These are difficult times for investors. The MSCI World Index has declined for four months and has given up its gains of the last year. NASDAQ is 30% below its December peak. The war in Ukraine presents such a wide range of scenarios that only the brave would add risk to their exposures right now. Inflation is at levels not seen since the eighties, making holding cash a real cost to investors. Rising interest rates are causing bond prices to fall and so bond funds are unattractive. Even gold has gone nowhere, falling from its recent highs despite the turbulence in the stock and bond markets. Bitcoin has fallen in line with equity markets.
There is no off-the-shelf solution to weather this perfect storm. But there are measures that investors can take to limit the impact on their portfolios of current market conditions.
The Importance of cash
LGB’s mission to work with and support growth companies sits in the ‘high risk, high return’ category, and so we are very used to dealing with high levels of volatility. We know that when times are tough, cash is king and that companies reliant on further fundraising to achieve their business goals will struggle in a risk averse world, relative to companies that are cash generative and have strong balance sheets. In the same way, investors should also position themselves to generate cash in order to withstand the storms. This comes down to a portfolio construction that provides access to liquidity.
How can one generate income? Dividend paying stocks and bonds are one option. Another way is to use LGB’s secured MTN programmes (MTNs), which are a convenient way to build fixed income portfolios with a ‘ladder’, receiving capital and interest payments regularly from different issues. This strategy is designed to provide current income while minimising exposure to interest rates. Most of our issues are short dated, up to three years, which allows investors to reassess their strategy each time there is a maturity.
MTNs are generally held to maturity and so a rise in market yields represents only an opportunity cost. In practice, although the ‘real return’ of these fixed income investments has reduced with inflation, the average rate of 8% p.a. still sits well above corporate bond yields and provides a decent hedge against inflation. The key to this strategy is the ability to re-invest the cash when it is paid out, and with LGB investors being offered on average at least one new MTN issue per month, we believe our investors are being provided with a good opportunity to keep their portfolios at work.
Stock selection
Once a strong portfolio foundation is in place, equity opportunities can be reviewed on their merits. Although our focus is on growth companies in the AIM market, this should only be part of investors’ overall equity allocation with more established (and dividend paying!) companies to be found in other parts of the stock markets.
We have never been ‘traders’ and always take a medium- to long-term view of portfolio companies. This requires a clear stock selection and monitoring process.
We believe in a thematic approach. We have identified four core uncorrelated investment themes that provide the key element of diversification and benefit from a following wind. These are decarbonisation, digitalisation, the future of healthcare, and new age consumer. We are actively looking for companies that play in these themes and encourage investors to make allocations across all four themes. We then apply our investment template to assess individual opportunities, focusing on qualitative criteria such as IP and knowledge, management, pricing power, and potential for scalability, but also quantitative criteria such as recurring revenues, growth and margins, debt/equity ratio, ability to generate cash or fundraising capacity, and of course valuation metrics. In difficult times we place greater importance on defensive factors.
Utilising tax benefits when available
Investors subject to UK income tax are able to reduce their risk when investing in certain equity opportunities by using the various tax reliefs which are on offer. The Enterprise Investment Scheme (EIS) in particular is very attractive. Not only can investors claim 30% upfront income tax relief on the amount invested, but any capital gain will also be tax free, and any loss can be offset again against income tax. This is subject to investors adhering to HMRC’s EIS rules, which can be found here. Generally speaking, EIS-qualifying investment will also qualify for Business Relief (BR) after it has been held for two years, meaning that the value of the holding will fall outside of the investor’s estate for inheritance tax purposes. These two tax reliefs, which only apply for UK income tax payers, mean the risk/return profile on these types of investments can become very acceptable despite some significant volatility at times. If investing with EIS in private companies, the biggest concern to investors is often the time it takes to achieve an exit. Private placements and IPOs on the smaller end of the AIM market however can often also come with EIS and are well worthwhile considering as an alternative as they have the added advantage of a secondary market on the stocks.
In summary, although we are all being impacted by the current market headwinds, investors should continue to have a disciplined and clear investment strategy. We believe that high-quality, balanced portfolios that generate cash should outperform in difficult markets and put investors in a strong position to take advantage of investment opportunities as they arise. UK investors who are looking for exposure to the growth sector should also consider the various tax schemes available to them in their approach. If you would like to discuss your portfolio with us, please do not hesitate to get in touch.
Disclaimer: This is not an investment recommendation. For further information, please get in touch here.
