Worth picking up today on a note from SG’s Global quantitative research team from yesterday called “There is nothing to fear but fear itself – Hedging inflation risk with equities”. This is very timely because as readers of this blog will know I think worry about inflation – or at least expectations of its re-emergence – is fast becoming a major topic. The SocGen paper rightly reminds us that worries about inflation are timeless and there is an endless debate about whether investors should worry about core rates shooting above 5%. It is an open-ended debate! That said investors are worrying more than usual about this topic as this useful chart below from SG shows.
The meat of the report though is what investors can practically do to hedge their inflation risk. A few comments are worth noting in more detail. The first is that factors probably won’t be of much use. As the SG report says “when we asked our Machine Learning (ML) system to help us ‘play’ the inflation theme within the equity market, it basically came back with “I don’t know”. Factors such as Value, Quality and Growth are not useful ways to play inflation, either because they aren’t or because we simply haven’t really had any sustained inflation to model”.
What about sectors?
“Primary businesses feature heavily in the inflation winners, with Fertilisers, Oil Production and Copper [are] clear beneficiaries given Food, Metals and Oil prices are key reasons for rising headline inflation [emphasis added] This makes sense, as ramping up oil, food and mining production is slower than ramping up production in a factory, especially if there is plenty of spare capacity. Farming is highly seasonal and lost crops are not easily replaced. On the losing side, Airlines are obvious losers from higher oil prices, but the rest is less obvious. Farming & Fishing for example might be a winner from higher food prices, but if their clients (supermarkets) refuse to accept cost push inflation, then margins would come under pressure.”
The chart below maps out those betas to inflation. Note commercial mortgage REITs as well and Home Construction (builders) on the downside.
“We end up with a concentrated basket of nine Mining and seven largely Fertiliser manufacturers, which we have screened to ensure the components have enough liquidity and therefore the basket is tradeable. “
One useful side note – adding (20% portfolio allocation) gold to the inflation basket helps reduce volatility.
New UK focused fund
Nice to see the IPO pipeline is restarting again. One in particular looks interesting in my view – it’s called the Tellworth British Recovery & Growth Trust (BRIT). The new fund “believes that many companies listed on the UK stock market are currently undervalued.”. You can see an early research note on the proposed IPO HERE.
Here’s the fund basics: BRIT is a new company that has been established to invest in the United Kingdom. Its portfolio will combine what the investment manager believes to be the best of British global leaders, British recovery stocks and British technology stocks. It will aid those British companies if they need more capital and aims to support many of them as they grow from small beginnings to the world-class companies of tomorrow. The investment team selecting stocks for inclusion in the portfolio is led by Paul Marriage and John Warren, who worked together at Schroders before setting up Tellworth Investments in October 2017. BRIT is seeking to raise £100m in its initial issue, which is open to both professional and private investors (in qualifying locations). There seems to be a hard-minimum fund raise at £75m working alongside Dickson Minto and Numis.
The obvious focus here is on UK focused businesses – the team “will actively seek companies that are UK-based and headquartered and that have significant UK activities in research, development, production or services without which their business could not thrive.” Crucially the team seem to be focused more on what I suppose one could loosely call ‘growth’ / quality stocks, thus differentiating the fund from more value focused peers.
“Over the past 20 years, members of the team have a developed a stock-selection methodology which aims to identify companies which are at an early-stage on their path to becoming world-leading public companies. The team calls this ‘P3M’ investing.
- Product – companies that offer a differentiated product, possess their own intellectual property and demonstrate strong levels of R&D.
- Market – companies that demonstrate strong global market positions.
- Margin – companies that demonstrate an ability to grow their margin over time and generate high returns on capital and cash.
- Management – companies whose management have a demonstrable shareholder value approach and who own stock in the company.
The team believes that companies that meet these criteria can be classified as existing and future British Global Leaders.”
In terms of screens used for this dynamic stockpicking process, for inclusion in the fund the following criteria are used.
- British Global Leaders – 20% of the business’s staff must be based in the UK at the time of investment.
- British Recovery – 50% of the business’s staff must be based in the UK at the time of investment.
- British Technology – 25% of the business’s staff must be based in the UK at the time of investment.
Overall, I think this sounds a really interesting new fund, especially given my core contention that UK equities are super cheap. It’s a growth/quality multi cap approach and so is quite different from many of the existing UK equity focused investment trusts such as Aurora (where I am a NED), the Fidelity Special Sits fund and Schroder UK Mid Cap. I suppose the main competition will be Baillie Gifford UK Growth. The ex Schroders team are highly rated and the timing for this new fund is excellent though I would note that across the (UK) sector discounts are still quite high, averaging around 12% the last time I looked.