22 Nov 2022
London has a visually striking mix of old and new, and from the top of Tower Bridge there are stunning panoramic views of the City of London. The bridge was built to solve a huge challenge facing the City of London Corporation, which was how to build a bridge downstream from London without disrupting river traffic activities. To generate ideas, the Special Bridge or Subway Committee was formed in 1876, with a public competition launched to find a design for the new crossing. Over 50 designs were submitted and many of these are on display at Tower Bridge, but it was not until October 1884 that Sir Horace Jones, the City Architect, in collaboration with Sir John Wolfe Barry, offered the chosen design for Tower Bridge as a solution. It took eight years and over 400 construction workers each day to build the bridge; the largest and most sophisticated bascule bridge ever completed (‘bascule’ comes from the French word for seesaw). The bridge was officially opened in 1894 and still operates for vessels to pass through with around 800 going through the bascules each year. Some of the largest ships entering Central London today are cruise liners with over 30 making this special journey in 2022.
When looking across to the City of London, in the foreground there remains the fully intact Tower of London which survived the Blitz in the Second World War. The first castle on the site dates from Norman times with parts of the present structure dating back to the 1200s. As the most secure castle in the land, the Tower guarded royal possessions such as the crown jewels and even the Royal Family in times of war and rebellion, but for 500 years it was also used as a luxurious palace. It was perhaps in its heyday in Medieval up to Tudor times, during which it also became the most important state prison in the country for anyone considered a threat to national security. The general layout today remains largely the one that was established during the late 13th Century.
While not under lock and key, the Covid-19 restrictions in China meant that there have been few visitors of managers of China funds to the UK and so I was delighted to take the opportunity to catch up with two members of the FSSA China team during their visit - Winston Ke and Qimin Fei. The recent Party Congress attracted much media attention with fears that with President Xi taking an unprecedented third term there would be a move away from policies focused on economic growth. In fact Xi, in his speech to the Congress, spoke about China focusing on a different type of growth to deliver common prosperity and security. While there is much debate about the new makeup of the Polit Bureau Standing Committee, the new members only take office in January, and it is at the March People’s Congress that new economic initiatives are traditionally announced. The current period is one of transition between the old leadership and the new team in terms of other senior officials, so it would be surprising if clear policies emerged at this stage. China has given its people a trade off between growth in income and living standards versus political freedoms to avoid social discontent and huge numbers of people have been taken out of poverty in the last 40 years. Qimin himself left China as a child for Germany 30 years ago when there were huge differences in living standards and prosperity of ordinary people. The concept of common prosperity is different in the Chinese language than English and can be interpreted more rigorously as becoming wealthy together, so the FSSA managers believe that there are two key messages from this statement; the first is that the leadership wants more wealth in the country and secondly, that more people will participate in this.
In the post-Deng Xiaoping reform period, policy initially focused only on growth as poverty was abundant, whereas now the authorities in China want to put in place measures that reduce, but not eliminate, inequality. This rebalancing would be bad for certain companies but good for others. Concept type companies which listed on stock exchanges with no real product or service and created instant billionaires will be frowned upon, whereas companies in things like house appliances, dairy and brewing will benefit from common prosperity and higher living standards with further growth of the numbers classified as middle class.
China’s zero Covid policy continues to attract attention in Western media. It needs to be remembered that for now the vaccination rate for the over 60s is still relatively low, although growing at 70%+ but people are only getting Chinese vaccines. These seem less effective, especially against the Omicron subvariants, but there are now two Chinese mRNA vaccines under the approval process and at least one should be available over the next 3-6 months. Investors should remember that China has shown itself adept at replicating Western technologies, so it is likely that these vaccines will be effective. There was also the winter flu season in China and Covid-19 cases are now rising on the mainland. More definite measures about Covid-19 are unlikely before the March People’s Congress which ties in with seasonal flu factors. Chinese New Year is late January when there is mass movement of people, with the return home of migrant workers and the team believe the authorities in China do not want to encourage a lot of movement ahead of this, wanting minimal cases going into the Chinese New Year period.
Australia too has eased travel restrictions, allowing fund manager visits to London and I took the opportunity to catch up with Head of Property Securities at First Sentier, Stephen Hayes, who leads a globally based team of seven portfolio managers investing in property equities. The team believe listed property returns are driven by local real estate fundamentals together with broader capital market conditions. The fund invests in listed equities, meaning unlike bricks and mortar retail offerings there is always daily liquidity, although the quid pro quo for this is that asset prices as listed shares can be volatile at times. However, they do offer investors daily dealing exposure to global property markets. The fund invests in high quality urban infill assets which have high barrier to entry focused on the world’s most bustling cities.
