Interactive Investor

ISA ideas: out-of-form areas pros think will make a comeback

While there’s always the risk of catching the proverbial falling knife, buying when valuations and sentiment are low could pay off over the long term.

20th February 2024 09:47

Ceri Jones from interactive investor

Most investors expect to keep their ISAs in place for a few years before calling on their savings, which provides an ideal opportunity to buy a cheap, out-of-favour sector in the hope that over time its performance bounces back.

This could be particularly opportunistic in the current market, where economic data has defied the odds, central banks are talking about cutting interest rates, and a soft landing (a severe recession avoided) now seems plausible.

Infrastructure under the cosh

Few sectors have been more depressed than the alternative investment company sector, which invests in real assets such as infrastructure and renewable energy such as wind farms. Last year, high interest rates put pressure on these listed funds, as investors use discounted cash flow to value such assets. Moreover, listed alternatives have always been in demand for their income but as rates rose last year, other asset classes, such as bonds and cash, competed much more for investor attention.

Encouragingly, companies in the sector have recently managed to sell assets in private markets above Net Asset Value (NAV), while their shares trade at double-digit discounts on the stock market.

Dan Ryan, multi-asset portfolio manager at Fidelity International, says “this is not necessarily surprising, as share prices reflect the price for immediate liquidity and short-term sentiment towards the stock market, while private investors can take a long-term view of assets’ fundamental return”.

He adds: “While selling assets at accretive prices is good for sentiment, public investors need a way to directly benefit from private investors’ appetite for alternative assets.”

He therefore recommends investment companies that are rewarding shareholders through buybacks, dividend growth and deleveraging.

Janus Henderson also backs the sector. “We expect inflation to remain above target for some time, driven by structural themes such as de-globalisation, the energy transition and ageing demographics,” says James de Bunsen, a multi-asset portfolio manager.

He points out: “In this backdrop, companies with secure, well-covered and progressive dividends look very appealing. We forecast net asset value returns in the high single digits, augmented by tighter discounts as rates fall, leading to double-digit annualised share price total returns. We like 3i Infrastructure Ord (LSE:3IN), International Public Partnerships Ord (LSE:INPP) and The Renewable Energy Infrastructure Group.”

Does opportunity knock for commercial property ahead of rate cuts?  

The prospect of lower interest rates also helps any company with significant leverage, including, of course, commercial property. Depressed property prices have further opened opportunities to acquire attractive buildings at discount prices.

Some Real Estate Investment Trusts have fallen to discounts of 40% or more. Investors have also avoided commercial property because several open-ended property funds have been shuttered in recent years owing to Brexit in 2016 and the pandemic in 2020. Fortunately, closed-ended investment trusts don’t face the same liquidity issues.

Rather than standard property sectors such as retail units, offices, warehouse units and industrial premises, a potentially more attractive risk/return profile can be found in specialist property funds that own care homes, student accommodation, supermarkets and GP healthcare facilities, which have lower sensitivity to the economic cycle given the stability of their tenants, long tenure of leases and long-term structural drivers for ongoing use. For example, Janus Henderson’s de Bunsen likes Empiric Student Property (LSE:ESP).

Social infrastructure funds focused on properties that maintain social services, such as medical facilities and nursing homes, have been on teen-like discounts, compared with trading at premiums to their net assets for much of their lives.

“We find good opportunities here with resilient operating models, almost complete lack of voids and ongoing rental growth,” says Ian Rees, co-head of multi manager funds, Premier Miton.

He adds: “Owning the physical buildings should be seen as a real asset that should accrete in value, supported by rental agreements that reflect an element of inflation linkage over time too. Their sensitivity to shorter-term interest rates presents a good opportunity for those willing to stomach this volatility.”

Self-storage also has strong growth potential, with “room for increased penetration—which is particularly low in the UK and Europe, as storage serves as a low-priced alternative to extra square footage in the home”, says George Ross, senior research analyst and portfolio manager at First Eagle Investments.

Biotech bounce-back?

The market cycle also plays into biotech. A rush of biotech companies came to market in the aftermath of Covid, but the Nasdaq Biotech Index has fallen back to 223 constituents. Last year, 55 novel drugs were approved, the most since 2018 and the second highest in 30 years.

“There is plenty of potential for biotech to catch up with broader sentiment given the outlook for innovation and prospect of falling interest rates,” says Zhoufei Shi, multi-asset analyst at Fidelity International.

Shi adds that pharma companies, which have close to $500 billion of firepower to do deals, are facing a patent cliff. He adds: “Numerous profitable drug patents are due to expire in the near future - and [pharma firms] could look to bolster their drug pipelines with acquisitions of biotech firms.”

Arun Sai, senior multi-asset strategist at Pictet Asset Management, also likes biotech, but sees it as a medium-term (three-year) play, not a tactical decision that will produce easy wins in six months.

“Biotech (especially in the mid-cap space) is another victim among the long duration sectors. From a structural point of view, we are big fans of their innovative track record, with progress in areas such as gene editing, and breakthroughs beginning to come through. But with Europe on a price-to-earnings  of 11x, and China on 8x, biotech at 20x is not dirt cheap.”

Jury is out on ‘cheap’ China

Among potential opportunities in different geographies, China is tipped by many investment professionals as a potential winner, but it is a country that could equally disappoint fiercely.

“This market has reversed China’s status from doyen of global growth in recent years to being considered almost un-investable by many...as a consequence of its fractious relationship with the US, and its clampdown on private enterprise,” says Rees.

He adds: “While geopolitical fears with the West have risen following events in Russia and ongoing tensions with Taiwan, we hope that cooler heads will recognise the necessity of trading links between these two super-powers. Miserable valuations of Chinese stocks reflect this weak sentiment and distrust, and even when looking at Chinese shares listed in Hong Kong, this market appears the cheapest it has been for over 20 years.

“We think that more cordial international relations, coupled with a greater demonstration of the economic might that can be driven by its own command economy, might encourage investors to revisit this land of opportunity.”

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