Foreword
By Annabel Brodie-Smith
Winter is on its way – it’s much colder, darker and my children have all gone down with the lurgy. The scarves and gloves are out and I’ve had some lovely Oxfordshire walks when it’s been dry.
We also now have an election campaign underway and live in hope that this might lead to the end of Brexit uncertainty… The political campaigning has already put the NHS in the spotlight and it therefore seems highly appropriate to lead this month on BB Healthcare Trust’s views on the developed world’s healthcare systems. They argue that “the trope that the NHS simply needs more money is mere political expediency” but the good news is “myriad new technologies have credibly demonstrated that the healthcare treatment paradigm is ripe for change, offering both improved care and lower costs.” BB Healthcare was launched to invest in this healthcare revolution and it’s fascinating to hear more about their investments.
Sentiment towards property is also much affected by the political uncertainty and Brexit. With Mothercare, the latest high street casualty, going into administration the outlook for property may be of interest to contrarian investors. We have asked UK commercial property managers for their views on the sector which is currently trading at a 1% discount and yielding 5.1%. They are relatively optimistic in difficult circumstances. Peter Lowe of BMO Real Estate Investments argues: “While there will be continued near-term disruption and the potential for ongoing volatility in markets, the sector is in relatively good health and offers much for the medium-term investor.” Similarly, Will Fulton, manager of UK Commercial Property REIT believes: “In spite of the uncertainty facing businesses, the occupational market is generally stable with the exception of the retail sector which faces its own structural challenges.” Watch our videos of Peter and Will to find out more.
Peter Lowe, Manager of BMO Real Estate Investments, discusses the benefits of investing in property with investment companies
The final piece by our investment expert Ian Cowie discusses the implications of the dominant and most concerning investment story of the year, the collapse of Woodford Investment Management. Ian discusses the lessons to be learnt about the all-important difference between an investment company structure and an open-ended fund structure. The open-ended fund, Woodford Equity Income, has been suspended since early June, so from then investors could not buy or sell the fund and it is now being wound up. On the other hand, investors can continue to buy and sell the investment company, Woodfood Patient Capital (WPCT) which is listed on the stock market. However, they may well not like the share price which is down to supply and demand for the shares. As a holder of WPCT, Ian goes on to explain why he has decided to hold onto the shares despite their poor performance. The investment company in the future is to be managed by Schroders and renamed Schroder UK Public Private Trust.
Will Fulton, Manager of UK Commercial Property REIT, discusses the benefits of investing in property with investment companies
I expect many of you already understand the income benefits of investment companies, but if you need a refresher or know someone who would benefit, please do take a look at our recent educational video in which financial advisers explain how investment companies work for income. They also explain the AIC dividend heroes and how to make a start on researching investment companies. Finally, the video highlights Income Finder, our new tool designed to help income seekers research and analyse investment companies.
Financial advisers discuss the benefits of investment companies when it comes to paying income.
The next Compass goes out on the day of the election result if there is a majority!
Wishing you a good month.
Annabel Brodie-Smith
Communications Director, AIC
Doctor's orders
BB Healthcare Manager Paul Major explains how to benefit from a healthcare revolution
Paul Major, Co-Manager of BB Healthcare Trust
2019 has not been an easy year for investors. Rarely can one recall a period where so many macro-political uncertainties have coalesced. The stockmarket seems to be flailing about like a wounded animal, veering from one factor driving performance to another (value, growth, momentum etc). At the time of writing, the FTSE 100 is up around 7% over the year-to-date. In dollar terms, it is up a little over 8% but, mirroring the pound, it fell in August into negative territory before rebounding again. Investors are variously told that the market is cheap or expensive, and that recession is both imminent and unlikely. Amidst so much apparent confusion, where can one find a stable outlook? Surely there must be somewhere that can offer growth, yield and a reasonable valuation?