There is also a strong belief in the correlation between responsible investing considerations such as environmental, social, and corporate governance considerations and share price returns. The major enhancement of the investment process has been the further integration of ESG inputs into the fund through enhanced carbon disclosures. The team have developed a proprietary methodology to assess real estate carbon emissions which account for around 40% of total emissions globally. Very often, landlords do not know the effect of carbon pollution on properties they own as they do not have control over tenants. The team believe that the building sector has the largest potential to reduce greenhouse gas emissions compared to other sectors and with a growing world population, urbanisation will continue to be a dominant trend.
While the most obvious emission of carbon is the operational use and maintenance of the building, the team are looking at the complete life cycle which includes extraction of raw materials, all the phases of the development of a building, and the carbon cost of redevelopment with calculations suggesting around 11% of emissions come from what is termed as embodied carbon.
The most important long-term driver of property equity returns are the direct property markets. In the UK, valuations have been coming off for a while, as is the case in many parts of the States. Retail property has been under pressure recently, but the slowdown in growth in on-line sales has put the logistics sector under pressure and Covid-19 has put office values under threat with work from home, something likely to be exacerbated as the global economy slows. The rise in bond yields (risk free rate) has also affected valuation levels. Within the fund, residential is a favoured area where there is still strong revenue growth and relatively low economic sensitivity, and in the US and UK there are several professional operators of buy-to-let properties whose landlords consider affordability of rental clients as they want tenants to remain for lengthy periods, providing stable cash flow. The fund also has exposure to student accommodation. Within retail, convenience stores are a favoured area, while investment in data centres only occurs after full analysis of embodied carbon emissions, with many landlords in this area now using renewable energy sources. The selloff in property equities this year has been indiscriminate when it comes to quality assets with low gearing hit as hard as low-quality ones, and the fund has fallen to a significant discount to its published net asset value of close to 25% which suggests expectations of falls in direct property market valuations are already priced in, to some degree.
While the sector faces headwinds at a time of slowing economic growth and rising interest rates, unlike in bricks and mortar valuations, investors in property equities always look forward and anticipate the next economic upswing, so this is an area for investors to watch for potential opportunities over the next 12 months. Stephen Hayes has built up an experienced team with a strong record in this area, with members located across all the major regions, allowing them to see first hand direct property market conditions.
I also caught up with the manager of equities in another out of favour area, UK mid-caps, which have been hard hit by the expected recession in the UK economy and the failed economic policies of former Prime Minister Liz Truss. UK mid-caps have also suffered from a move by wealth managers in the UK to internationalise their equity exposure, resulting in outflows from UK equities and in particular mid-caps. Many of the faster growing stocks in the UK are located in the mid-cap space and with the managers holding these assets seeing redemptions from their funds, there have been more sellers than buyers, driving prices down. Richard Watts believes there are now interesting opportunities at the stock level, after the massive valuation de-rating of many of these names. Favoured stocks include Trainline, a quick and easy way to book train tickets, not just in the UK but also across Europe and Wise - a phenomenally successful business which allows the easy transfer of money abroad in a cost efficient manner. Ascential is a specialist on-line information data and e-commerce optimisation company offering a B2B service looking to improve commercial performance on a global basis with the company looking to become the Bloomberg of the fashion industry in terms of information. Auction technology serves curated auctions around the world and should therefore benefit from higher prices due to inflation. So far in 2022, these companies have delivered on market expectations for profitability, although of course no business is immune to the effects of a recession globally, if it occurs.
The fund invests in a part of the market that is currently out of favour, but the manager believes that many of the businesses held have international growth opportunities, rather than being solely focused on the UK market, and have now fallen to levels where valuations for long-term investors are highly attractive. For investors with a contrarian approach, UK mid-caps could be an area to consider in 2023, as clearly a lot of doom and gloom on the UK economy has been priced into these stocks.
Regent Street was the first ever Central London location to boast Christmas lights in 1954 and has long been renowned for its spectacular light display during the festive season, This year, the display is named ‘The Spirit of Christmas’ and as it’s the first major street in London to switch on the lights, I took the opportunity of getting an early viewing before returning home.
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