Which sectors and trusts could benefit from lower rates?

Annabel Brodie-Smith, Communications Director of the Association of Investment Companies (AIC), said: “Many of the alternative investment trust sectors have suffered due to higher interest rates and a shift towards fixed income. Analysts are predicting that investment trusts in sectors like property, private equity and infrastructure may benefit from interest rate cuts. These trusts are trading on historically wide discounts, which could present a buying opportunity.

“Of course, investors should do their homework and no-one knows when interest rates will come down. If an investor is in any doubt about the suitability of an investment trust for their portfolio, they should speak to a financial adviser.”

Please be aware that analysts may recommend trusts that are corporate broking clients of the firms they work for. 

What sectors will benefit most and why?

Emma Bird, Head of Investment Trust Research at Winterflood, said: “In our view, investment trusts in the property sector are well placed to benefit from interest rate cuts in the UK. Underlying real estate valuations were hit in the rising interest rate environment, as demand for property from debt-funded buyers diminished. Property values across most sub-sectors now appear to be stabilising, but share price discounts to NAV remain at very wide levels. As the path of future interest rate cuts becomes clearer, property funds could see both asset prices and share prices improving as investor sentiment turns more positive.

“More generally, most private holdings have suffered in the higher rate environment. Therefore, it is not a surprise to see growth capital investment trusts among the top performing funds so far this year as sentiment about the likelihood of rate cuts has improved. We expect this momentum to continue as rate cuts materialise. 

“Finally, we view the infrastructure investment trust sector as well placed to benefit from interest rate cuts. Over 2023, the infrastructure peer group was amongst the worst performers in the investment trust universe as rising gilt yields reduced its appeal. As a result, the sector is trading at a historically wide weighted average discount of 22.3% versus a 1.8% average premium over the last five years. Hence, given the long duration and resilient nature of the asset class, we would expect the sector to be a key outperformer as interest rate cuts materialise.”

Iain Scouller, Analyst at Stifel, said: “Alternatives, such as private equity and infrastructure, should benefit across the board. They have been impacted as a result of higher rates making fixed income relatively more attractive. Those trusts offering long duration income especially should see some additional support. Many funds have debt on floating rates and so there should also be a direct benefit from lower interest costs.”

Dan Boardman-Weston, Chief Executive of BRI Wealth Management, said: “Many sectors look attractive at the moment, but the main beneficiaries of rate cuts are likely to be the property and infrastructure sectors. A combination of high starting yields, asset values picking up, and large discounts to net assets mean strong returns are likely as interest rates start to fall.”

Ben Newell, Investment Companies Analyst at Investec, said: “We think the infrastructure and renewables sectors look very well placed to outperform. In the main, underlying assets and projects continue to perform well operationally and we believe that the defensive characteristics that listed infrastructure exhibits, namely the relatively high initial yield and the ability to protect against inflation over the long term, remain attractive. As the direction of future interest rates becomes clearer, the disconnect between share prices and underlying valuations should reduce.”

What particular trusts would you recommend and why?

Iain Scouller, Analyst at Stifel, said: “The private equity fund sector has seen a fairly quiet first half of the year, with few realisations. However, given the maturity of investments in the portfolios we think there is a growing list of companies that are ripe for exit and a background of falling interest rates may oil this process, with long-term finance becoming cheaper. Our preferred funds in the sector with mature portfolios ripe for exit include NB Private Equity Partners, HarbourVest Global Private Equity and ICG Enterprise Trust.

“The infrastructure funds’ share prices are highly correlated with the trend in the gilt market – we think gilt yields are likely to see a ‘new normal’ level closer to 4% than the sub-2% level during the pandemic. However, many of the trusts are currently yielding 6% to 7%, which will be relatively attractive if interest rates fall. Our preferred funds include 3i Infrastructure, HICL Infrastructure, International Public Partnerships and BBGI Global Infrastructure.

“Biotech funds are overweight small and mid caps and so the long duration of the revenues of these companies means falling rates will be beneficial to valuations. We think that Biotech Growth Trust is most geared to this play as it is more overweight in small caps.”

Matt Hose, Investment Company Analyst at Jefferies, said: “We think infrastructure and renewables, given their assets with long duration cash flows, will see improving valuations as rates come down. It will be the funds in these sectors with relatively lower discount rates that benefit in particular, because there is less of a risk premium buffer embedded in their discount rates. That means that lower interest rates will directly translate into lower discount rates for those trusts, increasing published NAVs.

