Thomas McMahon, senior Investment Trust analyst at Kepler Trust Intelligence, names a trio of trusts for income seekers, a defensive trust that’s in a sweet spot, an idiosyncratic recovery play, plus his favourite ethical funds.
Lee Wild, head of Equity Strategy, interactive investor: Hello. With me today I have Thomas McMahon, Investment Trust Research Manager at Kepler Trust Intelligence. Thomas, it’s been another incredible year for stocks, both in terms of news flow and performance. What have been your highlights in the investment trust sector?
Thomas McMahon, senior Investment Trust analyst at Kepler Trust Intelligence: Yes, it's been a very, volatile year. I think some of the more surprising elements have come in in emerging market space. So, in 2020, China was one of the best places to be invested, and then this year we've had real reversion of that, and India's done exceptionally well, particularly towards the second half of the year, despite the fact of course it suffered during the pandemic in the first quarter, and it now looks to be in a very exciting place.
And even some of the smaller emerging markets elsewhere outside of the North Asia complex have had their time in the sun. So that was an interesting development. I think the continued strong dividend performance from the UK equity income sector has been a real highlight for income investors. Very few of the trusts had to cut their dividends, which was obviously really proving what managers have said for many years that they wouldn't be able – they would need to cut dividends in an extreme environment, so they really proved their worth.
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And I think another interesting development has been the under the radar recovery in the commercial property funds, which are one of the most out favour sectors during 2020, and one of the slowest to respond to the reopening trade. And discounts have come in, they’re still wide. Dividends have been repaired, restored, and there’s now some interesting things going on in the sector.
Lee: OK, what about the outlook for financial markets in 2022? More of the same, or new themes and events that might influence investment behaviour and that we ought to be watching out for?
Thomas: Well, I think we are going to see the impact of what is already a relatively prolonged period of high inflation, which I think is going to move through the economy and will affect the financial markets. So, at the start of the year, we were debating whether inflation would be a very assured phenomenon or not, and we’re already past the point where we could even argue that. So, I think that's going to be a key consideration for investors.
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Inflation historically is not a particularly great environment for equities or for bonds, so it potentially creates some problems. And I also think, you know, without wanting to kind of dull the mood of optimism at the start of the new year, that, you know, we've had a really strong rally from the nadir of sentiment in the Q3 2020. And I think we still to work through a lot of the problems that have developed during the pandemic, so I suspect 2020 won't be as good a year for equities as it was – as 2021, sorry, 2022 won't be as good as 2021 was, which, you know, it’s been a very good year despite the difficulties we've had. So that's not to say we should panic, but it's perhaps going to be a more difficult year than it was.
Lee: OK. Well, it might be more difficult, but are there any trusts that you think could outperform over the next 12 months?
Thomas: Well, I think if you are concerned about inflation, you know, if you start from where could you go to protect yourself from that, I think we’ve seen a huge amount of fundraising in the alternative real assets space. So, infrastructure trusts, renewable infrastructure, digital infrastructure, and various other areas, and I think these have very good credentials for an inflation environment in terms of being able to protect the value of their assets but also grow their income.
And a couple that come to mind would be Greencoat UK Wind (LSE:UKW) has a very strong dividend linkage in its – from its portfolio, so a very strong inflation linkage with dividends in its portfolio. HICL Infrastructure (LSE:HICL) in the more traditional infrastructure space, again, has very strong linkage with inflation in its dividend. So, I think for income investors, these could be interesting places to look, and I think commercial property might sneakily rebound, you know, the share prices might do relatively well. Dividends generally looking in good shape in that sector with the scope for increases in a number of number of trusts, and I think that maybe that's been, you know, the relatively low dividends which maybe haven't got back to pre-crisis levels is what has been holding those trusts on a discount, so potentially that could be a bit of an interesting idiosyncratic recovery play.
I think there's still – you know, as we're speaking now we are experiencing this concern about principle new waves, so markets have taken a hit, but I think some of the recovery is still there in the commodity space. I think that maybe in the short term energy and related commodities are going to take a hit, but I still think trusts like BlackRock Energy and Resources (LSE:BERI) look quite interesting. This can play both sides of the energy transition, so renewable energy, but also fossil fuels, and so I think there's still some potential for interesting returns there.
Lee: Well, you mentioned fossil fuels, but the majority of investment trust launches this year have had some sort of ESG focus. Do you expect more of the same in 2022? And of the new launches in 2021 do you have a favourite?
Thomas: I think the ESG theme is here to stay, the energy transition is happening. This is, you know, the settled well of the world’s politicians and we're making steps towards it. So, there's no question that trusts which invest in renewable energy and in companies which encourage the transition away from fossil fuels, are going to continue to launch and continue to raise money, and more and more investors are looking to allocate specifically to that.
I think we need to bear in mind that ESG sustainability, the funds with those goals have benefited from looking extremely good in the performance tables up to 2020 with growth outperforming particularly strongly, with energy and commodities doing relatively poorly. Of course, given what’s happened over the last year or so, if you look at the performance tables now it doesn’t look quite so good, so that has to be borne in mind that maybe a year ago it looked like you were buying a top performing strategy which is also politically favourable. There might be some harder choices to make when you look at – you know, when you weigh up the performance potential and credentials for the next year or so.
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That said, there's no question there is still going to be – you know, this is still going to feature very highly in terms of what investors are looking for. Maybe it’s time to look away from some of the more obvious players. And, you know, one trust that’s potentially interesting is Jupiter Green (LSE:JGC). So, this is a relatively small trust, and it tends to invest in the smaller end of the market capitalisation spectrum, so maybe it can capture more innovative companies that maybe haven’t already seen the story play out so much.
And I’ve mentioned BlackRock Energy Resources and Income, this, again, allows the managers a bit more flexibility to adjust where they are based on valuations, to buy a bit more into traditional energy and a bit more into renewables.
So, yeah, I still think it’s a very important theme, but, you know, I think if you speak to managers in the space they’ll agree that towards the middle of 2021 and later on, valuations in certain areas got pretty expensive, so that needs to be borne in mind as well. Maybe you need to look to diversity a little bit.
Lee: OK, I mean well there's quite a few headwinds possibly for 2022, but for a long term investor are there any defensive trusts that you like the look of currently?
Thomas: Yeah, I mean I really think that Ruffer Investment Company (LSE:RICA) looks really interesting in the current environment. So, for a long time this trust has positioned itself for a period of sustained high inflation, and that’s what we’re seeing now. So, the asset base – this is a multi-asset trust so they can invest pretty much anywhere. You know, they start with a blank sheet of paper, invest in anything they want, and one of the major themes in their portfolio construction is making sure that they are ready for this sort of environment. So, a large amount of index-linked bonds, some gold, and other strategies that are designed to benefit in this sort of environment.
And I think the other element that we need to bear in mind in the coming year or so is that central banks are probably going to be very cautious in raising interest rates. You know, while we are seeing high inflation, this is coming more from the cost push side rather than from the economy, you know, the demand pull side and the labour force being extremely tight, etcetera. So, this is not really the sort of inflation they want, they’re more worried about what’s going on in the labour market and so on.
So, I think, you know, we should expect relatively low interest rates and a relatively high level of inflation, and that’s the sort of environment that Ruffer are positioned for. So, I think that, you know, if I had to pick a defensive trust at this moment in time, that’s where I would be looking.
Lee: Thomas McMahon, Investment Trust Research Manager at Kepler Trust Intelligence, thanks for joining me today.
Thomas: Thank you very much, Lee.
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