James Baxter, Founder
A combination of;
- better news on inflation and interest rates with the US Fed confirming that it would be unlikely rates would now rise,
- economies remaining strong, epitomised by the UK economy rising from recession,
- and decent corporate earnings with 64% of companies who have reported so far for Q1 beating estimates (according to StreetInsider.com).
has led to continuing rises in portfolio values. We have new highs this year, and for all time, for most of our portfolios today.
As discussed in the last update the recovery in equities is broader based than just the US big caps. This is favouring our active managers with most managers outperforming the S&P 500 index in the last 3 months and giving our portfolios above US index equity returns.
FE Analytics, 17 May 2024
The good news, as we have highlighted before, is that, away from the big US stocks, there still is good value in equity markets.
The FTSE 100 index is now up c30% since the start of 2021 versus 39% on the US index. Whilst the FTSE 100, a proxy for more normal world stocks, is rapidly catching up the US index, 20% or roughly two thirds of that gain in both indices is simply keeping up with the last 3 years inflation.
Equity markets typically deliver inflation plus around 6% per year in returns so there could well be some room for the rebound in broader markets to continue.
Combining the Tideway equity returns year to date (YTD) of c8.8% plus a c3.4% year to date return on our fixed income portfolios is giving us c5.3% year to date returns on our Multi Asset Balanced portfolio after all fees.
It’s worth noting the UK gilt index is down c2.8% YTD and the UK corporate bond index down c1%, so we have relative outperformance in both bonds and equities. Long may it continue!
Well done to Nick and the Tideway investment committee for sticking to their guns and not capitulating to sell funds and buy the index whilst US indices roared.
Contrarian investing is always tough, the pull of the herd on humans is a strong one and it takes conviction to stick with your positions when others around you are vocally joining the herd.
Below Nick talks about the Unicorn UK Income fund, which I had my eyes on to sell. That’s why I’m only part of the committee and don’t get any bigger say than anyone else – Ben Klein and Nick both had strong conviction to hold on.
We have Josh Passmore from Artemis who works on the Artemis Global Income fund coming to talk to us at the Royal Thames Yacht Club in Knightsbridge next Thursday evening. Again, this fund was getting an amber light at one point in the last few years, but we stuck with them and the team at Artemis have gone on to do a great job as the tide turned in their favour.
For anyone who has not been to one of our events yet, the evening at the Thames will be a relaxed, informal affair. With drinks and nibbles it will be a great chance to meet members of the Tideway team, (rumour has it that James Saddington, our compliance officer, will be there) and hear from Josh, Nick Gait and me. We have flexibility on numbers but do please confirm with edna.oliveros@tidewayinvesment.co.uk if you would like to join us.
Tax
News from the Berkshire Hathaway convention on Warren Buffet’s explanation for selling around $40bn worth of Apple stock this year caught my eye. The late Charlie Munger reportedly dragged Warren into Apple in 2016, he was very late to the party having studiously avoided tech stocks up to then.
Despite being late in, Berkshire has still made roughly seven times on this initial investment, and Warren assured the audience, which included Apple CEO Tim Cook, that he thought Apple was a great business and he expected it to remain the firm’s largest listed investment at the end of this year. Warren went on to explain it was about tax. Berkshire would pay 21% tax on the profits banked and, looking at the US budget deficit and debt levels, Warren was hedging against higher tax rates in the future by banking some profits to invest elsewhere. It’s been revealed that they bought some 26million shares in the insurer Chubb (which will have pleased one of our clients if he is reading!). Chubb shares rose on the news and are up c12% YTD.
We are having several ongoing conversations with clients now around crystalising capital gains to allow for reinvestment elsewhere. The capital gains tax allowances have all but gone but the rate still sits at 20% for higher rate tax payers, 10% for basic rate. In my opinion these are attractive rates, which, like Warren, we should not be too unhappy to pay in order to bank profits and redeploy capital to better investment strategies.
Finfluencers
My last anecdote comes from James Saddington, who on a lighter note last night at our monthly update revealed that the FCA had been cracking down on Finfluencers. For those who like their reality TV the FCA is bringing charges against a host of stars from ‘Love Island’, ‘The Only Way is Essex’ and ‘Celebrity Big Brother’ for illegally promoting trading in Contracts For Difference (CFDs), in which, according to FCA, 80% of investors lose money.
My mind boggled! So many questions! I can only imagine the discussions going on between the likes of Emmanuel Nwanze and Holly Thompson (I had not heard of them either!) and their agents trying to explain to them the intricacies of CFD trading and Section 23 of the financial Services Market Act 2000 given they now face up to two years’ jail time.
Whilst the intent is clearly good, the cynic in me can’t help thinking that the FCA could have gone for the low hanging fruit. They have gone for the name and shame headlines and those least culpable will suffer in what is clearly the modern-day equivalent of investing in pink slips in the 1980’s. Think Wolf of Wall Street and lambs to the slaughter. What about the agents, the businesses happily profiteering from the trade in CFDs and of course Meta, which appears to turn a complete blind eye to what goes on at both Instagram and Facebook?
Nick Gait, Investment Director
Unicorn UK Income – Fund in Focus:
UK markets have been in the press more as of late, with the FTSE 100 reaching all-time highs over the course of the last couple of months. We thought this would be good time to highlight the merits of our own UK manager Unicorn UK Income which has also enjoyed good performance after a comparatively slow start to the year. We will also briefly cover why we prefer to hold Unicorn’s strategy over the broader FTSE100 index.