“This could prove beneficial for the likes of HICL Infrastructure, International Public Partnerships, BBGI Global Infrastructure, SDCL Energy Efficiency Income, GCP Infrastructure Investments, Foresight Solar Fund, Bluefield Solar Income Fund, NextEnergy Solar Fund and JLEN Environmental Assets Group.”

Dan Boardman-Weston, Chief Executive of BRI Wealth Management, said: “There are a number of trusts that look exceptional value at the moment. Warehouse REIT and Urban Logistics REIT are our top picks for commercial property. Both have strong management teams whose interests are aligned with shareholders and are exposed to the structurally growing area of logistics and industrial properties.

“Warehouse REIT trades at a 33% discount to net asset value, yields 7.5%, and has a number of levers it can pull to improve its performance moving forward. Urban Logistics REIT trades at a slightly narrower discount of 25% and yields 6.3%.

“It’s conceivable that, through a combination of a high starting dividend yield, a growing net asset value, and narrowing discounts, shareholders could receive double-digit annual returns over the coming years.

“Infrastructure funds have suffered in a similar manner to REITs, and while the discounts and the potential asset growth don’t look as appealing as REITs, the high levels of income and scope for recovery still make them an attractive part of portfolios. Key holdings include HICL Infrastructure and International Public Partnerships, both trading at discounts of around 20% and yielding over 6%.”

Emma Bird, Head of Investment Trust Research at Winterflood, said: “One of our favoured property investment trusts at present is Impact Healthcare REIT, which invests in UK care homes. This fund is currently trading at a 27% discount to its 31 March 2024 NAV, which we think offers considerable value, and believe there is scope for a notable re-rating when interest rate cuts are announced. In addition, this fund has seen its underlying asset valuations hold up considerably better than many other property investment trusts, supported by the contractual, inflation-linked uplifts in its rents, which we expect to continue to support earnings and dividend growth going forward. Impact Healthcare REIT offers an attractive 8.2% prospective dividend yield, with its dividend fully covered by earnings. It has increased its dividend every year since launch in 2017, and we view this progressive dividend policy as a key advantage of the fund, which should continue to differentiate it in a ‘higher for longer’ interest rate environment.”

Shavar Halberstadt, Analyst at Winterflood, said: “Within the Growth Capital sector, we continue to recommend Seraphim Space Investment Trust, as space tech benefits from the structural tailwinds of increased defence and climate spending across developed economies. It is the top performing investment trust so far this year, and in recent weeks some investors seem to have decided to take profits. However, we have not seen fundamental reasons to deviate from our call, as portfolio companies continue to convert those tailwinds into tangible revenue from government contracts and grants, as well as long-term partnerships with top defence contractors and other established counterparties. In addition, several larger holdings are profitable or funded to profitability, enhancing potential IPO prospects. Therefore, we continue to view the fund as a clear rate cut beneficiary.

“For investors that desire more diversified venture capital exposure, we view The Schiehallion Fund as a good option, given the high quality of its management team and investments in a wide range of world-leading private companies and prospective IPO candidates.”

James Wallace, Analyst at Winterflood, said: “We are currently recommending BBGI Global Infrastructure for core infrastructure exposure. The fund is trading at a 10.6% discount, which we think offers value relative to its 13.3% average premium over the past five years. We view the fund’s all-weather portfolio as a key positive during the current period of elevated macro uncertainty, as its portfolio features a ‘mechanical’ inflation linkage and contracted cash flows are sufficient to support 1% p.a. dividend growth over the next 15 years even if no further investment is made. Further, BBGI is well positioned with sector-leading dividend growth of 6% year-on-year guided for 2024 and strong cash coverage of 1.4x. The fund’s strong track record is shown by the fact it has delivered dividend growth that has outpaced CPI since its IPO and the long life of its assets and defensive nature puts it in a strong position to outperform should interest rates decline.”

Ben Newell, Investment Companies Analyst at Investec, said: “Our core recommendations in these sectors are HICL Infrastructure, The Renewables Infrastructure Group, Greencoat UK Wind, 3i Infrastructure and Pantheon Infrastructure.”
 

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Notes to editors

1. Discounts in analysts’ quotes were correct at time of submission. Please see theaic.co.uk for up-to-date information. 
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