Global equity markets suffered during October, falling 7.4% in US dollar terms and 5.5% in sterling terms. The largest declines were focused on the Asia Pacific region including Japan, closely followed by the US. UK equities were one of the better performers, helped by sterling weakness versus the US dollar. In fixed income markets, US Treasury yields continued to edge higher (and prices declined) but major European government bond yields declined (and prices rose). Corporate bond spreads (the difference in yield versus equivalent government bonds) broadly rose, particularly in the high yield sector. Similarly, emerging market bonds remained under pressure. Commodities were generally lower as the energy and industrial metals segments fell.
October will be remembered for the sizeable market falls across equity markets. While a lot of attention focused on US technology stocks, larger declines occurred in other sectors. Reasons could include rising US interest rates, trade tensions and more mixed corporate reporting. The positive investor sentiment towards certain types of stocks ebbed away and investors made the decision to rebalance towards less expensive areas. We believe that this is a market-focused event rather than the start of something more sinister.
Europe remained a source of political risk throughout the month. Italy was the epicentre of the worst moves as Italian sovereign bond yields spiked to almost 3.7%. The European Commission (EC) rejected the proposed budget as it broke European Union rules designed to ensure stability. Investors now await the EC’s decision on whether to punish the country. Banking stocks have been hit hard given the inherent link to the Italian sovereign. Elsewhere in Europe, Angela Merkel has promised to step down at the next election following continued underperformance in polling results.
The price of oil suffered a sizable decline as inventories in the US rose. Concerns about global growth, declining equity markets and a stronger US dollar also added to the weakness. Gold had a strong October despite a number of factors suggesting it should have been a more difficult environment for the precious metal.
Over the month of October the fund’s Net Asset Value (NAV) lost -2.4% whilst the share price return was -2.2%. Over the same period the Company’s Association of Investment Companies AIC Flexible Investment peer group returned -2.7% in share price terms (Source:Morningstar). The FTSE World Index, which the Company aims to outperform over the long-term, returned -5.5%. A relative outperformance of 3.3% (Source:Bloomberg). This continued strong performance is encouraging and provides credence to our theory that the abnormal returns of recent years are behind us and we are set for more volatile markets at this late stage in the business cycle.
It is worthwhile highlighting that the Company’s longer-term performance has continued to improve since the portfolio restructuring was completed. The left hand chart below highlights the attractions that Henderson Alternative Strategies Trust PLC (“HAST”) offers investors and the attractive value on offer in relation to the Company’s closest peers. HAST has the widest discount of the peers, has generated the second highest returns over the past three years in NAV terms and has a level of volatility towards the lower end of the comparators. The second chart highlights how performance has continually improved against the same peers over the past few years. The three- year performance number has continually trended up since early 2014.
During October, Property was the best performing sector in the portfolio, contributing 0.2% to performance. The fund’s largest position (6.1%) is currently CEIBA Investments Ltd (“CEIBA”), which primarily invests in Cuban commercial real estate. During October, CEIBA listed on the London Stock Exchange. Despite listing at a 16% discount to net asset value, we were able to realise an uplift as we had cautiously valued the position at a 25% discount prior to listing. CEIBA contributed 0.4% to performance during the month.
The Specialist Geography sector detracted 0.2% from performance. Despite emerging market debt performing well given the difficult macro backdrop emerging market equity suffered. The Sloane Robinson Emerging Market Equity Fund detracted 0.3% from performance.
We were pleased with the performance of the Private Equity sleeve during the month. The sector detracted just 0.3% from performance. Riverstone Energy Ltd suffered from the falling oil price and Harbourvest Global Private Equity Ltd was impacted by the risk-off environment, both positions cost the fund 0.2%. This was offset by our more idiosyncratic exposures such as Baring Vostok Investments PCC Ltd which released its mid-year report and accounts highlighting extremely strong growth at the underlying company level. 57% of the portfolio is seeing revenue growth in excess of 20%. We expect a strong uplift when these growth rates are incorporated into year-end valuations.
The Hedge Fund sector detracted 0.6%. The largest detractor was the BlackRock European Hedge fund which cost 0.4%. This position was impacted by the sharp rotation in markets as unloved sectors outperformed and those previously in vogue struggled. Our portfolio construction paid dividends in this respect as the Majedie Tortoise Fund’s strong contrarian positioning gained ground in a very difficult market for most investors. The position added 0.1% during the month highlighting the benefits of having exposure to a diverse range of managers. The Indus Pacifichoice fund detracted 0.3% from performance as Asian markets struggled.
The worst performing sector during the month was the Specialist Sector category. This category of investments has the highest beta to equity markets and so this was not surprising. The largest detractors were our healthcare exposures. The Biotech Growth Trust was impacted by negative sentiment towards the technology sector and detracted 0.6% from performance. Worldwide Healthcare Trust PLC was impacted by broader market sentiment and detracted 0.3%. Burford Capital Ltd (“Burford”), a new position, was the best performing position adding 0.1% to performance.
Burford was one of two new positions during the month. We have undertaken significant work looking into litigation finance as an emerging asset class. The market sell-off in early October provided a good entry point for us to open a position in Burford. Burford suffered as did many small and medium-sized high growth businesses in October. However we see litigation finance as an uncorrelated asset class generating high returns, a very underpenetrated market with significant barriers to entry. Burford is undoubtedly the leading litigation financier and we were able to open a position at an attractive level as the stock fell 23.5%, peak to trough in October.
Secondly, we saw good value in Euro Stoxx 50 Dividend futures, believing we can generate double-digit returns with less volatility than equities as they move toward maturity. We entered this position after the first sell off in mid-October and continued to build the position on weakness.
We used October’s volatility to top-up positions in both Worldwide Healthcare Trust PLC and Polar Capital Financials Trust PLC. We continue to favour both the financials and healthcare sectors. We see value in financials and believe that in a world where yields increase and growth remains moderate that they should rebound from their extremely low valuations. We see healthcare as an attractive late stage sector as it tends to be defensive, exhibits higher growth and has less correlation to interest rates than other defensive sectors as well as long-term support in terms of aging populations.
Financial markets continue to face several challenges, including tightening monetary policy, trade tensions and populism. There has been a degree of re-pricing to reflect these risks but, in our view, share price valuations, particularly in the US remain elevated. We also believe that investors will have to adjust to greater volatility going forwards. At this stage of the market cycle, missteps by policy makers are likely to be more keenly felt. Global growth seems to be gently rolling over, mainly led by China, although the US remains solid for now and this should support risk assets. However, we are becoming increasingly cautious and so remain vigilant and will look to react accordingly.