Columbia Threadneedle Investments: New opportunities as recession fears recede

Peter Hewitt, Portfolio Manager, Multi-Asset Solutions

While discounts in the investment trusts universe make headlines (the average sector discount has widened slightly over the first quarter to nearly 16%), as managers we get on with the day job of seeking out investments that have the prospects to grow and provide positive returns for the 16,000+ shareholders holding a stake in the CT Global Managed Portfolio Trust.

In 2024, three key themes are driving our investment strategy:

• Increasing exposure to undervalued UK small and medium-sized companies
• Taking advantage of the very wide discounts in Private Equity Trusts
• Accessing more exposure to Trusts with secular growth characteristics

Undervalued and ready for a turnaround

UK equities have been out of favour since the Brexit referendum in 2016, overshadowed by the dominance of US mega-cap tech stocks which have been fuelling the strong performance in US markets. The UK’s stock market has a very different make up with miners, oil majors and banks among the heavy weights, and these international businesses have a much greater sensitivity to cyclical growth patterns. With recession fears overhanging developed economies, such stocks have lagged. In a risk averse environment, smaller companies and alternatives assets tend to be the hardest hit and in this cycle that trend has been no different with these parts of the UK equity market bearing the brunt of being out of fashion.

However, it looks as though we are now past the worst. UK recession fears are receding, inflation has come down and even dipped to a level below that of the US (3.2% in March versus 3.5% in the US). Expectations that a rate cut in the UK could precede that in the US are now gathering momentum and this should be supportive for UK stocks, especially those smaller companies that have suffered disproportionately from being out of favour with investors and also being charged high borrowing costs from lenders.

Since the start of the year, we have been adding to investment companies with decent exposure to smaller and medium-sized UK equities. In our view, there are some excellent specialist investment trusts with good long term growth prospects. Purchases in the growth portfolio have included Aberforth Smaller Companies, Henderson Smaller Companies (an addition to our holding) whilst in the Income Portfolio a new holding ¹ was bought in J.P. Morgan UK Small Cap Growth and Income. Overall, our allocation to UK equity investment companies now totals around 25%.

Diverse businesses in their infancy

Investment opportunities in the private equity space are diverse, as by nature they are businesses in infancy. Yet to be tried and tested over a long period, their valuations can be volatile and as a result wide discounts can often open up. If they are temporary and the companies in question outlive this instability, they can present good prospects for medium to long term net asset value growth.

In the medium term, the next 2 years or so, we think the wide discounts on private equity have a good chance to recover. At their height, a couple years ago, discounts for private equity trusts had been as wide as 40% as investors feared that the valuation of underlying assets would fall substantially against the backdrop of recession. As recession fears pass so the discounts narrowed modestly. However, they are still wide, currently in the 25% – 40% range. Many of the Trust’s undertook active action themselves, to narrow the discounts. Trusts with stronger balance sheets engaged in shareholder friendly capital allocations, including undertaking substantial buy-back programmes.

In this exciting space, which now makes up about 20% of our portfolio, we have recently bought holdings in Pantheon International and Oakley Capital Investments ¹ whilst HG Capital Trust is the largest holding in the Growth portfolio. It specialises in European business software companies which are critical to efficient operation typically in legal, accounting, payroll and security areas. Most of their revenue is subscription based and grows at over 20%pa. Over the long term HG Capital has an outstanding record of net asset value growth.

Secular growth a long-term driver

Trusts with secular growth characteristics present the best opportunity to benefit from long term net asset value growth. Tapping into this strategic driver of performance, we have recently increased stakes in Polar Capital Technology Trust, Allianz Technology Trust, Scottish Mortgage and Monks Investment Trust ¹. A number of these trusts, as is evident from their names, have a technology bias and some of them including holdings in mega tech stocks such as Nvidia. In terms of performance, this segment of our portfolio has performed strongly over the past year. Technology is increasingly important in terms of efficiency and economic growth. We expect it to continue to play a pivotal role going forward with emerging innovations providing an edge to host businesses.

Transition ahead

Inflation in the UK looks like it could now fall faster than in the US. A cut in interest rates in the UK, ahead of the US, would provide an additional useful boost to UK equities. The themes described above, which we are mainly implementing through the Growth portfolio (although we are trying to replicate elements through the income portfolio also) should stand us in good stead as the economic transition plays out.

Performance in the Income portfolio has lagged Growth over the past year due to its constituents of alternatives, renewables and infrastructure, as these are areas where discounts have moved out more substantially. Looking ahead, as the broader equity market recovers and sentiment generally lifts, we would expect these segments to enjoy a noticeable pick-up in favour too.

¹ Mention of stocks is not a recommendation to buy or sell

Risk Disclaimer

The value of an investment is dependent on the supply and demand for the shares of the Investment Trust rather than its underlying assets. The value of an investment will not be the same as the value of the Investment Trust’s underlying assets.

Views and opinions have been arrived at by Columbia Threadneedle Investments and should not be considered to be a recommendation or solicitation to buy or sell any companies that may be mentioned.