Redmayne Bentley Publications Podcast January 2024

We are pleased to present the audio version of our Winter 2024 edition of 1875.


In this issue, we explore the current global economic and political landscape from a number of perspectives. We take a close look at the world of luxury fashion, assessing the growing success of French label Hermés International.

Also, in our Topic of the Month, we discuss the upcoming elections in the US, India, and the UK. With more than 50 countries going to the polls in 2024, what impact might these elections have on the economies involved?

TRANSCRIPT

A Busy Year Ahead
Alastair Power | Investment Research Manager

Welcome back and Happy New Year, we hope our listeners enjoyed a restful festive break.
The coming year is set to be yet another busy one, with politics expected to dominate the agenda. Nearly two billion voters across over fifty countries are expected to head to the polls in 2024, with key elections in the US, India, Taiwan and, as seems increasingly likely, the UK. While the US is likely to dominate in terms of importance, India leads in terms of size with nearly 900 million of the 1.4 billion population registered to vote according to some sources. In the US, a face-off between former President Donald Trump and incumbent President Joe Biden looks most probable and, in India, the odds favour Prime Minister Modi to win a third term.

Away from the headline-grabbing elections, smaller events in Taiwan and Mexico remain of importance. Geopolitical tensions between China and Taiwan have been brewing for some time and, with the incumbent leader unable to stand for a third term, the result could have significant geopolitical implications. Mexico will also see a change of leadership away from incumbent Andrés Manuel López Obrador, whose approval rating has remained above the 60% level since 2018, to one of two candidates and the certainty of the country’s first female leader.

In election years, one outcome is  most inevitable: an increase in investor anxiety. In Janus Henderson’s annual investor survey of nearly 1,000 mass affluent and high net worth individuals in the US, 49% of respondents were very worried about the upcoming US election. Delving into the data from 1937 to 2022, the survey highlighted an average election year return for the S&P 500 of 9.9% against an average annual return in a non-election year of 11.9%. While interesting and of high importance, markets are likely to remain focused on the path of inflation and central bank policy rates in the coming year.

Election years always have the potential to drive change, but one thing that looks set to stay the same is the demand for luxury items. Hermés, a family-backed luxury fashion brand formed in 1837, is explored in our Stock Focus article. An interesting business with consistent robust trading numbers, a unique policy of limiting product supply, and tailwind of Asian consumer demand for luxury brands, pique our interest in this edition.

Another area recording a robust year was the UK property market, with Halifax indicating that house prices rose 1.7% across the board despite the effects of rising mortgage rates. The private rented sector, urban warehousing and industrial logistics all continue to hold the positive tailwind of supply constraints against strong demand. Office and retail, however, are more divided in terms of their outlook. One theme remains constant, however: a desire for quality.

With the post-Christmas sales firmly underway and perhaps drawing to a close, we finish with a review of the investment trust sector, an area of the market seemingly on sale. Discounts to reported net asset values remain material with the average standing at 14%. Certain sub-sectors continue to be discounted, especially in infrastructure and private equity, where averages show share prices 15% and 30% lower than reported net asset values. Poor investor sentiment, macroeconomic conditions, and prohibitive cost disclosure regulations are contributing factors for a sector which is seemingly facing challenges.
 
 
Stock Focus: Chasing Returns in Style: Hermès International
Oscar Sheehan | Investment Executive

Those of you with a soft spot for fashion, France, or the finer things in life may well be familiar with the subject of this month’s Stock Focus, Hermés International. The company has been manufacturing what it defines as artisanal luxury products since 1837. From leather and silk clothing to perfumes and accessories, Hermés has exposure to a wide selection of luxury products and boasts an impressive international distribution network. Last year, we reviewed LVMH Moët Hennessy Louis Vuitton and what it was that made the wider luxury market appealing, alongside the challenges associated with it. Similarly, Hermés shares have also displayed robust performance, while the company has demonstrated consistently impressive revenue growth across all areas of its business. Given the recent struggles that a faltering Chinese economy has presented for the wider luxury sector, we felt this success warranted closer examination. What has driven this excellent run of form? Is it sustainable, and why are customers seemingly so enamoured with them?