The headwinds to UK Equities have been well documented over the last few years with UK institutional and retail investors alike preferring to allocate an ever-higher percentage of their capital to global markets on the back of strong historic returns. With more sellers than buyers, this has led to a broader derating of UK Equities and left them attractively priced versus their global peers in our opinion.
Although the absence of a catalyst for a broader market rerating is not obvious for the UK market, there are some additional drivers at play which are contributing to already strong cash returns and shouldn’t be ignored; the two we have identified are M&A, from both private equity and foreign buyers plus share buybacks which a lot of investors are perhaps less familiar with.
The case for continued investment in Unicorn UK Income:
Strong business fundamentals:
- Healthy starting dividend yield of 4.8%. In isolation, dividend yield is not an investment thesis with companies potentially paying out a disproportionate amount of cash to investors and neglecting reinvestment in their businesses. This can often increase the probability of dividend cuts later down the line leading to negative share price performance and poor total returns. In the case of Unicorn UK Income this dividend yield is covered twice by company earnings which helps mitigates the potential of cuts to the dividend yield going forward.
- Potential for a growing dividend: We continue to be an advocate for fixed income investing, especially in the Credit space with healthy real yields above inflation still available. The differentiating factor with dividends, particularly in this strategy is the potential for a future increase in dividend payments, whereas bond coupons are largely fixed. The companies held in the fund are projected to grow earnings by 11% in 2024 according to consensus estimates. which should help fund some healthy dividend increases going forward. As a side note, contrary to the prevailing narrative, it is possible to find businesses in the UK which are growing.
- A more diversified dividend: Compared to the wider UK market, we believe the dividend of Unicorn UK Income is much more diversified with the broader UK index owing a significant contribution to its dividend from a just a few large players and is one of the major reasons why we prefer to stay active in this market. According to Unicorn Asset management and Link Dividend Monitor Q4 2023, 28% of dividends in the index come from just five companies and with the top fifteen accounting for 60%. Furthermore, there is significant concentration from a sector perspective within the broader index with 28% of dividends coming from Commodities and 25% from the Banking Sector. Although some of these companies are held in our global mandates, we feel more comfortable in allocating a portion of our capital elsewhere.
- Strong balance sheets: One of the fastest ways to destroy capital is by investing in companies with weak balance sheets leaving them particularly susceptible to a slowdown in operating performance. This leaves companies unable to pay off any outstanding debts often leaving equity holders with nothing to show from their original investment. This is something that Unicorn analyses closely in their investment process and can be evidenced by the fact that 59% of portfolio companies have a net cash position on the balance sheet – This means these companies could pay for all outstanding liabilities from cash already sitting on the balance sheet.
Low starting valuations:
- Price is important: The price you pay for a company remains an important factor for long-term future returns. There is no doubting that the global index contains many of the world’s best and fastest growing businesses. Companies on high valuations continually need to exceed these expectations for continued strong share price performance.
- Low starting valuation: This strategy is attractively priced in our opinion with thirty-six out of the forty companies within the portfolio trading below their 5-year average. The 2024 price to earnings ratio of just 12.4 times also compares favourably to global markets, when comparing businesses in equivalent sectors.
Additional return drivers:
- M&A Activity: One product of low valuations amongst UK companies is that it has left them ripe to takeovers from both Private Equity and foreign buyers. Although this is not necessarily a positive for the UK market in general, it is certainly a positive for investors with large premiums often attached to any deal. A few recent examples of companies held in the UK Income fund which have proved accretive to returns.
o Numis: +61.07% increase previous day’s listed share price. Announced 28th April 2023.
o Wincanton: +34.6%. Announced 29th February 2024.
o Alpha Financial Markets: +38.81%. Announced 1st May 2024. - Share Buybacks: Low valuations have been a source of frustration for company management as well as investors. One of the options available to company management should they believe their shares are undervalued is to buy back their own shares in the market. With fewer shares in circulation, each remaining shareholder gets a larger stake in the company and a higher percentage of future dividends.
- Within the fund eleven share buybacks have been announced in last twelve months with these companies representing 28.6% of the fund by weight. We have more detailed metrics available for those who are interested.
- Severfield is the most extreme example to illustrate the value of share buybacks. Company management announced a share buyback of £10m on 17th April 2024 which represented c.5% of the company’s market capitalisation at the time. With continued strong operating fundamentals, the share price increased by c.19% on the day.
- Not all buybacks produce these results immediately but think it is an important driver in helping the market understand the value of some of these companies.
Summary:
Tideway’s Investment Committee have continually debated the case for holding UK Equities as part of a globally diversified portfolio. Although many investors continue to shun the UK market, we believe that the UK market continues to deserve a portion of client capital on merit. Although we cannot predict future returns, we believe that overall balance of risk and return very much in the favour for patient investors.
- High quality companies which are able to strengthen their market position during challenging periods. Continued strong business fundamentals with companies growing their earnings.
- Lower valuations compared to history and to global comparable businesses globally. Provides a margin of safety.
- Strong cash returns while you wait in the form of a healthy well covered dividend yield with accretive returns to be found from both company management buying back their own shares as well as takeovers.
- The content of this document is for information purposes only and should not be construed as financial advice.
- Please be aware that the value of investments, and the income you may receive from them, cannot be guaranteed and may fall as well as rise.
- We always recommend that you seek professional regulated financial advice before investing
