June 2020
In 2018, almost a decade after the Great Financial Crisis we wrote a piece on the prominent investment themes that were influencing the shape and construction of our portfolios. In recent months, many of the trends we identified have experienced a rapid acceleration as a result of the extraordinary reaction to the emergence of COVID-19 from governments and central banks in particular, with global lockdowns becoming the norm. In this article we will explore five of these accelerating trends and how we are responding to the threats and taking advantage of the opportunities that are being created.
The accelerating trend: Ever more creative and looser monetary policy
In our investment themes article written in August 2018, we noted that “monetary policy was extraordinary and we should not be tempted to treat it as anything other than that despite many coming to the viewpoint of policy in the post Global Financial Crisis environment as being ‘normal’”. ‘Extraordinary’ can now be replaced by ‘unprecedented’. The action of the Federal Reserve Bank of America (Fed) in particular has been astonishing in its scale and speed in the wake of COVID-19. In a matter of weeks, the Fed injected more liquidity into the market than had been seen during any of its previous quantitative easing programs. They have gone as far as buying high yield corporate bond ETFs (exchange-traded fund), with some commentators expressing outrage that this is illegal as it strays from monetary policy towards fiscal policy. Modern Monetary Theory has accelerated from derided theory into mainstream practice with central banks on a printing spree, directly buying newly issued government bonds. The result has been government bond yields that are anchored at or near all-time lows, with credit spreads (the additional yield above and beyond the government bond yield) also at or near all-time lows prior to the COVID-19 sell off.
How we are responding: Easy money has resulted in a ‘hot potato’ effect, as investors have been forced into riskier assets in the search for higher returns. This has resulted in crowding into high quality businesses with the result being eye watering prices for some large cap companies, notably the FAAAMNs (Facebook, Apple, Amazon, Alphabet, Microsoft and Netflix). Our valuation driven process means we will not chase expensive assets higher, especially when they are offering paltry, and even negative, prospective returns. We have taken a more unconventional approach to income investing, seeking secure income from less well known but attractively valued sources including asset backed debt, music royalties and emerging market and Asian debt. The recent COVID-19 induced sell off enabled us to shift the portfolios’ bond exposure back towards conventional investment grade and high yield bond funds on compelling valuations. But the subsequent sharp recovery in spreads means unconventional income continues to remain an important component of our portfolios. Despite the rise of digital currencies over the past decade, gold remains the ultimate physical store of value and the best hedge against a loss of confidence in monetary authorities and fiat currencies. Not only is gold a hedge against this extreme event, but historically it has protected the long term purchasing power of investors in both inflationary and deflationary environments. We have exposure to both physical gold and gold mining equities, which trade at historically cheap levels relative to the precious metal price.
The accelerating trend: The Death of the High Street
One of the trends in recent years which has received a lot of media coverage has been the ‘death of the high street’ and the shift by consumers towards online shopping. This has impacted many business models, with traditional bricks and mortar only offerings having to adapt quickly. The result has been a surge in demand for warehouse and last mile logistics space to facilitate home delivery. Despite this, small and mid-box warehouse space across the UK is still valued at below the cost of replacement, meaning it is not profitable for speculative development to occur. This is constraining supply at a time of surging demand. It was forecast that 25% of retail sales would occur online by the end of 2022, but so far this year over 30% of retail sales have been transacted over the internet. If the proportion continues to hover around this 30% figure, 50 million square feet of additional warehouse space will be needed almost immediately, putting significant upward pressure on rental growth and property valuations.
How we’re responding: We access this theme in each Fund through a position in Urban Logistics REIT, a trust that owns single let warehouse space focusing on last mile and regional logistics centres in the UK.
The accelerating trend: Aging demographics and improving healthcare provision in developed markets
Birth rates in developed markets have been on a downward trend in recent decades, and when combined with improved healthcare provisions, has led to an acceleration in the average age of developed market populations. In 2015, there were around 901 million people aged 60 years plus worldwide, representing 12.3% of the global population. By 2030, this will have increased to 1.4 billion (16.4%), and by 2050 to 2.1 billion people (21.3%).1 As populations age, additional strain is placed on healthcare systems as demand for medical attention increases. There is greater need for specialist living facilities and care homes which are able to cope with age related diseases such as dementia. The current supply of this infrastructure significantly lags the growing demand, with the increased strain being put on hospitals reflected in lengthening waiting times for appointments. Improving and increasingly efficient healthcare provision is vital, as are sources of funding for new discoveries and innovations.
How we’re responding: All of these themes are accessed within our portfolios through property specialists like Impact Healthcare REIT and Civitas Social Housing REIT, equity specialists BB Healthcare and Polar Capital Biotechnology, and debt specialist Biopharma Credit. The latter provides debt to life science companies, senior secured against the cash flows of proven and approved drugs or technology. This frees up capital at these businesses to pursue new, innovative healthcare solutions. More broadly, as increasing numbers of people reach retirement age, the way they save and consume changes. Pension funds shift into drawdown mode and money drains from financial assets towards real goods and services. This opportunity is captured by our more generalist developed market equity exposure in our Funds.