Hermés has certainly been a strong performer as of late and has quickly become a favourite of fund managers active in European markets. Its share price has increased by 266.31% over the past five years, providing significant outperformance when compared to the MSCI Europe (ex UK) index which returned a more humbling return of 52.93% over the same period. Given the current political backdrop, with the ongoing war in Ukraine and high levels of inflation across the world, European equities have performed relatively well and, despite this, Hermés has outperformed the region five times over. The real question is: what has driven this success? Well, Hermés is perhaps the model example for how a company can cultivate brand desirability and heritage. Starting with its products, it has ensured that it maintains a high degree of quality. For example, artisans are required to undergo a minimum of five years of in-house training before they are allowed to start working on Hermés’ top of the line handbags. On top of this, the firm does an excellent job of limiting supply and of carefully selecting who it does business with. All of this plays into the luxury brand image that only a select, elite few can have the privilege of owning. For example, the special editions of Birkin or Kelly Bags, Hermés’ signature items, have been known to go for US$195,000. This has a knock-on effect on the more commercially available products the company sells and makes them seem more prestigious in turn. The company has almost complete control over its distribution network and, as such, can pick and choose who has access to its products and where they are sold. Sales managers can decide who it is that has the privilege of buying the firm’s products, ensuring the company maintains an extraordinary amount of control over its brand image.

Hermés has also been a benefactor of economic growth in the Asia-Pacific region. As is typical with the luxury sector, the growth in the Asian middle and upper class has created a new market and large amount of demand. Hermés has done an excellent job of capitalising on this, four of its top six countries in terms of revenue generation are found in the region. The eastern hemisphere has already become the largest market for luxury brands globally, with Asia alone generating US$136.29bn in revenue annually and this is expected to grow at a rate of 4% per annum for the next five years. Given the stagnation of luxury markets in much of the developed world, Asia-Pacific is a key market for Hermés, and it seems they have done an excellent job in capitalising on this opportunity. The company has just opened their 33^rd store in China and has refurbished a large store in Japan, its largest market, making it clear it has identified the region as a top priority.

One could argue that this focus on the Asia-Pacific region does little to differentiate the company from its competitors. Other Luxury brands such as LVMH are arguably more exposed to countries such as China. What has really set Hermés apart has been the resilience of its customer base. One of the driving forces of the luxury sector has been the growth of the ‘aspirational’ shopper. These are customers who buy the occasional luxury item but are perhaps less economically well off than the people we might often associate with luxury brand.

These customers are notoriously sensitive to recessionary and inflationary pressures as they tend to have less disposable income. This can help fuel growth when times are good, however, it can be a drag on performance when the economy goes into a tailspin. Hermés, on the other hand, has a very loyal, repeat customer base. Wealthy clients have demonstrated that they are happy to spend hundreds of thousands of pounds to even potentially qualify for some of the company’s more exclusive items. It is this high-net-worth client base that has provided Hermés with its exceptional growth, but also crucially, more protection during recessionary environments as high-net-worth individuals are more likely to maintain their spending habits through these time periods than the average consumer. Given that the number of people who qualify as high-net-worth is also rising in the Asia-Pacific region, Hermés is well positioned to continue its growth in this market.

To conclude, Hermés has done a fantastic job at increasing its sales while maintaining its brand image. Whether or not the company is now ‘priced for perfection’ remains to be seen. With such a high price-to-earnings ratio (47.2x), the company could feasibly experience substantial earnings growth and still see a drop in its share price if it misses its own lofty forecasts. That said, Hermés has an excellent track record and a reputation that most companies can only dream of. Shall its phenomenal run continue? Only time will tell.
 
