REGIONAL REIT

OSCAR SHEEHAN | INVESTMENT EXECUTIVE

As many who follow financial news will know, the bond market has had a bit of a bumpy ride recently. With inflation at a 40-year high and interest rates rising, many bonds have seen their prices enter free fall. While this has caused some serious damage to the fixed income portion of portfolios around the world, it also presents us with some exciting opportunities as yields rise and bonds start to trade below par value, creating the opportunity for increased returns when they reach redemption. This type of volatility is not normally what we look for in our fixed-income investments; that said, there are several opportunities available in the space that are starting to look attractive. Bonds that are closer to maturity, such as the unsecured 4.5% fixed-rate bond issued by Regional REIT that redeems in 2024 (RGL1), are a good example of this.

Short-dated bonds tend to experience less volatility than their longer duration counterparts. Bonds are considered short-dated if the date at which the bond holder will receive their principle sum back is approaching, typically within the next five years. The prospect of this payment stops the price of the bond from fluctuating too much. As a result of this, RGL1’s price has fallen only 6% this year, unlike longer dated securities, such as the treasury gilt TG41, which reaches maturity in 2041, and which has seen its value fall by 43.14%. You could argue that the large drop in value and the corresponding increase in yield for TG41 make it an attractive investment, and you would be right. An annual return of 4.89% certainly seems appealing, particularly by recent standards. However, there is no guarantee that the price of the bond will not fall further given the political and economic instability that we have experienced recently. Meanwhile, RGL1 offers a return of over 5%, with the cash you lent being returned to you significantly sooner than if you held the long-dated gilt. On top of this, its short duration means that as the bond approaches maturity, investors benefit from a ‘pull to par’, the phenomenon by which a bond starts to trade upwards towards the value of which it will be paid back to you, typically 100p. This then, of

Bonds such as RGL1 could act as something of an anchor for portfolios over the next few years. With a recession looking inevitable and Goldman Sachs forecasting a 1% contraction in the UK economy next year, the cashflow offered by such bonds could be invaluable.

course, provides a degree of stability for portfolios at a time when they need it most.

Generally, corporate bonds are considered riskier investments then government debt and, as such, it is important to pay close attention to the financial condition of the issuer and the state of the market in which they operate. From this perspective, Regional REIT is in good shape. As of the 30th June 2022, the trust had generated over £28m in profit before taxation for the previous year, which is comfortably ahead of its expenses of only £8.5m. The REIT also stands to benefit from shifting dynamics in the office real estate sector as companies continue to encourage their employees back to the office. Due to hybrid working, companies now require smaller, higher quality office space and this should help to drive a continued recovery in Regional REIT’s net asset value due to the focus on premium office space.

Regional REIT’s extensive use of gearing is one of the things that sets it apart from its competitors. Fund managers ‘gear’ their portfolios by borrowing money to increase the total amount that they can invest. As of June 2022, the trust held £443m in debt, just over 43% of its total value. The RGL1 bond forms a portion of this debt. This gearing has the potential to enhance any positive returns generated by the portfolio, but as the debt needs to be serviced it can also magnify any negative returns and this is part of the reason that Regional REIT has seen its share price drop more than 33% year to date. It is important to note that buying the bond is very different from buying the REIT itself; the trust’s use of gearing may have provided something of a headwind on performance recently, but unless the trust defaults on the debt, which would have serious ramifications for any future borrowing it wishes to engage in, this will not affect the bond from generating returns. With profits comfortably outstripping expenses, and a large property portfolio at its disposal, the bond appears to be at minimal risk of default.

Bonds such as RGL1 could act as something of an anchor for portfolios over the next few years. With a recession looking inevitable and Goldman Sachs forecasting a 1% contraction in the UK economy next year, the cashflow offered by such bonds could be invaluable. The recent crisis in the inflation-linked bond market has reminded us that there is no such thing as risk-free investments and, while RGL1 is no exception to this, it could provide ballast for portfolios at a time when other assets are seriously struggling to generate returns.

Please note that this communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned.