Let loose

Will August be the month when the Bank of England finally takes the plunge on interest rate cuts? The Bank’s Monetary Policy Committee is due to meet next week [1 August] and after several months of largely benign inflation data, many believe that it will start the process of loosening policy. A recent poll conducted by Reuters of 65 leading economists found all but two expected a rate cut in August. Most predicted at least one further reduction before the end of the year.

What would that mean for asset prices? Well, broadly speaking, interest rate cuts are regarded as a positive for the stock market. All other things being equal, easing of monetary policy tends to lead to outflows of cash from bonds into equities – but also into a number of other asset classes. 

That potentially creates some interesting opportunities in the investment trust universe. First, equity-invested funds – certainly those with exposure to the UK – should get something of a fair-wind effect. But it is in the alternative assets arena, where investment trusts offer several key advantages, that analysts are now feeling most optimistic.

Property is one good example. Falling interest rates are good news for the property sector because a lower cost of financing boosts profitability for developers of real estate, who typically depend on debt. That should be supportive of both asset prices – with demand for property boosted – and the share prices of companies in the property sector.

Then there’s infrastructure – assets such as transport and energy networks, logistics centres and digital properties. These are typically associated with the promise of long-term income, often fixed and sometimes backed by a government guarantee. When interest rates fall, this income looks especially attractive, boosting demand for infrastructure assets. Renewable energy assets, where there is particular interest in the context of the Labour government’s focus on green power, could be one important part of the infrastructure play.

Private equity provides a third area where analysts expect a beneficial effect if interest rates do start to fall. The PE sector operates with relatively high levels of borrowing, often on floating rates, so when the cost of financing comes down, this provides a more supportive environment. PE investors should also benefit if firms’ underlying investments – their holdings in privately-owned companies – get a lift from lower interest rates.
Note that these asset classes all share one thing in common. For retail investors, investment trusts are really the only viable way to get exposure to them.

There are a couple of reasons for that. First, the upfront investment required to take direct holdings in property, infrastructure and private equity is too large for most individual investors. And second, these are illiquid assets – that is, it can be difficult to buy and sell them. That means you need a collective fund structure that can cope with illiquidity; investment trusts do this well because their own shares can be bought and sold with ease without any need to trade the funds’ assets.

All of which is prompting a great deal of interest in investment trusts that hold alternative assets. Shares in these funds have been trading at significant discounts to the value of their underlying assets, but those discounts have begun to narrow in recent months. A decisive move from the Bank might see that effect become even more pronounced.
None of which is to suggest these funds are right for everyone. Still, with the economic mood music now seemingly set for a change of key, they are certainly worth a look.