Topic of the Month: 2024: The Year of Elections
Greg Lodge | Performance & Risk Analyst

More than fifty countries will see voters going to the polls in 2024, in what is set to be the year of elections. Worldwide, more voters will cast their ballots than at any other time in history. The decisions they make will have a substantial impact on their home nations, the geopolitical order and global investment markets. Some of these high-profile elections have been headline news for months. UK Prime Minister Rishi Sunak has signalled that the most likely time for the next general election at home will be in the autumn and polls suggest that a regime change is on the horizon, with labour consistently polling around 18% ahead of the incumbent Conservative Party.

Let us first examine the impact the upcoming UK general election might have on the FTSE 100 index. It is an old axiom that markets dislike uncertainty, and an analysis by Schroders in the run up to the 2017 snap general election would seem to corroborate this. It examined the performance of the FTSE in the six-week run up to polling day on the previous seven elections and found that the index had a tendency to rise when one party had a clear polling advantage above another. Where elections were predicted to be closer, the market performance was flat or negative. Given the Labour Party’s comfortable lead in the current polls, the 1997 election is perhaps the most comparable. In the lead up to New Labour’s landslide victory, the FTSE returned 4.39%. It will be interesting to see if these two trends continue in 2024.

Across the Atlantic, Donald Trump is easily outpacing his competitors in the Republican primaries. Although plenty could happen before the party formally decides on its candidate in July, the 2024 presidential election is shaping up to be a rematch of 2020. This would likely see either a continuation of ‘Bidenomics’ or a return to Trump’s protectionist leanings. With the nation poised to take one of two very different directions, markets will be paying close attention to the race as it develops. Analysis by Forbes found a similar pattern of returns in election years to the UK. Both equities and bonds were seen to produce smaller returns in election years, compared to non-election years. Interestingly, the analysis also found that a new party in the White House led to an average market return of 5%, whereas a re-elected president saw average returns of 6.5%. Here we see again the dampening effect of uncertainty on markets.

This year will also see some elections that could prove to be existential. The self-governing island of Taiwan, located between the South and East China seas, re-elected President Lai Ching-te in mid-January. While none of the leading candidates had outwardly expressed a desire to fully declare independence, their policies vary as to how open to cooperation with Beijing they might be. The Communist Party of China has described Lai Ching-te as a ‘dangerous separatist’ and recently threatened to take the island by force. Taiwan is home to the Taiwan Semiconductor Manufacturing Company (TSMC), the largest chip maker in the world which represents around 25% of its entire stock exchange market capitalisation, with its products becoming indispensable components of everything from cars to smartphones. Unease at the potential impact of a military invasion on this vital link in the global supply chain has led to calls for chip manufacturing to be moved away from China’s sphere of influence. Increasing tensions in the region could see an acceleration of this trend.

India, currently the world’s most populous country, is due to hold an election in the summer. In Incumbent Prime Minister Narendra Modi of the right-wing Hindu nationalist Bharatiya Janata Party is expected to secure a third term. On the campaign trail, Modi has been keen to point to his government’s record of developing infrastructure and increasing India’s burgeoning middle class since it came to power ten years ago. India has increasingly come to the attention of overseas investors, attracted by its growth prospects and as a ‘China plus one’ investment; a phrase describing the tendency to gain Asian exposure while redirecting investment from China to avoid overconcentration in one market.

Predicting the outcome of an election is an imprecise science at the best of times, but it does not take a great deal of rigorous analysis or prognostic powers to forecast the likely outcome of Russia's upcoming presidential election in March. Vladimir Putin’s fifth re-election bid is likely to be successful, given that any realistic competition has been removed; with opponents imprisoned or prevented from expressing their views. With little doubt as to this election’s outcome, it seems likely that Russia’s occupation of eastern Ukraine will continue for the foreseeable future. Investors will be attuned to the impact this will have on natural gas markets, armaments manufacturers and defence contractors such as Rolls Royce and Boeing.

In this unprecedented year of elections, markets will have to contend with a potentially radical reshaping of trade policy. There is unlikely to be a coherent sense of direction as the governments elected this year will have their own views on protectionism, fiscal policy and propensity to mitigate climate change. Various sectors and industries will suffer or flourish accordingly. Uncertainty can be frustrating, but it also presents opportunities.
 
