Following the severe turbulence encountered last year, many risk assets – particularly developed market equities – have delivered solid gains in 2023 in the face of ongoing macroeconomic uncertainty and geopolitical tensions.
However, numerous pockets of the market found it difficult to attract investor attention as broader nervousness continued over the period, especially with interest rate rises accelerating. Despite the persistent pessimism, 11 specialists share reasons to be optimistic about the prospects for some of the market’s unloved areas for 2024 and beyond.
Renewables offering appealing yields
By Charlotte Cuthbertson, co-manager of the MIGO Global Opportunities Trust
We focus on investment trusts which are mispriced, with catalysts for change. The situations seem to be plentiful in the renewables sector, which has fallen from double-digit premiums to double-digit discounts over 18 months. Typical renewables trusts offered a 5% yield at launch, so were highly sought-after when interest rates were near zero. As rates have risen, investors have turned to other assets, like gilts, with similar yields but lower risk.
This fall in demand, with constant supply, means renewables trust share prices have fallen to the point where dividends are delivering closer to a 7% yield, and investors are better compensated for the risk.
Every renewables trust is different, so separating the wheat from the chaff involves a lot of legwork meeting managers. After plenty of analysis, we have recently been investing in this area. One trust we have invested in is Atrato Onsite Energy, which invests in solar on roofs or alongside factories and large retailers, selling the electricity back to the site. Unlike some of its peers, its revenue is nearly all contracted, so it is less risky than those that sell power at market – or merchant – prices. Atrato Onsite Energy trades on a similar discount to other trusts, but without that power price uncertainty.
Meaningful discounts in preferreds
By Bill Scapell, head of fixed income and preferred securities at Cohen & Steers
High-quality preferred securities, primarily issued by investment-grade-rated companies, currently offer 7-9% yields – considerably greater than what is available from investment-grade corporate bonds. Yields on over-the-counter (OTC) and contingent capital (CoCo) securities, which compose more than 80% of the market, are generally much higher than those on exchange-listed issues.
Issuers have the right to redeem the securities at par value at the reset date. But as many shorter-reset securities are currently trading at discounts to par, a redemption would only increase these securities’ total return. If a security is called, investors can then use the proceeds to invest in issues that are most likely yielding more.
Although preferreds have partially rebounded from the March lows, they continue to trade at meaningful discounts. Historically, the OTC and CoCo markets have both traded at a premium, while the retail market has traded at only a slight discount. We believe current prices present a potential capital appreciation opportunity in preferreds – in addition to the securities’ attractive income rates. Any reversion to the mean, potentially spurred by more clarity around Fed policy, would imply an appreciable price move.
Three tailwinds for overlooked China
By Anh Lu, portfolio manager of the T. Rowe Price Asia ex-Japan Equity strategy
While the diversity of Asia ex-Japan markets should favour stock picking, finding winning stocks has been more difficult in recent times as macroeconomic events have overshadowed company fundamentals. We see this especially in China, where policy shifts have been a major market driver. Going forward, we expect fundamental factors to reassert themselves once more and an environment that is more conducive to bottom-up stock selection.
At a broader level, we note three key areas of opportunity in China. The first is the pockets in the market where valuations look heavily depressed and fundamental conditions are stabilising. Internet companies, for example, have endured years of intense government scrutiny, which we see easing. With a less punitive policy regime, businesses are now able to refocus on growth.
Second, we see secular growth opportunities for companies in industries where China is globally competitive. We believe companies along the EV and green energy supply chains are well positioned for multiyear expansion, not just domestically, but also abroad as they ramp up exports. Related to the second tailwind is our third area of opportunity – import substitution. Geopolitical tensions have forced China to rely less on imports and to become more self-sufficient via accelerated innovation, especially when it comes to making semiconductors, software, autos, and a host of industrial products.
Biotech ripe for M&A acceleration
By Ailsa Craig, co-lead manager of the International Biotechnology Trust
The biotech sector has historically been through cycles of favourability for investors. Rises in interest rates since 2022 have pushed down valuations, with the sector lagging the wider market during this period. The companies that have been most impacted are the younger, development-stage businesses that are yet to achieve profitability and will be relying on external financing in the next five to ten years.
Despite biotech’s recent underperformance, we are optimistic about a rebound and believe the most exciting opportunities to take advantage of reduced valuations can be found in the small and mid-cap segment of the market. M&A activity is beginning to recover, with large pharmaceutical firms looking to acquire undervalued biotech companies to fill clinical pipelines as existing drugs’ patents expire.
This has historically been a precursor to a wider rebound in biotech, suggesting that this could be an attractive entry point for investors looking to capitalise on biotech’s enduring long-term drivers, including accelerating scientific innovation and a continued ageing population.
Selectivity within disappointing EMs
By Alison Savas, investment director at Antipodes Partners
Emerging markets have long been touted as offering significant growth opportunities for investors, yet EM equities as a whole have disappointed. This is why we believe investors should take a highly targeted approach to the region. We are building confidence in emerging economies like Indonesia, Brazil and Mexico, where valuations are cheap and economic fundamentals are improving.
We are encouraged by Brazil’s sensible approach to fiscal spending and tax reform, coupled with accelerating economic growth, assisted by high commodity prices such as iron ore and soybeans. A key investment opportunity is Itau Unibanco, one of the leading private banks in Brazil which is taking market share from the state-owned incumbents and will benefit from broad economic health and low penetration of household debt/GDP.
Indonesia, meanwhile, posted solid growth of 4.9% in the third quarter, with robust private consumption helping to offset falling exports as global growth slows. Indonesia is much less dependent on global growth than its regional counterparts: exports account for 20% of GDP, compared with 60% for Thailand. Higher government spending in the run-up to the 2024 general election should support economic activity. In the long term, the country will benefit from plentiful natural resources, a large and youthful working population, and a growing middle class.
