As I survey the market carnage of the last few weeks, I’m tempted to shout: “I told you so!” I’ve been traipsing around the UK to investment events, thundering on about why the Great Oil Crisis is far from over, and that we’d only see the end of this sorry saga when prices hit $20 a barrel. I don’t think (as some fear) that this will mean a huge burst of deflation. But equally, only a blind optimist could imagine that such a huge shift in wealth from oil producers to oil consumers wouldn’t trigger massive volatility. Imagine what would happen if all those oil-based sovereign wealth funds started selling their equity holdings.
However, while I have switched to cash for a large part of my portfolios, I don’t think we are facing a new global recession, requiring investors to take all risk off the table. The falling oil price will be a tonic for the world economy. The eurozone should also continue its slow but steady recovery, and I think China’s government will be forced to deploy quantitative easing later in the autumn, perhaps after its local stockmarket has wilted under another 20%-30% of losses.
Another, more mundane, measure gives me confidence that we aren’t heading for a total meltdown. I keep a close eye on the defensive and income-orientated parts of the global stockmarket. A coordinated, correlated sell-off across anything even faintly risky (such as these sectors) is a major warning sign. If I’m right, these aren’t yet pointing to Armageddon.
Defensive bets have held up well
Let’s take the past month’s figures as a guide. Global equities fell by around 8.8% in the four weeks to 24 August. Emerging markets are down by 13.6% and crude oil is down by 20%. US equities are down by 7.5%, with the UK down by 7.2%. But the midcap FTSE 250 index is down by a more modest 5%, with UK small caps down by just 3.4%. Indian stocks are down by 2.3%. Among sectors, aerospace and defence stocks have fallen by 3.2%, big tobacco is down by 2.3%, and healthcare is off by 3.8%. The smallest falls have been in electricity stocks, off by 2.2%. As for different investment styles, most indices picking out stocks with low levels of volatility have fallen only modestly.
The story is similar among investment trusts, one of my favourite areas, with China, Japan and mining trusts hit hard, but trusts focused on small and midcap UK stocks coping well. However, utility equities-based funds have also had a tough time, falling by 13.7%, suggesting a market overreaction. But the most interesting part of the story is that infrastructure funds are up by 0.1% on average. Renewables funds are up by 2.1%, as is the average real estate investment trust (Reit). Leveraged loan funds are up by 1%, peer-to-peer funds are up by 0.3%, and real estate debt funds are up by 1.4%.
In short, this has not been an indiscriminate sell-off. UK-focused funds have got off lightly, as have defensive (think big tobacco) and quality-based assets, especially those with real asset backing and steady cash flows. Long-dated bonds have risen as you’d expect in a risk-off tailspin, but investors are still willing to back equities with strong cash flow. In short, income-orientated specialist equities (such as real-estate funds and loans-based trusts) should continue to prosper. Investors are signaling that they expect interest rates to remain low for a long time (maybe decades), even if US rates do gently rise by, say, 0.25% or 0.5% in the next six months. That’s good for the income-rich funds I dwell on here.
Nice little earner
On that score, I’ll make a final observation about a relatively obscure fund that is set to raise another dollop of money. SQN Asset Finance Income Fund Limited (LSE: SQN) launched last July. It’s focused on a boring part of the finance market – asset-backed finance. This is for firms that need to buy an expensive but revenue-generating piece of kit. This could be an anaerobic digesting machine for a farmer, say, or a power-generating unit for a big food manufacturer.
The fund is run by well-established trans-Atlantic managers who have been making steady, patient money on “mid-market leasing tickets”. In other words, they don’t buy and hire out expensive planes or cheap photocopiers – they stick with items in the middle, ones too cheap for a big bank but too costly for your bog-standard leasing business.
The end result is a diverse set of assets producing an income of between 8%-12% a year. Security is fairly good, defaults and arrears virtually non-existent, and cash flow very visible on a monthly basis. At 108.8p, the shares trade at a 9.4% premium to net asset value, but given the market environment I’ve described, this could easily move into double-digit territory – investors seem to like the fund’s steady yield, currently around 6.7% a year.
It won’t blow the lights out, but it is a fairly safe, even dull stock that should sit nicely in a portfolio of Reits and other loan funds. The managers are likely to hit the markets with a new “C” issue of shares in the next two quarters. My guess is that they’ll be looking for well over £100m, given market demand and that premium – which should in turn help improve liquidity and narrow the bid-offer spread, which is a bit high at 1.1%.