 
The January Sale, an Investment Trust Sector Outlook
Konrad Pietka | Investment Research Team

With the festive period behind us and 2024 underway, the usual post-Christmas sales are in full swing and, in some cases, approaching their end. Stroll down any high street and the “sale” signs are hard to miss. Discounting is underway and the markdowns are considerable, sometimes in the 50% region. In the financial markets, the investment trust sector is one in which a sale is underway. With the cheapness of the vehicles usually measured by a company’s share price discount to Net Asset Value (NAV) per share, the current state of play is one in which these discounts are trading at levels materially wider than history. As an indication, the investment trust sector’s average discount currently stands close to 15%, compared to the 2% level of two years ago. Macroeconomic headwinds, poor investor sentiment, and regulatory issues are all likely influences, but the question remains as to what the coming year holds for a sector which has been in existence for over 150-years?

Given their permanent capital structure, investment trusts are one of the few ways retail investors can gain access to illiquid assets such as private companies and infrastructure. In the years leading up to 2020, a swathe of investment companies floated, aiming to provide investors with income via investments in infrastructure projects. With yield hard to find at that point in time, their popularity was notable, along with the premium trading of their share prices to NAVs. Cue inflation and rising interest rates, and the story has changed with discounts widespread across investment trust sectors.

With discounts on offer, the ability for investment companies to re-purchase their own portfolio at a discount through share buybacks has led to a swathe of activity from boards of directors. In 2023, a record £3.57bn worth of buybacks occurred within the sector, far outstripping the £2.70bn of 2022. Companies such as the £1.65bn market capitalisation private equity trust Pantheon International grabbed headlines upon announcing a £200m buyback program. An activity which proves accretive to earnings of the investment trust, 2024 is set to be another year with heightened share buybacks. The scale, however, depends on company cash levels and given the level of activity seen last year, it’ll be interesting to see how much dry powder remains.

It wasn’t just buybacks that were abundant last year, the sector saw four mergers and eight liquidations. Japanese-focused Nippon Active Value assumed both Atlantis Japan Growth and Abrdn Japan Investment Trust to create a merged vehicle with a £315m market capitalisation. We would expect this activity to continue through the coming year, with four more mergers already announced, including the proposed merger of LondonMetric Property and LXI REIT to create a combined entity valued through £3.5bn. The sector continues to experience a persistent issue with subscale funds, with seventy-eight subscribers to the Association of Investment Companies having market capitalisations below the £100m (excluding venture capital trusts), making them unbuyable by the wealth management firms who’s activity is significant in the sector. Given increased scrutiny placed on investment trust boards, further merger activity is expected in the coming year to create viable cost-effective investment vehicles with enough liquidity to attract a diverse shareholder base.

Recent years have also seen a regulatory overhang for the sector following a piece of European legislation in 2018, and updated in 2022, around cost disclosures. Required to report costs associated with investment, the result has been an overinflated cost figure which the investor never actually pays, given the costs bearing out in the financials and thus reflected in the earnings, which drives the share price over time. Sector participants have been vocal in their displeasure, with notable figures such as former Member of European Parliament Baroness Bowles raising the topic in the House of Lords. Chancellor Jeremy Hunt announced in his recent budget an intention to replace the regime with a new regulatory framework. Consultations are underway, with over three hundred signatories, including Redmayne Bentley, in a combined response to a recent HM Treasury plan on the topic. At the heart of this issue lays the treatment of investment trusts in the same manner as open-ended funds, instead of treating them as listed equities. Whether new legislation will be enacted in 2024 remains to be seen, but change is on the horizon.

Market outlooks don’t normally focus on a fund structure but given the frequency of use in private client portfolios on both a discretionary and execution only basis at Redmayne Bentley, highlighting the challenges faced for the upcoming year can help in deciphering the reason behind wide discounts to net asset values. On a selective basis, these vehicles are expected to continue to be a strong contributor to portfolio performance despite current challenges.
 
