1875 Autumn Private Client

1875

A PUBLICATION FROM REDMAYNE BENTLEY

AUTUMN 2023

CHANCELLOR ON THE HUNT TO REFORM UK ISAS THE JP MORGAN GLOBAL GROWTH AND INCOME TRUST BEWARE THE LONG BOND REFORMING INTEREST IN UK EQUITIES UK SMALL CAPS: THE SIZE DISCOUNT

1875

CONTENTS REFORMING INTEREST IN UK EQUITIES

3

THE JP MORGAN GLOBAL 4 EQUITIES AND INCOME TRUST (JGGI) BEWARE THE LONG BOND

6

TOPIC OF THE MONTH

8

Chancellor on the Hunt to reform UK ISAs

UK SMALL CAPS: THE SIZE DISCOUNT

10

OPENING HOURS

Monday–Friday, 08:00–17:00 GIVE FEEDBACK

publications@redmayne.co.uk HEAD OFFICE

0113 243 6941 FOR MORE DETAILS

redmayne.co.uk

RISK WARNING Investments and income arising from them can fall as well as rise in value.

Past performance and forecasts are not reliable indicators of future results and performance. There is an extra risk of losing money when shares are bought in some smaller companies. Redmayne Bentley has taken steps to ensure the accuracy of the information provided.

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 2

1875

REFORMING INTEREST IN UK EQUITIES ALASTAIR POWER | INVESTMENT RESEARCH MANAGER With winter months looming and days rapidly shortening, we approach the latter stages of 2023. A difficult year for many participating in financial markets with multiple stumbling blocks along the way, mainly centring around the ever-present dark cloud of persistent inflation and subsequent rising interest rates. A small cohort of names in the US have been responsible for driving US market performance, while in the UK return drivers were more diversified. For the first time in years, UK government bonds became a common discussion point, alongside issues maturing in the near-term.

Infrastructure funds, the popular destination for income investors in prior years, felt the pain of rising long bond yields, with share prices collapsing.

Despite the strong performance of UK equities in the year-to-date, our domestic market remains unloved, and the dominant buyer of some company shares continues to be the companies themselves through significant buyback programs, especially within the banking sector. UK equity valuations currently trade at significant discounts to their global peers, igniting debate around how to regenerate interest in investing in UK equities.

With the Autumn Statement approaching, our topic of the month highlights one potential area of reform, Individual Savings Accounts (ISAs).

Suggestions for reform include a UK-focused ISA allowance, enabling further tax-free saving provided investment in UK equities. Whether this materialises remains to be seen, but the redirection of a portion of the near £280bn held in cash ISAs as of the end of the financial year in 2022 into the domestic financial markets is expected to be a goal of Chancellor Jeremy Hunt.

UK equity valuations currently trade at significant discounts to their global peers, igniting debate around how to regenerate interest in investing in UK equities.

Recent focus around opportunities at the short end of the bond curve has increased, with issues maturing in the near-term and thus being less

sensitive to interest rate movements having shown all-in yields through the 5% mark. With the longer end of the curve being seen as risky in the event of persistent inflation, “Beware the Long Bond,” an additional article in this edition, highlights the potential dangers of the long end of the curve.

Our Stock Focus article delves into a core global equity holding for many, JP Morgan Global Growth & Income. The listed investment company provides access to a portfolio of the fifty best ideas from across one of the most well-resourced research platforms in the industry alongside an attractive dividend policy of 4% of preceding financial year end net asset value.

Finally, we reflect on one of the hardest hit areas in recent years, UK smaller companies, and a potential beneficiary of improved investor sentiment to the UK. Share prices of smaller companies have declined significantly in the last two years, with significant valuation multiple compression a key reason. Two years ago, the space looked expensive. Today, it is optically cheap. Looking through, operating performance of selected companies within the space remains robust and trading statements positive. Should this continue, share prices could re-rate. As always, there is no guarantee, but if share prices continue downwards, UK smaller companies could be too cheap to ignore.

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.

Investments and income arising from them can fall as well as rise in value. Past performance and forecasts are not reliable indicators of future results and performance.

3

1875

THE JP MORGAN GLOBAL GROWTH AND INCOME TRUST (JGGI) OSCAR SHEEHAN | INVESTMENT EXECUTIVE

Over the last few years, investing in markets has been akin to riding a roller coaster blindfolded.

