James Carthew: Dramatic 2023 leaves sector radically different

Corporate action has continued at a rapid pace at the end of the year and the sector is in very different position than it was at the start of 2023, but there are burgeoning signals of optimism.

The rationalisation of the sector continues.

There has been a flurry of announcements over the past couple of weeks: Abrdn Diversified Income and Growth (ADIG ) announced a managed wind down; Triple Point Energy Transition (TENT ) declared it will begin an orderly realisation of its assets; GCP Asset Backed Income (GABI ) kickstarted a strategic review that could see it sold or dismembered; RM Infrastructure Income (RMII ) published more information on its wind down proposals; and Abrdn European Logistics Income (ASLI ) revealed that it was considering its future having concluded that a dividend cut was needed.

Digital 9 Infrastructure (DGI9 ) also looks likely to fall (or be pushed) upon its sword following the disappointing outcome of its sale of Verne Global. Plus three more mergers were announced.

As we approach the end of 2023, the sector is in radically different shape than it was at the start of the year. Back then there were, by my reckoning, 344 investment companies with a collective market cap of £186.2bn. At the end of November, that had fallen to 327 companies and £168.4bn.

In November, only 11 companies issued new stock and within that just JPMorgan Global Growth and Income (JGGI ) and Ashoka India Equity (AIE ) issued more than £5m worth. By contrast, 113 companies were shrinking through buybacks and tender offers and 24 of those retired more than £5m worth of shares.

We have had just two new funds in 2023 and both of them are tiny. Onward Opportunities (ONWD ), which was admitted to trading on AIM at the end of March, raised just £12.8m for its UK micro-cap strategy and can at least claim not to have lost money for investors since, with its net asset value (NAV) and share price marginally up on opening levels.

Ashoka Whiteoak Emerging Markets (AWEM ) can tell a similar tale, delivering returns just ahead of its benchmark since launch, which is good news for the manager which charges no base fee and lives off its performance fees, but still has a market cap of just £33m.

AWEM’s launch was in contrast to the general shrinkage of the global emerging markets sector in recent years, including the loss of Fundsmith Emerging Equities. Similarly, OMWD’s came just a few months before Downing Strategic Micro Cap (DSM ) called it a day.

It is a gloomy picture and 2023 probably counts as one of the worst years for the sector since the financial crisis. However, poor years are often followed by better ones. What have we got to look forward to?

The outlook for 2024

The big news is that interest rates have probably peaked. In retrospect, I think we will look to end-October/November as the point where markets turned for the better. The yield on the US 10-year bond fell from close to 5% on 19 October to 4.3% on 30 November and has carried on falling since as the Federal Reserve talked about cutting rates next year.

There have been some sharp recoveries in the share prices of rate-sensitive investment companies such as renewable energy and infrastructure funds. Ecofin Global Utilities and Infrastructure (EGL ) is 23% off the low it hit on 11 October.

However, I think most of these share prices have a long way to go yet.

As US interest rates fall, the dollar will continue to weaken. That puts downward pressure on funds with high US exposure, but history suggests that this is also great news for emerging markets. This unloved part of the investment companies market could have a much better year in 2024.

Japan’s stock market has been roaring in 2023 but yen weakness has masked that. The Bank of Japan has made very tentative moves to ease up on its ultra-low interest rate policy. A stronger yen could be an important driver of returns in 2024. It will not be great news for some Japanese exporters, but managers will have been factoring that into their stock selection.

The corporate governance story in the country will run and run – to the benefit of Nippon Active Value (NAVF ) and AVI Japan Opportunity (AJOT ). We could also see a recovery in the fortunes of the more growth-oriented funds like JPMorgan Japanese (JFJ ) and Baillie Gifford Japan (BGFD ).

Lower interest rates should ease the pressure on growth-focused strategies in general. It was interesting to see sharp upward moves in the NAVs of the likes of Baillie Gifford European (BGEU ) and Montanaro European Smaller Companies (MTE ) in November, as well as tech-focused names such as Allianz Technology (ATT ) and Manchester & London (MNL ).

The real star of November was Schiehallion (MNTN ) –  investors that have been despairing about returns in the growth capital sector could see some light at the end of the tunnel. Included in that group is Chrysalis (CHRY ). Its news from the other day about a likely disposal could spell significant buybacks and discount narrowing as well as an NAV uplift.

We could see a reopening of the IPO market – though I think election uncertainty may be an issue here so I doubt we will be firing on all cylinders in 2024.

Then there is the cost disclosure problem that I discussed at the end of October. There are encouraging noises coming from all quarters on this and I am hopeful that we will make positive progress. That would help underpin renewed interest in investment companies from a wide group of investors.

The other major issue that needs to be tackled is the clutch of governance issues with funds such as Home REIT (HOME ) and Hipgnosis (SONG ). The news has been overwhelmingly negative on this front for some time, with disappointing updates from both those companies and, most recently, Asian Energy Impact (AEIP ). There is no quick fix for this small clutch of funds.

Nevertheless, it is important to remember that most funds in the sector have been doing a good job in difficult circumstances over the past couple of years.

Here is to a better 2024 for the whole sector!

James Carthew is head of research at QuotedData.

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