The accelerating trend: The rise of Asia and Emerging Markets
Whilst we are seeing aging demographics accelerate in western developed economies, across emerging markets and Asia many populations are in a sweet spot for growth and consumption. The rapid rise of China as a global powerhouse has created a burgeoning middle class with disposable income to burn, and a number of companies both old and new are moving quickly to try and capture the imaginations of this demographic. The story is not limited to China, with the growth in the middle class seen right across Asia. Statistics centred on the continent are staggering. Asia is home to over five billion people, two-thirds of the world’s mega-cities (populations in excess of 10 million people), one third of the global economy (but currently contributes around two-thirds of global economic growth), thirty of the Fortune 100, six of the ten largest banks, eight of the ten largest armies and five nuclear powers.2 Whilst healthcare systems lag behind the western world in many Asian countries, younger demographics leave them better placed to successfully navigate through the COVID-19 pandemic, which disproportionately afflicts elderly patients. Meanwhile, debt levels are more manageable across Asia as governments have not been in a position to add the excessive levels of debt western economies have taken on to support their economies. Paying off debt in the long-term will constrain economic growth in developed markets, a burden that will not be as keenly felt in Asia.
How we’re responding: Long-term equity valuations are currently attractive and provide a good foundation for returns. However, as the above statistics suggest, the need for highly selective active exposure has never been more important to navigate such a diverse region. Single region focused funds have come into existence. In the same way that there are many US or UK dedicated funds, there are now China or India focused funds amongst others. The opportunity is not just limited to equity investment. We are accessing this theme across multiple asset classes including equity, debt and even song royalties via funds including Ashoka India Equity Investment Trust, Muzinich Asia Credit Opportunities and Hipgnosis Songs.
The accelerating trend: Peaking globalisation
The pace of globalisation has slowed in recent years, and has perhaps even reached a turning point where we accelerate away from globalisation towards more closed and autonomous economies. Tensions between the US and China have resurfaced, having taken a backseat as attention was turned to management of the pandemic. As the November Presidential election in the US draws nearer, it would not be a surprise to see Trump drum up the blame game around COVID-19 and further escalate tensions. We may see an acceleration in manufacturing activity returning closer to home as a direct result of the virus, in a bid to reduce the level of disruption experienced in supply chains. Trade restrictions, particularly centred on goods of strategic importance such as medical equipment and pharmaceuticals are becoming more prominent. As barriers to global trade increase, exporting goods and services becomes more difficult. This will have a greater negative impact on large companies that require overseas expansion to continue their growth, over smaller companies that benefit more from domestic demand, particularly if foreign countries seek to boost tax revenue to fund elevated debt levels by targeting large global corporates.
How we’re responding: The past decade has seen impressive outperformance from mega cap companies, breaking the long-term trend of smaller companies outperforming. The process of deglobalisation may see this reverse in the coming years. We are generally finding that valuations and growth prospects for small and mid cap companies are more compelling than large and mega caps, and this is reflected in a general tilt within our equity exposure towards medium and smaller companies. One other consequence of deglobalisation is inflation given, among other things, globalization has been cited as a major deflationary force over the years. Most of our property exposure is inflation linked, and equities generally benefit while government bonds lose out in inflationary environments, an asset class we have very low exposure to.
Conclusion
We are living through an extraordinary time of accelerating trends. It is impossible to predict the future with any certainty, but one thing that appears clear to us is that an active approach to investment management has never been more important, with traditional passive vehicles particularly vulnerable to the acceleration of many of the trends that we are seeing today. We believe the construction of highly diversified portfolios invested in assets with a margin of safety that take advantage of a multitude of accelerating and decelerating trends is a powerful combination that provides a strong foundation for attractive long term returns for our investors.
Dan Cartridge – Assistant Fund Manager
¹https://www.ons.gov.uk/peoplepopulationandcommunity/birthsdeathsandmarriages/ageing/articles/livinglongerhowourpopulationischangingandwhyitmatters/2018-08-13
²The Future is Asian – Parag Khanna, 2019
This financial promotion is issued by Hawksmoor Fund Managers which is a trading name of Hawksmoor Investment Management (“Hawksmoor”). Hawksmoor is authorised and regulated by the Financial Conduct Authority. Hawksmoor’s registered office is 2nd Floor Stratus House, Emperor Way, Exeter Business Park, Exeter, Devon EX1 3QS. Company Number: 6307442. This document does not constitute an offer or invitation to any person, nor should its content be interpreted as investment or tax advice for which you should consult your financial adviser and/or accountant. The information and opinions it contains have been compiled or arrived at from sources believed to be reliable at the time and are given in good faith, but no representation is made as to their accuracy, completeness or correctness. Any opinion expressed in this document, whether in general or both on the performance of individual securities and in a wider economic context, represents the views of Hawksmoor at the time of preparation and may be subject to change. Past performance is not a guide to future performance. The value of an investment and any income from it can fall as well as rise as a result of market and currency fluctuations. You may not get back the amount you originally invested. HA3919