Few things in life are certain, but some axioms hold fast: there are ever more people in our world, and they are, on average, getting older. The bulk of healthcare resources are consumed by the elderly, since the price we pay for a longer lifespan is an increased burden of chronic disease later in life. In developing markets, health spending rises faster than GDP as the emerging middle classes have the time and resources to focus on remaining healthy. The combination of all these factors is unremitting demand growth. Put simply, healthcare is the secular growth story of our age and one that is likely to accelerate as medical discoveries and new technologies open up ever more opportunities to ease the burden of human suffering.
There is, as ever, a catch. The healthcare systems of the developed world were not designed to cope with this elderly, morbid population and healthcare expenditure has been rising as a proportion of GDP, eating into our marginal wealth gains from productivity. This trend will worsen if the system is not reformed.
The trope that the NHS simply needs more money is mere political expediency; more cash will not magic up trained doctors and nurses, nor will it tame the beast of above-inflation medical cost trend. However, one need not surrender to this fate – myriad new technologies have credibly demonstrated that the healthcare treatment paradigm is ripe for change, offering both improved care and lower costs. It is not just society that will benefit; the investor can profit from this profound revolution as well.
Our fund, BB Healthcare Trust, was launched in late 2016 to profit from this necessary and inevitable healthcare revolution. We manage a concentrated portfolio of operationally geared exposures to key areas of profound change. These changes will likely happen first in the United States, but will be global. However, the spoils of victory will be accruing to a very different set of companies than those whose incremental innovations in drugs and medical devices have powered portfolios in recent decades, so our fund is unconstrained and can thus invest in relevant adjacent areas such as technology and consumer products. We are total return focused, but offer a divided out of capital as many of these companies will not pay dividends for decades, if at all. This also allows us to offer a competitive payout in a world where yields are hard to find (especially ethical or sustainable income – how much FTSE yield comes from extractives and tobacco?).
In addition to a raft of novel treatments and products, the companies and themes driving our fund include electronic triage (e.g. Teladoc), Robotic surgery (e.g. Intuitive Surgical), Genetic testing and molecular diagnostics (e.g. Illumina). Healthcare has been a contentious political football for many years, but the NHS knows what the future can offer and the politicians should leave well alone and allow healthcare ‘to heal thyself’.
Property prospects
With an election hanging in the balance managers share their outlook for the sector
With Brexit hanging in the balance, a general election now weeks away, persistently low interest rates and high street store closures soaring, many investors’ eyes are on property. But what are investment companies’ views on the sector and what does the future hold for this asset class?
With assets totalling £15.9bn, investment companies investing directly in property make up a large part of the investment company industry. Across the five sectors investing directly in property, these companies give investors access to a considerable variety of different property types, ranging from offices and shopping malls to supermarkets, social housing and warehouses.
At a recent roundtable held at the AIC Peter Lowe, Manager of BMO Real Estate Investments, and Will Fulton, Manager of UK Commercial Property REIT, discussed their investment strategies and the outlook for the sector. Their thoughts have been compiled alongside comments from Stephen Inglis, CEO of London & Scottish Property Investment Management Limited, the asset manager of Regional REIT.
At £10.7bn, the Property – UK Commercial sector accounts for more than half (67%) of direct property-focused assets under management. The sector, with an average yield of 5.1%, may also be attractive to income-seeking investors in the current low interest rate environment, and investment companies in this sector now stand at an average 1% discount.
Annabel Brodie-Smith, Communications Director of the Association of Investment Companies, said: “The closed-ended structure of investment companies makes them particularly well suited to investing in hard-to-sell assets such as property. This was highlighted by the differing fortunes of open-ended and closed-ended property funds following the EU referendum in 2016. Despite discounts widening, closed-ended property companies continued to trade, with their managers able to take a long-term view of the market, whilst their open-ended counterparts were forced to suspend due to high outflows.
“The fact that investment company managers don’t need to worry about meeting redemptions means that property-focused companies can hold less cash than open-ended property funds, resulting in more money being invested and put to work for the end investor. During low interest rate periods, investment companies provide a structurally sound vehicle through which investors can access this illiquid asset class, providing attractive levels of income and the prospect of long-term capital growth.”