The British Property Outlook
Samantha Cory | Investment Research Team

There’s no denying the British love discussing property. With higher interest rates, a focus for many was around how much house prices might fall in the wake of tightening budgets and refinancing mortgages away from the rock bottom rates seen in recent years. Used as a catch all term, ‘the property market’ is generally associated with residential house prices. The ‘market’, however, is extremely diverse, covering a variety of sectors from private residential housing to industrial logistics assets. In a whistlestop tour of some of the main areas, we’ll be covering a short outlook of the sectors with longer-term tailwinds.

The private rented sector is one that most people will experience at some point in their lives, with renting a likely step before a first house purchase. Recent news headlines have focused on the rate of rental growth, with the average UK rent rising 6.2% in the twelve months to November 2023, the largest annual increase since January 2016. Rising interest rates have only increased the rental growth tailwind, with an additional supply squeeze from shrinkng landlord profit margins. A further squeeze is the growing difficulty for many to get on the first step of the property ladder, largely due to a number of pressures including high interest rates and the cost-of-living crisis. With such a highly fragmented market where individual private landlords are abundant, it is unsurprising to see institutional capital flow into the sector to take advantage. Listed companies such as Grainger Plc and PRS REIT have been growing their portfolios in recent years, with the latter surpassing its 5,000th portfolio home in mid-2023. Student housing provider Unite Group is also in on the action, with its first 178-unit build-to-rent property in Stratford, east London. It’s not just British investors entering the market, US private equity giant Blackstone secured a portfolio of yet-to-be-built houses from housebuilder Vistry for £819m in November, aiding its push into the sector. With the supply and demand imbalance tailwinds in place and significant capital flowing into the sector, private rental remains a key area for strong rental growth and stable asset pricing in the years ahead.

Logistics assets are arguably at the opposite end of the spectrum to residential, especially when it comes to size. Big box logistics warehouses are huge, and mainly found close to key infrastructure given their importance to supply chains. If you drive anywhere along the M1, you’ll be hard pushed to miss one of the giant sheds lining the roadside. Demand continues to grow as the e-commerce market shows little sign of slowing. The “bull case" put forward from property group Savills highlights the expectation of online sales capturing 28% of the retail market by 2027 from the 22% level in 2022. Estimated to generate another 48 million sq. ft of demand, the requirement for big sheds remains robust. Property company CBRE highlight in its outlook that while increased supply in the space has provided increased choice for occupiers, a slowing of the development pipeline is expected to continue in the coming year. While the proportion of vacant logistics assets could soften marginally, demand for the assets is expected to remain high from discount retailers and nearshoring companies. As such, rental growth is expected to remain relatively strong for the asset class going forward.

Modernisation of healthcare properties has been a key trend in recent years, with the demographic trend of an ageing population, increase in complex healthcare issues, and greater focus on reducing the burden on hospitals, healthcare centres capable of providing primary care services are of continued importance. Primary Health Properties, one of the leading Real Estate Investment Companies investing in the sector, estimates that 40% of the current primary care estate isn’t fit for modern healthcare requirements. With the continued working through of the COVID-19-induced backlog, modernisation of the estate is important, but faces a headwind of slowing development activity on the back of increasing build costs and lower risk tolerances according to CBRE. With costs higher, new investment activity is expected to remain muted with the focus placed on improving the current UK healthcare estate where covenants remain strong with the government the primary lease counterparty and the rent review structure mainly inflation linked or upward only. Current high-grade healthcare properties are expected to remain an attractive proposition, but rental growth is still required to offset increased development costs and improve the viability of new projects.

No matter the sector, a common theme remains a structural supply and demand imbalance. Growing demand and supply struggling to come onto the market provides stability for asset pricing and a driver for rental growth in the coming years. This imbalance coincides with another theme in the market, a focus on quality. Energy efficiency associated with higher grade assets is of continued importance with onset of sustainability reporting and regulations around minimum efficiency standards. The drivers highlighted above are expected to be consistent across the sectors, but more pronounced for the highest-grade assets within each.
 
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