Neil Birrell, Premier Miton’s Chief Investment Officer and lead manager of the Diversified fund range, discusses a pick-up in M&A activity and, along with credit analyst Kishan Paun, reviews why the allocation to high yield bonds has fallen.
For information purposes only. The views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
In favour: corporate activity
We have seen investors leave the UK equity market in droves over the last few years, Neil Birrell writes.
In fact, in the case of pension funds, the trend has been a long term one. The move to the exit was turbocharged by the Brexit referendum in 2016, with domestic institutional and retail as well as international investors alike departing in big numbers.
What will be the catalyst to get investors back into UK equities?
The question I am repeatedly being asked recently is this one: “What will be the catalyst to get investors back into UK equities?”.
As I have said a number of times, I’ve never thought there would be one catalyst. It would be a confluence of different factors.
These could include; attractive valuations relative to history (check) and globally (check), falling inflation (check), stronger economic growth (check), lower interest rates (on their way), improving consumer sentiment (check) and a pick-up in corporate activity.
Let’s look at that last one. There are two types of buyers of company shares.
Firstly, those who want to be shareholders These include institutional and retail investors and other corporate entities which want to be strategic shareholders. They are all just holders of some shares who are likely to sell them at some point.
Then there are those who want to buy the whole company, usually other corporate or private equity investors.
Anglo-American, Alpha FMC, Redrow. Well, it’s happening…
In the UK, in the highest profile example, on 16 April BHP proposed an offer for Anglo-American, but there are many others around of a lower profile.
Across the Diversified fund range (excluding the Sustainable Growth Fund) there are two good examples, and in both cases the company’s share prices reacted strongly.
Alpha Financial Markets Consulting (FMC), the London-based company which provides financial consulting services globally, announced at the start of May it is a potential takeover target for two private equity firms: Bridgepoint and Cinven.
The company received a non-binding indicative proposal from Bridgepoint regarding a cash offer for all existing and to-be-issued shares, subject to the completion of the required due diligence. Meanwhile Cinven is reported to be interested in the company but has yet to make an indicative proposal.
Property developer Barratt Developments announced the acquisition of Redrow with the aim of creating a UK homebuilder capable of overcoming market challenges. The transaction was announced on 7 February and is expected to be completed by 31 December, although the Competition and Markets Authority (CMA) is launching a formal investigation into the potential impacts of an acquisition.
M&A is also on the rise in the property shares allocation. The closed-end real estate investment company LXi REIT was held across the Diversified funds and was subject to a merger with FTSE 250-listed Londonmetric Property.
It is a similar story in the alternatives allocation, where we use investment trusts for some of the exposure. The boards and managers of many trusts are busy trying to find ways to close the discounts to Net Asset Value on which their share prices trade, but there is M&A taking place as well.
The Hipgnosis Songs story
Another one of the holdings in the Diversified fund range (excluding the Sustainable Growth Fund) was subject to an offer. Hipgnosis Songs has been a long story of success, then mis-management, then shareholder dis-satisfaction and more recently two offers for the company.
It has been a bumpy ride since we first got involved at launch in 2018, selling and buying shares over time. But, in the end, corporate buyers have seen the value, are trying to buy it, and shareholders are getting the short-term reward.
The share price (£) of Hipgnosis Songs since it came to the market in July 2018
Source: Bloomberg 7.10.18 – 5.10.24.
The performance information presented on this page relates to the past. Past performance is not a reliable indicator of future returns.
Out of favour: high yield bonds
Within fixed income we look at government, investment grade and non-investment grade (or high yield) bonds, as well as alternative fixed income investments. The allocation to high yield has been on the decline and Kishan Paun explains why below.
Why should investors be cautious with high yield bonds?
Within the exciting world of bonds, we’ve become increasingly cautious on the high yield segment of the asset class for several reasons, Kishan Paun writes.
Firstly, we’ve seen default rates rising to levels not seen since pre-global financial crisis (GFC).
This has been notable in the very public default of Kemble (the Thames Water holding company) amidst multiple restructurings across the whole market.
Our expectation is that rates will likely continue to remain higher for longer. Subsequently, with a significant maturity wall approaching over the next two years, highly levered firms that relied on free money will see their debt serviceability severely hindered and credit metrics deteriorate.
Secondly, the valuation differential between investment grade bonds and high yield bonds has compressed significantly since the start of the year, now approaching pre-pandemic levels.
Any further compression amidst the impending maturity wall feels akin to picking up pennies in front of a steamroller.
Lastly, for the first time in a decade, bonds have, in our view, become attractive as a long-term investment and are providing a real return on capital.
With investment grade bonds within our portfolio offering high single-digit yields, we don’t need to reach for companies with weaker balance sheets and weaker cash flows to produce strong returns for our clients.
Where we do have high-yield exposure, it is generally subordinated debt of investment grade companies, or companies which have a positive and improving credit trajectory.
In and out
It’s an exciting time for active managers. There are lots of opportunities to take advantage of and lots of potholes to miss!