What impact is the political uncertainty and Brexit having on UK property?
Peter Lowe, Manager of BMO Real Estate Investments, said: “The impasse at Westminster and the prospect of a change of government is destabilising for the market. The UK is a vibrant, capable economy with a skilled workforce and many comparative strengths, but the continued delays have paralysed business and are adversely impacting the economy.
“The most immediate impact of the continued uncertainty on the real estate market is the collapse in transaction volumes which have fallen sharply and are now below long-term averages. While there will be continued near-term disruption and the potential for ongoing volatility in markets, the sector is in relatively good health and offers much for the medium-term investor. There is plenty to like about UK real estate, not least the yield premium, income growth in most sectors outside of retail, good levels of occupancy for quality stock and a relative absence of typical ‘late cycle’ behaviour in the lending and development space.”
"The UK is a vibrant, capable economy with a skilled workforce and many comparative strengths, but the continued delays have paralysed business and are adversely impacting the economy."
Peter Lowe, Manager of BMO Real Estate Investments
Stephen Inglis, CEO of London & Scottish Property Investment Management Limited, the asset manager of Regional REIT, said: “Brexit uncertainty is providing buying opportunities for experienced asset managers who are able to methodically identify the most suitable assets where their unique skills can best be deployed. The future is still uncertain but we have seen office letting continue to perform well in the regions. We anticipate that any negative impact will disproportionately impact the prime markets and London specifically, neither of which we invest in.”
Will Fulton, Manager of UK Commercial Property REIT, said: “The likely path that Brexit negotiations can take remains extremely complex. The subsequent uncertainty created is largely being reflected through a more subdued investment market for UK real estate, with year to date investment volumes down 27% on the same period last year. Investment activity has been largely skewed towards the industrial and alternative sectors where income streams are typically more durable and defensive. Moving forward I would expect investment market activity to remain subdued, at least until more clarity is provided from a political perspective.”
What’s your investment strategy?
Will Fulton, Manager of UK Commercial Property REIT, said: “Our investment process is underpinned by a wide, research-based view of the market and our deep-seated stock-picking expertise, enabling us to identify the right buildings in good locations and in sectors experiencing tailwinds. For example, the long-term structural changes are being driven by ecommerce, physical improvements to infrastructure or the wider built environment (transportation and public realm) which we believe will enhance future value and grow rental income. All of this is enabled by our strong balance sheet. UK Commercial Property REIT has one of the lowest gearing ratios in its peer group in the range of approximately 16% (to 22% fully invested) and with £85 million available to deploy in new opportunities. The portfolio is heavily weighted towards the best-performing market segments and is diversified by occupier, geography and sector.”
Stephen Inglis, CEO of London & Scottish Property Investment Management Limited, the asset manager of Regional REIT, said: “Put simply our strategy is to invest in quality office and industrial assets in the major regions of the UK outside the M25 to generate high income for our shareholders. This income is paid through quarterly dividend distributions, currently offering a high dividend yield of 7.9%.”
What sort of property do you invest in?
Peter Lowe, Manager of BMO Real Estate Investments, said: “Property fundamentals come first. We seek robust residuals with significant value in the real estate rather than simply the lease contract, and an absolute focus on the occupational underwrite. Over the last few years I have positioned the portfolio to lean more towards the industrial market, which now accounts for over 40% of current assets by value, and the office sector. These positions have been made predominantly via sales from the retail portfolio, where the smaller average lot size of the company portfolio has preserved some liquidity in a testing market, and reallocation of proceeds to other projects.”
Stephen Inglis, CEO of London & Scottish Property Investment Management Limited, the asset manager of Regional REIT, said: “We acquire high-quality, income-producing, predominantly office and industrial properties across the UK regions.
“A good example is 800 Aztec West, a 73.292 sq. ft. office building in Bristol’s premier business park. Following significant asset management activities, the building is now 100% let with EDF and the Secretary of State for Defence as anchor tenants. The property was acquired for £6m in January 2016 and now has a market value of £18.4m.”
Will Fulton, Manager of UK Commercial Property REIT, said: “In 2015, we proactively undertook to reposition the portfolio and build an overweight position in the industrial and logistics sector (now 48% of the portfolio), while materially reducing our exposure to retail. Proceeds from the strategic disposal of, for example, two shopping centres were reinvested into assets benefitting from longer-term, positive structural trends. These included a large industrial estate on the M25 at Radlett, which has grown significantly in value and the development funding of a new ‘pre-let’ hotel in Newcastle with a 35-year index-linked lease. Other examples are an office in Reading which had been fully refurbished at a cost of £16 million before we acquired it and benefits from a dynamic tech-led occupier market. It is about to have a step-change in infrastructural transport connections when the Elizabeth-Crossrail line is switched on. Lastly, another example is one of the UK’s most successful cinemas in the heart of Glasgow, also on a long lease with built-in fixed rental increases.”
What’s your outlook for the property sector?
Stephen Inglis, CEO of London & Scottish Property Investment Management Limited, the asset manager of Regional REIT, said: “Uncertainty will always provide risk and opportunity, though going forward these may be less discernible than at present, which may result in many regrets for those not taking action. We have extensive experience in dealing with similar assets through the 2008-2012 downturn where the valuations fell but income was maintained. In fact, the income was increased by 3% over that period, reflecting the resilience of the UK core and core plus regional office and industrial markets.”
Will Fulton, Manager of UK Commercial Property REIT, said: “Our outlook for UK real estate is being shaped by the current political backdrop and as such, we continue to favour sectors that provide more durable and defensive income qualities. In spite of the uncertainty facing businesses, the occupational market is generally stable with the exception of the retail sector which faces its own structural challenges. Performance for this sector will be more challenging as a result.
“The industrial sector remains one of our favoured sector calls, which is largely due to the strength of the occupational market. Robust levels of rental growth in London, the South East and the best urban locations across the UK are a clear illustration of this. In addition, we see selective opportunities arising in the alternative sectors and expect interest in more operational sectors, which provide greater exposure to the underlying performance of income-generating assets, to increase going forward.”
Peter Lowe, Manager of BMO Real Estate Investments, said: “The market is slowing. Whilst we expect single-digit positive total returns at the all-property level, sector and stock selection can significantly improve prospects. Income return will drive performance and the preservation of income will be vital. Lower interest rates for longer could provide additional support for the property market, with long leases and secure income seen as a favourable alternative to gilts.”
What are the benefits of investing in property with investment companies?
Peter Lowe, Manager of BMO Real Estate Investments, said: “For the longer-term investor, the most obvious benefit has been the performance, with investment companies having delivered attractive relative returns against some alternative structures. Using an investment company structure to hold real estate means investors can benefit from a higher exposure to the asset class itself, as investment companies can take advantage of gearing and the reduced requirement to hold higher levels of cash. With income being the bedrock of real estate returns over any extended time scale, the ability to employ prudent levels of gearing has allowed managers to enhance returns. This has been particularly true over the last few years given the yield on real estate and the comparative cost of debt.”
"Unlike other types of investment funds, investment trusts can also borrow money to invest to boost potential returns. Every investment trust also has a board of directors that’s independent of the investment team to ensure the trust is being managed in the best interests of its shareholders."
Will Fulton, Manager of UK Commercial Property REIT
Will Fulton, Manager of UK Commercial Property REIT, said: “As an investment trust, a REIT is a public limited company and a closed-ended fund which can offer particular benefits to real estate investors. For example, a REIT doesn’t need to liquidate holdings to return money to shareholders. Instead, its shares can be sold (and bought) at any time on the stock market. This means there’s no delay for shareholders who want to sell. Because assets don’t need to be liquidated to redeem shares, a REIT doesn’t need to hold large amounts of cash. So more of its capital can be invested in property – plus the manager never has to be a forced seller of any of their holdings at a sub-optimal price.
