As well as penning this blog, and writing for various publications about investment, I’m also a non-executive director for two investment trusts – the Aurora Investment Trust and the SQN Secured Income fund. I tend not to write about either for the simple reason that I think it slightly inappropriate, professionally, to comment on stuff where I have such a direct interest. But in this blog I am going to explain why I believe the current Aurora placing (available until the end of September) makes sense, especially for retail investors.
Crucially I want to explain why I have invested in Aurora – and walk readers through my own mental investment process. I’ll also try and keep it simple and to the point, and minimize the inevitable jargon.
And please do always bear in mind that I am NOT entirely impartial on this, though I genuinely think the step through process below makes real sense.
So, step one is the easy bit. UK equities look reasonable value in my view. US equities are I think, by common agreement, looking expensive. I’m still a big fan of Eurozone equities but even I admit that the recent increase in the value of the Euro might cause some short term volatility, and slightly undermine this positive story.
UK equities by contrast look OK value – as opposed to US equities which look poor value. Crucially we have, collectively, as a nation devalued our prime, liquid assets after the Brexit vote. I make no comment on the rights and wrongs of that vote, but merely observe that a great many quality UK equity assets – businesses listed on the LSE – have become suddenly very cheap for foreign buyers. And this happens at the same time as we have a late business cycle M&A boom which has helped fuel a sudden uptick in Private Equity deals. I’d also observe that UK listed businesses are unusually liquid in global equity terms, with a very open financial infrastructure which usually welcomes foreign takeovers.
So, the UK looks interesting, in relative terms. This might all change as the terms of Brexit becomes clearer but I would wager that the real long term impact of our departure from the European Union won’t be felt mostly until 2019 and beyond. Or maybe even longer if we have a transition.
Also I think there are very real threats from the possibility of a Corbyn government – and I say that as a free market social democrat (!?). JC has the potential to cause absolute mayhem with his covert Marxist agenda but I also think he is still a few years away from power yet and a great many things could change in the intervening period.
In the meantime, I think there’s also plenty of evidence that headline media coverage about the existing UK economy is far too pessimistic. M&Gs Bond Vigilante blog only a few days ago presented evidence that the UK economy was surprising on the upside and I’d concur with that analysis.
Yes, there are troubling signs, but I think the structural drivers still look positive.
Crucially we’re all being fooled by the national debate about low wage growth and the associated productivity problem. There are indeed many medium to long term problems, showing up in the national macro data but my hunch is that
It’s being vastly amplified by left wing politicians and think tanks chasing (quite rightly) their own agenda
It’s also more localised, regionally, and in different labour sectors i.e in low skills employment sectors in the regions
In many skilled labour sectors, wage growth is strong.
None of this is to deny that we have a problem with the sheer number of poorly paid, low skilled workers, in the regions, which needs fixing. But we should be careful not to project our political concerns on to a macro investing take that might prove to be erroneous.
In simple terms, the UK economy is ticking along fine. We are way under growth potential and that growth is highly uneven, but from a pure investment perspective there is no crisis at UK PLC.
So, UK assets look attractive and the main catalysts for any dramatic revaluation (actual Brexit and the rise of Red Britain) are still a long way off in investing terms.
Step two. How do you buy UK exposure? My core argument is that currently investing in passive fund strategies within the UK is arguably a bad idea. The FTSE 100, as we all know, is a very unrepresentative sample of the UK economy. It also contains huge dispersion between sectors and macroeconomic sensitivities. This is also increasingly true of the UK mid caps sector, expressed through the FTSE 250. Put simply, if you want to buy into the UK, buying the FTSE 100 and the FTSE 250 via an ETF is probably NOT the smart choice in my view.
By contrast actively managed funds can express an investment preference in a more concentrated portfolio manner. Crucially active managers can run very concentrated portfolios where they pick the best stocks to express where we are in the late stages of the current business cycle.
Step three. Which bit of the market to target with active fund managers? Two choices are obvious. Smaller cap stocks with a growth bias as opposed to larger cap stocks with a more value bias. The former has outperformed over the last few years while the latter has underperformed largely because value stocks have failed to shine.
On the smaller cap side of the debate I think there’s a good argument for saying that we are seeing a profound shift in the AIM, with better, more robust quality stocks starting to emerge and dominate the market. I also buy Gervais William’s arguments that smaller businesses represent a smart choice in the new populist age.
But I also worry that smaller cap businesses are highly rated. By contrast there are many mid to large cap businesses that boast great P&Ls and strong balance sheets, where the share price looks out of kilter.
The trite overall answer is to say that you might think about buying both smaller and larger cap stocks but if I was pushed I would opt for larger businesses with more defensive attributes – and more liquidity bearing in mind where we are with the current M and A cycle. If one buys this analysis then we are forced to look at cheaper, large stocks which will be attractive to foreign bidders – or private equity firms.
So, lets do a checklist of what we think we know so far:
UK stocks are interesting and represent decent value in relative terms
Mid caps to large caps are arguably more interesting
Active fund managers are likely to add the most value in this late bit of the business cycle
We also want a more concentrated portfolio to pick out key themes, with an ideal portfolio somewhere between 15 and 35 stocks
This process, I think ends up producing a relatively short list of funds that are worth considering, which includes Aurora but also Nick Train and His Finsbury Growth and Income vehicle – an excellent choice by the way.
So why particularly Aurora over the competition? Ideally, you’d probably have a few fund managers in this space but having chosen an active approach I’d actually want some evidence of actual activity i.e some portfolio activity. On this score, Mr Train isn’t exactly known for his feverish portfolio activity although his long term track record is of course excellent. Many other value orientated managers willing to take a contrarian punt are focused on smaller cap stocks.
The Phoenix team behind the Aurora fund on the other hand have been busy. They’ve sold down a large stake in a number of housebuilders – which is I think the right thing to do given the impending deep structural change in the planning and policy framework for UK housing (expect more social housing and less executive starter homes, proportionately). They’ve also bought into new vehicles such as EasyJet. Now, I’ll be honest and say that I had my doubts about EasyJet – I’ve always been a Ryanair man myself, regarding it as the lowest cost operator par excellence. But in retrospect its been a smart decision and the fund manager’s logic for buying into the airline was and is impeccable. Crucially you get a portfolio that is highly concentrated, jam packed full of mid to large cap names, with a strong UK consumer focus – and full of possible takeover candidates.
The Aurora placing is open until September 28th. You can see more details here : http://www.londonstockexchange.com/exchange/news/market-news/market-news-detail/ARR/13352530.html
Please note that I am an investor and non-executive director of Aurora.