Unforeseen highs and lows have left even the most experienced analysts dumbfounded while increased geopolitical tensions have added an additional element of unpredictability to portfolios. Extended periods of market volatility are never easy, and they tend to coincide with very real challenges in our day-to-day

4

lives. We are all aware of the additional stress this can generate. In this publication, we have done our best to highlight the bright spots in the faltering global economy and ensure that we keep our gaze fixed firmly on longterm investment prospects. These periods of market volatility can present opportunities both for investors, and for savvy fund managers seeking to take advantage of shifting valuations.

1875

The JP Morgan Global Growth and Income Trust (JGGI) is an investment trust that has done an admirable job of navigating these troubled waters. The Trust takes an unconstrained bottom-up approach to investing in global equity. Essentially, this means that it can invest in any company it likes, and this strategy allows it to make full use of JP Morgan’s research capabilities. JP Morgan is truly a titan of the industry, and this Trust can utilise almost 100 specialist equity analysts with an average of over 19 years. Few trusts can hope to match the scale of its operation and the result is a high conviction portfolio of around 50 companies that maintains the flexibility to pivot into sectors and geographical regions as opportunities present themselves. Despite the bottomup approach, the Trust’s managers do pay attention to how diversified the portfolio is in order to ensure that returns are not overly dependent on one region or sector.

There are no guarantees that this performance continues into the future, and this is certainly not investment advice, but what I hope this does is highlight that even in the darkest of storms it is possible to successfully navigate markets.

JGGI has been a rare bright spot in the investment trust space in recent years and its performance demonstrates the importance of having diversified exposure to a range of the best managers with proven track records.

Recently, the Trust’s performance has been surprisingly robust; it has returned almost 11% so far this year and 55% over the past five years. Despite many closed-ended investment vehicles struggling and trading at substantial discounts to their net-asset-values, JGGI is currently trading at a premium of 0.59%. The Trust has a very small amount of debt on its balance sheet and, as such, it has not been as negatively affected by rising interest rates when compared to some of its peers. This, combined with well-timed investments into the likes of Meta and Amazon, has helped the Trust to capture the rally in large North American tech stocks. On top of these investments, the Trust’s managers made the decision to shift their long-held growth tilt into

a more balanced position with more cash generative and profitable companies. This has been beneficial as it means the 4% annual dividend has become more sustainable as more natural income is generated in the fund.

The Trust also merged with the Scottish Investment Trust (SCIN) back in August 2022. Both had global mandates and the merger gave JGGI the ability to reduce its costs as the total increase in assets gives the managers greater purchasing power and economies of scale. Post merger, the liquidity of the Trust has also improved due to an increase in the breadth of the shareholder base. Initially, after the merger, it began trading at discount of 6% before returning to closer to its baseline level at less than 1% and these mergers have been a positive thing for the Trust. It is also worth noting that, as part of this merger, JGGI took on SCIN’s debt. This takes the form of a bond that redeems in 2030 and pays out a coupon of 5.75% with about £82m left outstanding. If this bond needs refinancing, it is likely JGGI will be able to negotiate much better terms due its size, the predicted fall in interest rates, and its overall lack of gearing. Getting this off the balance sheet should be a net positive for the Trust.

That said, this is by no means without risk. Despite slightly shifting more into dividend paying investments, the Trust still largely pays its 4% income out of capital, creating the possibility for capital erosion if the market turns. This will have the effect of magnifying any potential future losses.

The unconstrained nature of the fund also means that it is difficult to predict how it will perform in any given situation.

By investing in the JGGI you are placing your trust in the managers and the ability to position their portfolio for success.

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. The value of investments and any income derived from them may go down as well as up and you could get back less than you invested.

5

1875

BEWARE THE LONG BOND GREG LODGE | PERFORMANCE & RISK ANALYST

Earlier in October, yields on 30-year US treasuries reached a 16-year high on the back of a market-wide sell-off. Partly behind this sell-off was a tranche of data suggesting the US economy was much stronger than expected. The monthly release of non-farms data – the payroll data of around 80% of all workers in the US and an important measure of the health of the US economy – showed that 336,000 jobs had been added in September, far outstripping expectations. Given the apparent resilience in the economy, the Federal Reserve has been indicating that it intends to keep its benchmark rate (currently 5.5%) higher for longer. With this news digested, markets adjusted to accommodate a longer period of relatively high interest rates and correspondingly higher borrowing costs.

