (WHR), a £160 million investor in distribution centres, a boom area due to the growth in online shopping, whose shares have slipped to a 9% discount since September.
Mick Gilligan: impressed by infrastructure
Defensive portfolio
Following a challenging few months for markets, James Burns, a fund selector at Smith & Williamson, was more cautious in his outlook than he has been for a while. ‘It is hard to paint a picture where I am excited about many equity markets at the minute. I feel that next year could be similar to this year – where we need to hunker down and focus on preservation, more than worrying about making lots of money,’ Burns said. With this in mind, he feels positive about the prospects for BH Macro (BHMU), the investment company which offers access to the Brevan Howard hedge fund whose traders exploit pricing anomalies in currency and bond markets. Its performance has been lacklustre over the past three years, as Burns notes the ‘macro traders had nothing to get their teeth into’. However, it has come into its own since June and is up 16% so far this year. ‘It has proven itself to be a proper diversifier when things don’t go well in equity markets,’ Burns added. With a continuation vote scheduled for January, Burns says that it would a ‘disaster’ if shareholders vote for the fund to wind up – because he believes it is just starting to get interesting. As 2018 comes to a close, investors stand to benefit from taking a selective approach and taking advantage of some of the attractive valuations in the investment trust space.
Neil Woodford: be patient
