JP Morgan Cazenove backs biotech debt, Japan and a hedge fund after 3i-propelled 2023

Analyst Christopher Brown has recorded three changes to his investment company model portfolio, which outperformed thanks to outsized returns from private equity giant 3i Group.

JP Morgan Cazenove analyst Christopher Brown has made just three changes to his investment companies model portfolio for 2024, with switches into a specialist loan fund, a Japan trust and a leading hedge company.

In his annual review, Brown said 2023 was a tough year for London-listed funds, with the FTSE All Share Closed End Investments index delivering a total return of 4.9%, its eighth-worst absolute performance of the past 10 years, although it marked a partial recovery from a 16.6% fall in 2022.

Macroeconomic concerns over inflation and interest rates knocked investor confidence, but more trust-specific woes such as the derating of higher yield alternative funds, corporate governance controversies, fee wranglings, and an influx of competition from ‘long-term asset’ products from US private asset managers also weighed on sentiment, Brown said.

Nevertheless, the analyst’s non-benchmarked model portfolio, which seeks to take advantage of compelling investment opportunities while offering defensive diversification, had a good year. It generated a 12% total return that beat the closed-end index and also the 9.4% from the FTSE UK Private Investor Balanced index and the 7.9% from the FTSE All-Share.   

Private equity giant 3i Group (III ) accounted for 60% of the returns after its barn-storming performance last year, but there were also good contributions from JP Morgan American (JAM ), up 26.6%, Pershing Square Holdings (PSH ), up 24.7%, and 3i rival Pantheon International (PIN ), up 19.6%.

The main detractors to performance were Higpnosis Songs Fund (SONG ), down 13.8%, BlackRock World Mining (BRWM ), off 10.4%, Fidelity China Special Situations (FCSS ), retreating 9.3%, and HICL Infrastructure (HICL ), 10.5% lower. Not holding Scottish Mortgage (SMT ) as the Baillie Gifford flagship rallied 12.5% after its thumping in the growth selloff of 2022 also sapped returns.

Looking ahead, Brown said the bright spots for this year include the ‘rerating potential for listed infrastructure funds if real [interest] rates decline’, further corporate activity around heavily discounted alternative funds, the return of activist investors, which could result in more trust mergers, positive reforms to cost disclosure rules, and ‘significant’ share buybacks to enhance shareholder returns.

The three changes Brown made to his 20 investment company picks were:

Bigger BioPharma stake

BioPharma Credit (BPCR ), a corporate broking client of JP Morgan Cazenove, was deserving of a larger position in the portfolio, said Brown. It had been one of the smaller holdings at just 2.8% but the analyst’s removal of Capital Gearing (CGT ) last October when the defensive, multi-asset fund suspended share buybacks left the analyst with a 7.9% gap to fill.

He decided to lift BPCR to 5% to reflect his ‘high conviction’ after the life sciences debt fund resolved the uncertainty around its investment in LumiraDx. The fund confirmed this month it will recover more than 80% of a large loan it advanced to the struggling US diagnostics platform after Swiss drug giant Roche confirmed it would buy all of LumiraDX’s point-of-care diagnostics business for $295m (£233m).

Brown said the decision to invest more heavily in BPCR also reflected the discount to net asset value (NAV) of 6.2% the £951m portfolio trades at and the yield of 7.5%.

He said the trust ‘benefits from a robust discount control mechanism’ and that although it was ‘disappointing’ to see the first default on the loan strategy in LumiraDx, ‘the amount recovered is a high proportion of initially deployed capital and no lending strategy is likely to experience zero losses forever’.

‘BPCR is one of our top ideas and we think it is an excellent choice for an alternative income portfolio,’ he said.

Switching Europe for Japan

JP Morgan’s global equity strategy team is underweight Europe and overweight Japan for 2024, which has prompted Brown to make a trust switch.

He said that though the eurozone is cheap, it is also a ‘global cycle value play that could struggle to outperform in the event of earnings downgrades’. In contrast, Japan is ‘dislocated from the global cycle due to yield curve correction’ and is a beneficiary of an ‘exit from deflation’.

Improving governance and increasing share buybacks in Japanese companies could also be a boon to returns.

To take advantage of this, Brown removed the £1.4bn Fidelity European (FEV ) from the model portfolio, although he maintained his positive recommendation, and instead added Schroder Japan (SJG ).

He upgraded his recommendation on SJG, the £283m trust run by Masaki Taketsume, from ‘neutral’ to ‘overweight’ in October on the back of improved NAV performance and a ‘balanced portfolio that does not have either a growth or value bias’.

SJG is a top performer among its peers over one, three and 10 years, with NAV growing 17.1% over the past year while the shares have added 19.7%.

Brown said there is ‘discount protection from a performance-linked tender offer that could trigger in 2024, although SJG appears to be on track to achieve the 2% outperformance hurdle that would mean no tender is offered’.

New addition

The ‘unique offering’ of BH Macro (BHMG ), the diverse £1.3bn hedge fund strategy overseen by Brevan Howard’s Alan Howard, has been added to the JP Morgan portfolio given it has performed well in ‘periods of market stress and macroeconomic shocks’.

Brown said 2024 is a year of elections, including the UK and US, which could ‘lead to some shock political outcomes and an environment that favours the BH Marco strategy’, which takes leveraged multiple positions in currencies, bonds and interest rates via Brevan Howard’s $11bn Master fund in the Cayman Islands.

While Brown noted that fees were raised in 2021 and the fund’s ‘transparency is poor relative to most other listed funds’, it could play a ‘diversifying role’ in the model portfolio this year.

After a £315m share issue in February 2023, BH Macro shares derated, falling from a premium to a current discount of 12.4% that Brown thought was attractive, with the company, also a corporate broking client of JP Morgan Cazenove, now buying back its shares.

‘There would be a class closure vote if the average discount exceeded 10% over any full year,’ the analyst noted, giving investors the opportunity to exit at close to asset value. 

The model portfolio in full at 11 January:

3i Group (III ) 10.9%
3i Infrastructure (3IN ) 5%
Bellevue Healthcare (BBH ) 3.3%
BH Macro (BHMG ) 5%
BioPharma Credit (BPCR ) 5%
BlackRock World Mining (BRWM ) 3.9%
Edinburgh (EDIN ) 5.5%
Fidelity China Special Situations (FCSS ) 3.6%
Greencoat UK Wind (UKW ) 3.8%
HICL Infrastructure (HICL ) 3.1%
Hipgnosis Songs (SONG ) 5.3%
JPMorgan American (JAM ) 6.8%
NB Private Equity (NBPE ) 4.8%
Pantheon International (PIN ) 6.8%
Pershing Square (PSH ) 6.7%
Petershill Partners (PHLL )  2.7%
Real Estate Credit Investments (RECI ) 2.4%
Riverstone Energy (RSE ) 6.5%
Schroder Japan (SJG ) 5%
Tetragon Financial Group (TFG ) 2.7% 

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