The impact was seen most strongly on the longer dated treasuries. Let’s explore why and take a look at how longdated bonds behave and their relationship with interest rates.

6

The parameters of what exactly classifies as a long-dated bond vary. In the US, this usually refers to a 30-year treasury – the longest maturity issued in that market. In the UK, anything maturing in 15 years or more is called long-dated. The UK has also in the past offered ‘ultra-long’ gilts with maturities of 50 years, primarily aimed at helping pension schemes in planning to meet their long-term obligations. Corporate bonds can be issued with a variety of maturities. New US issues in 2023 had an average of 10 years to maturity.

Given their time horizon, investors in long-dated bonds are more exposed to interest rate risk, default risk, and the effects of inflation on coupons and the capital value of the bond at redemption. As such, they are usually compensated with a higher yield – a risk premium. Likewise, shorter-dated bonds usually offer a lower yield as their investors are taking on less of a risk. The respective yields of bonds over the various maturities can be plotted on a graph. This is known as the yield curve. As we have discussed, generally a longer-

1875

dated bond has a higher yield than a shorter one, and so the yield curve typically slopes upwards. When this yield curve deviates from its usual shape, market participants often use this as an insight into what market forces are at play. For example, when short-dated yields rise above long-dated, the curve is said to be inverted. A common explanation for this phenomenon is that markets are expecting interest rates to fall. A strongly inverted curve has historically been an indicator of an impending recession.

bond has delivered stunning returns.” And at the time it was true, having returned 75%. Investors would have been thrilled. By late 2020, as governments sought to shield the economy from the impact of COVID-19 measures by keeping rates suppressed, the bond had reached an all-time high, trading at over double its face value. That same year, another century issue was launched, with a coupon of only 0.85%. It was eagerly snapped up by investors, with €16bn in orders submitted.

Given that yields and interest rates are so fundamentally linked, bond investors need an objective measure of interest rate risk which takes into account a bond’s maturity, yield and coupon. This measure is called duration. It is expressed as time in years, which reflects the time taken for the price of

It couldn’t last. With their low coupons and ultra long maturities, the Austrian century bonds were extremely sensitive to changes in interest rates. When rates began to rise again, the resulting effect on these bonds was inevitable and brutal. The 2017 issue currently trades at 64 cents on the Euro. If bought at its peak and sold today, this would represent a loss of around 75%. The 2020 issue has fared no better, and trades below 33 cents on the Euro. Consider also that Austria has one of the highest credit ratings and has never defaulted on either bond. The change in the direction of interest rates alone has been enough to inflict heavy capital losses on the unfortunate investor. These are perhaps somewhat extreme examples, but nevertheless serve to illustrate how long duration can be a dangerous thing. Beware the long bond – it can be all too easy to become entangled.

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. The value of investments and any income derived from them may go down as well as up and you could get back less than you invested.

“ In the years following the Great Financial Crisis of 2008-09 interest rates were slashed in a bid to revive the economy.

There they languished, until soaring inflation prompted central banks to begin raising them again. During this period of near-zero rates, bond issuers did not need to offer much in the way of coupons to make their issues attractive to investors. Additionally, some bonds with extremely long maturity dates were issued. One notable example was the hundred-year Austrian government bond which was launched in 2017 with a 2.1% coupon. By September 2019, The Economist proclaimed the headline “Austria’s 100-year

“

a bond to be returned via its cashflows. A bond which has a low coupon and/or is long dated will have a longer duration.

The higher a bond’s duration, the greater its sensitivity to changes in interest rate and, therefore, its volatility. A cautious investor, or one who is expecting interest rates to rise over time, would find a bond with a shorter duration more appealing.

Given their time horizon, investors in long-dated bonds are more exposed to interest rate risk, default risk, and the effects of inflation on coupons and the capital value of the bond at redemption. As such, they are usually compensated with a higher yield – a risk premium.

7

1875

TOPIC OF THE MONTH CHANCELLOR ON THE HUNT TO REFORM UK ISAs KONRAD PIETKA | INVESTMENT RESEARCH

CA & S SH CK ES ISA STO AR H S

Chancellor Jeremy Hunt is endeavouring to amend the UK’s Investment Saving Accounts (ISAs) to encourage more savers to invest, especially in UK companies. The ISA is a tax-free savings account which allows the saver to keep income and capital growth generated from it. Concrete details are anticipated in the run-up to November’s Autumn Statement at the time of writing.