“Unlike other types of investment funds, investment trusts can also borrow money to invest to boost potential returns. Every investment trust also has a board of directors that’s independent of the investment team to ensure the trust is being managed in the best interests of its shareholders. These shareholders have the right to receive an annual report and attend and vote at the trust’s annual general meeting, giving them an active say in how their fund is managed.”
Lessons in liquidity
Ian Cowie reflects on Woodford and the structural benefits of investment companies
Ian Cowie
When a city figure as senior as the Governor of the Bank of England says that one form of pooled fund holding billions of pounds on behalf of millions of people is 'built on a lie' it’s time to sit up and take notice. The truth is that Square Mile jargon has obscured the fact that many investors in unit trusts may not be able to get their money back when they want it.
The bad news is that this has already happened to hundreds of thousands of investors in Woodford Equity Income (WEI) and Woodford Income Focus (WIF). These open-ended funds sacked their former high-flying manager, Neil Woodford, and suspended dealing - so they will not allow units to be exchanged for cash at any price until further notice.
The good news is that dealing continues as usual at Woodford Patient Capital Trust (WPCT), which is a different form of pooled fund, an investment trust or investment company. Shareholders in WPCT - including your humble correspondent - can get back into cash if we want to; or buy more shares, if we prefer, or simply hang on in hope.
Ordinary people may wonder why an apparently trivial variation in terminology - between an investment company, on the one hand, and an open-ended fund, on the other - can make such a big difference to the way investors are treated. What it all boils down to is 'liquidity' or the ability to exchange an asset for cash.
Investment company shareholders benefit from liquidity because these companies’ shares are traded on the London Stock Exchange every business day. However, we may not always like the price at which we can buy or sell, because this is set by the interaction of supply and demand on the stock market.
For example, WPCT shares have lost two thirds of their value since their flotation nearly five years ago. But we can always make our own decision, taking into account our personal situation - such as our attitude to risk and reward or our need for cash to fund some imminent expenditure - to buy, sell or continue to hold these shares. The latter is what I am doing at WPCT because I bought on a 10-year view and we aren’t even halfway there yet.
By contrast, investors in open-ended funds may have no such choice and can find the liquidity tap turned off without notice if the fund manager decides to suspend dealings. Unlike shares, units are not listed - or bought and sold - on the London Stock Exchange or any other stock market. Open-ended fund investors can only get back into cash if the fund manager is willing and able to provide it. Woodford isn’t.
Both forms of pooled fund aim to diminish the risk of investment by diversifying individuals’ money over many different assets. But some forms of asset - like the unlisted shares held by WEI, WIF and WPCT - are inherently illiquid. So is commercial property - such as office blocks, shopping malls or warehouses - because it may be difficult to sell these assets for a reasonable price in a hurry. This fact has forced several open-ended funds investing in commercial property to suspend dealing in the past, most recently after the referendum vote for Britain to leave the European Union on June 23, 2016.
That is why Mark Carney, Governor of the Bank of England, told the Treasury Select Committee inquiring into the Woodford scandal: "This is a big deal. You can see something that could be systemic... These funds are built on a lie, which is that you can have daily liquidity for assets that fundamentally aren’t liquid."
Even in good times, open-ended fund managers often hold more cash than they might otherwise wish to, in order to meet redemptions or unit holders disinvesting. These cash buffers often prove a drag on returns when interest rates are low. Worse still, in bad times liquidity - or the lack of it - can suddenly be transformed from seeming to be a tedious technicality to the only thing that matters. These are among the reasons this long-term investor is an investment trust shareholder and not an open-ended fund holder.
Woodford and his unit holders were not the first to find cash can be readily available until you really need it. They are unlikely to be the last. Schroders has been appointed as the new manager of WPCT and BlackRock is winding up WEI by selling assets, whether or not unitholders might prefer to hang on. WPCT will be renamed Schroders UK Public Private Trust.
"These cash buffers often prove a drag on returns when interest rates are low. Worse still, in bad times liquidity - or the lack of it - can suddenly be transformed from seeming to be a tedious technicality to the only thing that matters."
Ian Cowie