The UK offers attractive prices
Ben Peters, fund manager of the Evenlode Global Income Fund
Over a long period of time, we have been decreasing our US exposure and investing in this side of the pond in Europe and the UK. More recently, prices have become attractive in the UK market, so we have increased the weighting and it is about 23% the portfolio now.
We own very multinational businesses. Diageo is a relatively recent addition to the portfolio. We started to buy it in the summer, as the share price had come down about 20%. Globally, we see strong demand drivers for spirits in the long term, so despite some potential short-term headwinds, we are still adding to it.
Then we have Experian, which has a huge US business, and RELX, which is a very multinational and multi-product business.
These companies all happen to be UK-listed, they are all excellent businesses and for various reasons are trading at very attractive valuations at the current time.
Turning point for Europe’s small caps
By Hywel Franklin, head of European equities at Mirabaud Asset Management
After the historical drawdown that we have seen, we should now be getting very close to the turning point for European small caps. If we compare the typical underperformance of small caps compared to larger companies that we see around recessions, we have already witnessed the full extent of that in numerous markets.
Many of the factors which hit smaller companies hard, such as higher borrowing costs, higher wage bills and sharp increases in raw material costs, are now going into retreat, giving companies an opportunity to rebuild their margins.
We have always been attracted to the agility of smaller companies and we are already seeing many management teams taking the action required to address costs and improve performance. This kind of ‘self-help’ puts the destiny of such companies in their own hands and delivers improvements unconnected to the market backdrop.
Strong REITs to go bargain hunting
By Rick Romano, portfolio manager of the PGIM Global Select Real Estate Securities Fund
The recent sell-off in the real estate market has depressed asset prices and raised capitalisation (cap) rates. Public REIT cap rates, which measure the potential rate of return for properties based on their market value, are near the highest levels seen in recent years.
We believe we are in the early stages of a ‘great consolidation’ in the real estate market. Well-capitalised firms have a long shopping list of attractive properties, which they can now buy for steep discounts. While consolidation has already started in many areas, we expect to see increased M&A activity and strong privatisation trends in the REIT sector as the macro environment stabilises and credit markets open up, which should raise REIT asset prices and fuel a strong rebound.
More broadly, investment opportunities will be driven by a combination of better entry prices and rental growth prospects underpinned by structural shifts in occupier trends, including digitalisation, demographics, and decarbonisation.
Canada offers a stable financial system
Greg Eckel, portfolio manager of Canadian General Investments plc
Canada is often overlooked as an investment opportunity by foreign investors but has shown itself to be a rewarding experience for those willing to participate in the offering. Granted, for those only looking for size and scale, there are limitations relative to other global areas but there is quite an array of interesting ideas available.
Be reminded that Canada can and does punch above its weight quite often and is a G7 member with a responsible fiscal prudence as shown by its ranking of the lowest debt load amongst the group. It has a robust and extremely stable financial system as demonstrated through the financial crisis, abundant natural resources, a highly educated workforce and a diverse and growing population.
In these days of heightened geopolitical risks, Canada also offers a relative calm and does not have the level of internal political polarisation that can disrupt the investment opportunity. The main benchmark for Canadian equities, the S&P/TSX Composite Index ranks very well in terms of performance over the long term relative to its global peers and offers not only a diversification factor for foreign investors in the theoretical model but does so with the added potential for adding absolute return.
A lot of world class companies are attractively valued
Neil Denman, portfolio manager at Sarasin & Partners
It may seem odd, but equity markets do not like companies following the long-established model of doing business. Historically, markets rewarded successful companies that looked to continue expanding though capital expenditure. However, markets today are frequently concerned that the free cashflow being deployed will fail to deliver the level of return the company previously generated.
We do not agree. In fact, this market mindset has opened up a wonderful opportunity to buy attractively valued world class companies with fantastic track records of delivering profitable growth.
A prime example of the recent flawed market mentality can be seen in Texas Instruments (TI). TI is currently adding to its entirely US-based semiconductor manufacturing capacity in Texas and Utah, spending $5bn per year through 2026 to support future growth. Its chipsets are likely to be in demand as we see increased utilisation through automation, connected equipment, and energy saving device management. Electric vehicles and a smarter electrical grid also use the chipsets TI produces.
TI currently offers a 3.4% dividend yield, which has grown by a compound rate of 13.8% over the past five years. We are extremely happy to collect this attractive dividend and wait for the longer-term thematic thesis to play out.
The UK could be a beacon of stability
Mark Barnett, manager of TM Tellworth UK Income and Growth
We are often asked what the catalyst is to correct the discount for UK assets. The underlying state of the UK economy might be the factor that makes the difference. Honestly, it is hard to see exactly where the loathing comes from. When you look at the hard data, the UK economy is doing OK. It’s not great, but nor is it collapsing into the abyss as it is often perceived to be. Take the latest employment and wage inflation data released in mid-November.
We are now witnessing falling inflation and robust wage growth to the extent that wages are rising in “real” terms after a long period of lagging. This is set to continue for the next few months as the outlook for inflation continues to moderate, and although the job market is slowing, the status of the overall market remains tight. Even within the UK political arena, our next election (almost certainly in 2024) offers a choice between two parties that are largely pursuing similar policies to tackle the major issues facing the country, and although the constant political noise is aggravating, it’s also not unique to Britain. Given the likely change of government at the next election a year from now, the UK could be a beacon of political stability with a moderate centre-left government with a decent working majority.
There could be a significant change in external perception given the starting point today. A long way of telling you to stick with your disliked UK holdings, as we could be seeing some light at the end of this long, dark tunnel.