Any changes will likely focus on increasing individual participation in the stock market and improving the valuation of UK equities, which have long been trailing behind their global counterparts.

8

A S I

The proposed plan for increasing share ownership focuses on streamlining the ISA structure, by allowing savers to hold both the cash savings and stocks and shares ISAs in one account. This could prompt an uptake in ISA subscriptions by enabling savers to control their investments with greater ease and convenience. Moreover, such a move may convince more ISA holders to store their assets in stocks and shares, rather than cash which, between 2021-2022, comprised 38% of the £741.6bn market value of all ISA holdings.

On top of this, there are signals that both the Innovative Finance ISA and Lifetime ISA (LISA) could be tweaked

1875

as industry leaders believe the convoluted and restrictive nature of both schemes has deterred many from transferring savings into them. The LISA revamp could encompass either a reduction in the early exit penalty, from 25% to 20%, or a separation of the £4,000 LISA annual contribution limit from the yearly £20,000 ISA allowance. Such reforms could be particularly beneficial to the self-employed, who could utilise the LISA investment vehicle as a means of expanding their pension pot savings.

Unfortunately, for the Chancellor, there are a few headwinds on the horizon which may curtail the efficacy of the foregoing reforms. HMRC’s recent insistence on the non-ISA eligibility of fractional shares has been perceived as a major blow for young and first-time investors, if it is upheld at Hunt’s Autumn Statement. As the name suggests, fractional shares enable investors to purchase parts of a company’s shares.

For instance, an investor could spend £100 to purchase a fractional share of Microsoft, rather than the full £270 necessitated for one complete share. The benefit is a lower barrier to entry for investors with smaller pots of capital and

The proposed plan for increasing share ownership focuses on streamlining the ISA structure, by allowing savers to hold both the cash savings and stocks and shares ISAs in one account. This could prompt an uptake in ISA subscriptions by enabling savers to control their investments with greater ease and convenience. the chance to build a more diversified portfolio. Removing fractional shares from the tax-free ISA wrapper would diminish their appeal and generate a barrier for many younger people trying to save and invest, an important habit for the younger generations to develop, especially amongst the backdrop of an incrementally ageing population. However, this issue could be remedied quickly, if the Chancellor clarifies the rules at November’s Autumn Statement.

A factor the Treasury cannot control is the receptiveness of the population to the reforms. Past initiatives like the “Tell Sid” Privatisation and 1999 ISA launch have failed to halt the gradual decline in private share ownership, which declined

from 54% in 1963 to 12% in 2020 of companies listed on the London Stock Exchange (LSE). The timing is also not overly favourable, as many households will be reluctant or unable to allocate extra funds towards long-term investments due to economic uncertainty. Although, the steep reduction in the capital gains and dividend allowance should help convince investors to shift investments into the more tax-efficient ISA if they have not already exceeded their annual allowance.

Chancellor Hunt’s ISA reform is likely a part of the Government’s strategy to divert additional funding into domestic firms, with reforms in other areas of the economy also being steered towards the same objective, such as the proposed Mansion House Reforms, seeking to channel part of the UK’s £2.5tn pension market into unlisted UK companies.

The aforementioned single cash and shares ISA should attract new investors and persuade existing ones to hold more of their savings in equities, rather than cash ISA deposits. Even though, an increase in ISA held shares could indirectly benefit UK companies, with Hargreaves Lansdown estimating that approximately three quarters of its ISA client portfolios consist of UK equities, there is speculation that another type of ISA, created solely for investing in UK companies, could be introduced. This would likely take the form of a separate annual ISA allowance for domestic companies, helping direct interest towards the UK equity space.

Despite the plan appearing to make sense, it would add further complexity to the ISA structure, which would be diametrically at odds with the initial motive behind the reform, to eliminate complexity and promote greater participation in the scheme amongst savers. Additionally, a revamp of transaction reporting to HMRC would have to follow suit, along with high levels of interest and engagement with this new type of ISA, for it to have any noticeable impact on the valuation of UK companies. This is because over half of the London Stock Exchange’s share ownership originates from overseas investors. Therefore, any attempt to noticeably increase the share price of UK listed companies would require a positive shift in foreign sentiment towards UK firms.

Regardless of the specific steps the Chancellor decides to take, it is probable that the reform will not generate any drastic changes in ISA holdings or UK equity valuations in the very short run, especially considering the current uncertain economic backdrop. However, an improvement in macroeconomic conditions, encompassing a drop in inflation and interest rates, could allow the new ISA framework to help facilitate an uptick in investment activity within the population in the future.

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. Investments and income arising from them can fall as well as rise in value. Past performance and forecasts are not reliable indicators of future results and performance.

Please note that tax treatment depends on the specific circumstances of each individual and may be subject to change in the future.

9

1875

UK SMALL CAPS: THE SIZE DISCOUNT SAMANTHA CORY | INVESTMENT RESEARCH

Over the past year, small-cap companies in the UK have had a tough time, with overall returns of the FTSE Small Cap Index falling by 7%. Large-cap companies have also been hit, but still managed to pull through with an increase in returns of 7.5%. This past year, investors have been playing it safe, maintaining a ‘risk off’ attitude amidst the uncertainty of the economic climate. Instead, they have been gravitating towards large-cap stocks, which hold a stable valuation and dividend growth. This cautious attitude, however, has left small-cap stocks feeling unloved due to their high volatility, limited public information and relatively low liquidity levels.

10

The composition of indices, such as the Financial Times Stock Exchange (FTSE) indexes, highlights the contrast between the difference in markets. The FTSE Small Cap Index comprises of a significant 50% allocation to investment trusts, and an additional 7% to Real Estate Investment Trusts (REITs). Conversely, the FTSE 100, which exclusively holds large-cap equities, exhibits a notable emphasis on energy and banking, while their presence is relatively small in the smallcap index.

Right now, the lacklustre performance of UK small-cap stocks is making waves in the world of investments. It’s got investors at a crossroads, trying to figure out whether they should take a leap of faith or play it safe – a classic risk

1875

versus reward dilemma. Fever-Tree, known for its premium beverages, has seen its price to earnings (P/E) ratio compress from a peak of 75x in 2020 to 33x currently. It’s not just Fever-Tree, most companies have taken a hit over the last seven months. Rightmove, the property search platform, also had its P/E ratio compress from 55x in 2021 to a more modest 23x currently, alongside a fall in the share price by 60% over the same period. It is easy to look at this and worry, but this is all part of the natural cycle that small-cap stocks tend to go through.

What could the future hold? Small-cap investors remain optimistic with many companies in the sector reporting strong trading updates, showing their resilience against current headwinds. Though share prices have declined, operating performance hasn’t followed suit. Rightmove, has seen its share price move lower through the last two years while earnings continue to advance. Other companies, such as the currency services firm, Alpha Group, have experienced similar feats with the share price declining while earnings increase. With resilience being proven, such companies cheapen, further share price declines only improve optical attractiveness. This is a common discussion point when talking to smaller companies’ fund managers and a key underpinning factor being their optimism.

While a common theme within the smaller-cap companies, many names exhibit the opposite trend of declining share prices and earnings. Some common risks that small caps can face include low liquidity, access to capital, lack of history, and limited information. Low liquidity levels can cause

trouble for investors when selling or buying shares, as there could be too many or too little available. They can also have trouble gaining access to capital, so when times are hard, it can be tricky to finance gaps in cash flows. Compounded by current interest rates, financing has become very expensive, and not available to all companies. Thus, selectivity remains key and simply buying the index could lead to a missed opportunity, given it includes the good, bad, and ugly. While direct stock picking is one investment option, a potentially more attractive one comes through the purchase of a listed investment company, of which the larger cohort focusing on UK smaller companies trade at discounts to Net Asset Values (NAV) in the mid-teens. The benefit of which comes in specialisation, immediate diversification of exposure and the ability to buy an already discounted area of the market at a further discount.

Looking forward, it will be interesting to see what happens to the UK smaller companies sector. Will it remain optically cheap? Or will it experience a resurgence due to a change in sentiment and growth potential? Predicting the catalyst and timescale is impossible, but for anyone who has experienced the sector for a significant period, when it moves, it has the potential to do so quickly.

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. The value of investments and any income derived from them may go down as well as up and you could get back less than you invested.

11

redmayne.co.uk