Markets ended 2021 on a firm note, despite concerns about the economic impact of the Omicron variant, the belated decision of the Bank of England to raise interest rates and of the Federal Reserve to scale back quantitative easing. That share prices reacted positively to these decisions is a sure sign that investors see tighter monetary policy as necessary.
The biggest puzzle of 2021 was why bond yields remained so low in the face of soaring inflation, which was steadily proving to be less “transitory” than first billed, as economist Anatole Kaletsky of investment-research firm Gavekal has pointed out. “The refusal of bond investors to push yields much higher seemed to defy all rational explanation,” wrote Kaletsky. “Many analysts have responded by dismissing bond investors as irrational or by denouncing governments and central banks for ‘manipulating’ markets.”
However, “bond yields tell us almost nothing about the long-term prospects for growth or inflation”, he continued. Most bond investors are not concerned about negative real yields, or even with earning more than a very short-term return. “So long as ten-year US Treasury yields rise only steadily higher, reaching 2.2%-2.5% in 2023, the outlook for equity prices and global economic growth for the next few years will remain very favourable.”
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Kaletsky was right in 2021 and the sceptics were wrong. Loose fiscal and monetary policy is being scaled back and there is no sign of a panic in the US bond market. With common sense returning to the Federal Reserve and to legislators in Washington, the chances of such a panic are dwindling. Investors who are holding back from the stockmarket risk missing out. There is an abundance of value around, not so much in “cheap” shares, but in recovery, reasonably priced growth and neglected corners of the market.
In addition, some investment trusts trade on a much wider discount to net asset value (NAV) than the average of 1.5%. In some sectors the NAV is based on historic asset value and conservatively estimated so the true discount is wider. Buying on a discount will increase your returns if the discount narrows, but it should not be the main reason for investment. The opportunities for bargain hunting in the specialist trusts are not limited to those on wide discounts.
The UK is attractive as growth returns
After years of underperformance, the shares of UK-listed companies trade at significant discounts to those in other markets, hence the flurry of takeovers from overseas. UK domestic earners have been the weakest – flat over five years, according to Laura Foll of Janus Henderson Investors, while international earners have returned 40%. Yet valuations are attractive, earnings estimates are very conservative and growth is returning to companies that have been struggling for years.
This provides an attractive environment for value investor Temple Bar (LSE: TMPL) on an 8% discount and for growth-at-a-reasonable price investor Finsbury Growth & Income (LSE: FGT) on a 5% discount. Lowland Investment Company (LSE: LWI) on an 8% discount and Henderson Opportunities Trust (LSE: HOT) on a 13% discount have the draw of not being tied to one style, but being able to switch focus between growth and value, large and small cap, recovery and steady earners, depending on what looks best.
Smaller companies should beat large
The long-term trend of small caps’ out-performance looks sure to continue, yet is not reflected in either their valuation (lower than for large caps) or the rating of the small-cap specialist trusts (often on significant discounts). They are attractive everywhere, but especially in the US where they trade on an average price-earnings multiple below 16. This is in line with the 20-year average, yet US smaller companies have all the advantages, such as the scale of domestic opportunity, benign political, economic and regulatory outlook and entrepreneurial culture of larger ones on much higher valuations. JP Morgan US Smaller Companies (LSE: JUSC) and Brown Advisory US Smaller Companies (LSE: BASC) are still attractive.
It’s been an excellent year for listed private equity with strong progress in the underlying firms, great prices achieved on disposals and some surprisingly engaging new investments. Fears that too much money waiting to be invested will push up prices and lower returns continue to look premature and portfolios continue to be cautiously valued.
Yet share prices of many private-equity trusts still trade on significant discounts. Private wealth managers shun the sector because of its costs, regardless of the high returns achieved, yet private equity should account for at least 10% of any equities portfolio.
Even on a small premium, HgCapital Trust (LSE: HGT) is appealing, given strong underlying growth and modest valuation in its portfolio. Direct investors Apax Global Alpha (LSE: APAX) and Oakley Capital Investments (LSE: OCI) on discounts of 12% and 6% respectively, funds-of-funds Pantheon International (LSE: PIN), Harbourvest Global Private Equity (LSE: HVPE) and ICG Enterprise Trust (LSE: ICGT) on discounts above 15% and sector giant 3i (LSE: III) on an apparent premium of 36% (but in reality much less) all look attractive.
Momentum is building in Japan
Japan bulls can sound like gramophone records with the needle stuck. But Japan does offer great valuations, earnings growth, a growing focus on rewarding shareholders and improving corporate governance.
JP Morgan, Baille Gifford and Fidelity manage growth-orientated trusts with great records, but the smaller AVI Japan Opportunity Trust (LSE: AJOT) has a solid record of investing in under-managed, overcapitalised firms with the potential to streamline performance for the benefit of shareholders and then persuading them to change. Momentum is picking up, the approach is paying off and the potential is large.
Back healthcare in a post-pandemic world
The poor performance of biotechnology held back most of the trusts in 2021, although not Polar Capital Global Healthcare (LSE: PCGH). However, that hardly explains the US healthcare sector’s underperformance in 2021 or its 20% valuation discount (17 times 2022 earnings versus 21 for the wider market) in a world in which the focus on healthcare has been increased by the pandemic. (US firms dominate the global sector.)
Polar Capital Global Healthcare, BB Healthcare Trust (LSE: BBH) and Worldwide Healthcare Trust (LSE: WWH) all look worth backing, as do the biotech trusts Biotech Growth Trust (LSE: BIOG) and IBT Biotechnology Trust (LSE: IBT), although these are higher risk and higher reward. After a difficult year, private equity start-up specialist Syncona (LSE: SYNC) received a boost from the sale of gene-therapy firm Gyroscope to Novartis at a premium price in December. The fund now trades on a reasonable premium to NAV, while its strategy is being vindicated.
Property still offers value
The lag between stated and current NAV will always make property companies cheaper than they look in a rising market. There is still value in the sector despite strong performance in 2021. BMO Commercial Property Trust (LSE: BCPT) on a 20% discount, Regional Reit (LSE: RGL) on a 4% discount and Ediston Property Investment Company (LSE: EPIC) on a 4% discount stand out. The latter focuses on retail parks, which are flexible, low cost and in demand, rather than shopping centres or the high street. The news from the sector has been better than expected, yet valuations and share prices continue to be weighed down by short-term concerns over the pandemic. TR Property Investment Trust (LSE: TRY), trading on a negligible discount but yielding nearly 3%, is a good one-stop-shop for the sector in the UK and Europe.
Too much pessimism about Latin America
Emerging markets had a dull year in 2021, but the three-year and five-year record remains good thanks to Asia’s strong performance. However, Latin American equities have had negative returns over one, three and five years, as has the main trust in the sector, BlackRock Latin American Investment Trust (LSE: BRLA).
Yet “Brazil (and the rest of Latin America) is benefiting from its core resource exports enjoying strong demand and high prices”, points out Udith Sikand of Gavekal Research. “Finances are on the mend and real interest rates are quite attractive.” Latin America is shaking off the pandemic and pessimism about the political outlook looks excessive. BRLA trades on a 5% discount to NAV, yields 6.1% and consequently looks well worth a bet.
Bullish signs for markets
The abundance of attractive opportunities is a bullish sign for markets. When it is hard to find good value, it is usually time to sell and when it is easy, it generally means the market is going up. There is always short-term downside, but those who wait for the perfect buying opportunity are always left on the sidelines. Bull markets climb a wall of worry; when the risks seem to have disappeared, it is time to get very worried indeed.
Rising inflation will diminish real equity returns, but not nearly as much as for cash, bank deposits and bonds. Besides, while inflation is proving to be more than transitory, it is still less than endemic. The era of zero interest rates, money-printing and government extravagance is coming to an end and that bodes well for inflation in the medium term.
It is time for investors to grab the bull by the horns and stop worrying about the short term.
Max has an Economics degree from the University of Cambridge and is a chartered accountant. He worked at Investec Asset Management for 12 years, managing multi-asset funds investing in internally and externally managed funds, including investment trusts. This included a fund of investment trusts which grew to £120m+. Max has managed ten investment trusts (winning many awards) and sat on the boards of three trusts – two directorships are still active.
After 39 years in financial services, including 30 as a professional fund manager, Max took semi-retirement in 2017. Max has been a MoneyWeek columnist since 2016 writing about investment funds and more generally on markets online, plus occasional opinion pieces. He also writes for the Investment Trust Handbook each year and has contributed to The Daily Telegraph and other publications. See here for details of current investments held by Max.
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