LGB’s Market Commentary for Q1 2024

We have commented in the past about the futility of forecasting and the importance of understanding where we are – in the words of the great investment guru, Fatboy Slim – right here, right now. Markets are a reflection of current sentiment not a predictor of the future. The difference between the wisdom of the hive mind and the madness of crowds is only one of perspective.

At the beginning of the year there was an overwhelming consensus that interest rates were on an inexorable downtrend across the G7 (with the possible exception of Japan). The Fed was anticipated to be about to embark on seven rounds of cuts. Conflict in the Middle East and tension around Taiwan seemed to be an acceptable risk.

Since then the interest rate outlook has changed significantly, particularly in the USA. The Middle East has got rather more worrying, and the position of the Ukraine worse, bringing a direct threat to the NATO Baltic countries that little bit closer, and there has been no improvement around Taiwan or in the South China Sea. At the time of writing an Israeli strike on Iran still seems to be a possibility with unpredictable consequences.

The Current Situation – starting with the biggest market

So, where are we now? Equity markets, which had been on something of a tear, led by the so-called Magnificent Seven tech stocks in the USA since October, seem to have hit a brick wall since around the 20^th March.

This was despite a Fed meeting after which Jay Powell (US Federal Reserve chair) said that there was no change in attitude towards rate cuts.  As the FT suggested, this seems to have represented peak optimism that the US could grow strongly with full employment and simultaneously see rate cuts and disinflation. The growth and with it high employment seem firmly embedded, and correspondingly significant rate cuts appear less likely, as evidenced by the higher level of options market-implied rates forecast. In addition, quite a few prominent analysts are now predicting Fed rate hikes this year.

Since the Fed meeting we have also seen a sharp increase in tension in the Middle East, oil prices nudged up (Brent is up about 17% ytd, currently around $90, and the IEA which was forecasting a surplus is now projecting a deficit), Tesla reporting declining unit sales and subsequently job cuts, and still overall strong US growth and employment numbers.

US Bonds

10-year US Treasuries are now yielding almost 4.7% vs just under 4% at the beginning of the year (and two year are at almost 5%):

and implied inflation-adjusted yields have risen from around 1.5% to over 2%:

The US remains the standout economy, and with Tesla and Apple perhaps excepted, it has the standout tech companies, but the bond market is exacting a price for that. If you think that 4.7% nominal and somewhere around 2% real returns before tax are acceptable on a ten year view, and that the strength of the US economy will continue to strengthen the US dollar which is already towards the top of its range vs the Euro (with the exception of the spike after the outbreak of the Gaza conflict) since before the Global Financial Crisis, then US Treasuries can be a good allocation. As a reminder you can buy US bonds via your LGB Investment Account, which is a multi-currency account.

Interestingly a view (which until recently was seen as an eccentric offshoot of so-called Modern Monetary Theory) is now taking hold that higher rates in the USA are actually boosting economic activity, as higher yields are being recycled into the economy, with savings being higher than mortgage debt. In the US mortgage interest is up to a certain level deductible against income tax which also protects households.

US Equities

The search for beneficiaries of the AI revolution will continue to throw up names. To what extent these will be (with the exception of specialists like Nvidia, and perhaps the data storage companies) pure AI companies and to what extent AI will simply become a productivity tool is unclear. Those of us who remember the tech boom around 2000 will recall that the snake-oil salesmen were out in force and many spurious companies were floated as supposed beneficiaries. Of course the internet did “eat the world” but it also ate many of its tech bubble babies. No doubt the same will apply to AI. Investors can gain exposure to this area directly by picking preferred shares, or via funds, or ETFs which track the performance of for example the S&P US Technology Sector (Invesco and State Street Global Advisors among others have relevant ETFs available to UK investors which are accessible via the LGB investment platform)

Closer to Home

The UK remains plunged in gloom. The consensus seems to be that neither the current nor a future Labour administration will have any fiscal room to manoeuvre, the Truss/Kwarteng interlude having shown the intolerance of the bond and currency markets for anything adventurous; that growth will remain muted for the remainder of the year and that the UK equity market will continue to see departures across the Atlantic (or to private equity). We are now hearing investment managers making comments like: “the UK looks cheap, we’re not saying we’re investing there”.

Certainly, with an economy where 22.2% of the working population is economically inactive (neither employed nor unemployed), and another 4.2% is unemployed (an eight-year high), the UK is an outlier in international terms with respect to the participation rate still being worse than before the pandemic. The Labour party has so far been extremely coy in giving any details on its proposed policies, and what has been seen seems to be more aspirational than concrete. Aspiration without detail is certainly not the monopoly of a single party and the Mansion House speech which was supposed to herald an influx of investment to smaller growth companies has yet to deliver anything concrete. The British ISA £5,000 supplement – still not in place – can hardly be said to move the dial, and HMRC still provides a tax shelter for investment in non-UK companies, which may appear eccentric. Inflation is clearly particularly embedded in the UK, even though it fell to 3.2% in March (the lowest since 2021), but core inflation seems very stubborn. Over the last month or so the consensus has shifted from three interest rate cuts this year to two. The Bank is having to trade off pressure on sterling from lower interest rates with a concomitant increase in imported inflation vs the impact of higher rates for longer on domestic economic activity.

The case against the UK can perhaps be made too easily to be true – think back to the Truss period and the confident assertions that sterling was going below $1. A continuation of strong oil pricing, and any continuation of the modest recent bounce back in iron ore prices, following the recent stronger recovery in copper pricing, has a positive effect on the FTSE given the weighting towards energy and mining companies, and the very recent tightening of sanctions on Russian imports is already having an effect on some metal prices. Low valuations ultimately attract bid activity and even if private equity firms’ “dry powder” seems to have been rather dampened, in-market deals have not stopped entirely.

AIM

AIM is the gloomiest area (this is the AIM 100 over three years):

vs the FTSE 100 over the same period:

With limited fund-raising activity the brokers themselves are facing consolidation and job losses so it is hardly surprising that they are not exuding good cheer. The AIM market fell 11% in 2023 vs a FTSE rise of almost 6%. Delistings, last a major problem around 2009 in the wake of the financial crisis, have reappeared, in some cases driven by major shareholders who see the possibility of subsequent relistings in the USA but also the potential ability to attract venture capital funding away from the spotlight of the public market – VCs dislike the requirement to mark valuations to market. The number of companies on AIM peaked at 1,694 in 2007, was 753 last year and looks set to drop below 700 this year. Changing the downtrend will require something to change and it is difficult to see what that will be. As things stand it is hard to be confident that money can be made in capital-hungry companies. On the positive side those that have turned the corner to profitability however are being rewarded by the market. And it makes sense to provide follow-on cash to development stage companies if an inflection point is really in sight.

MTNs and Gilts

On the ground all is not gloom. The alternative finance companies LGB has set up MTN programmes for are by and large seeing good activity levels, and defaults well within historical parameters, whilst they continue to benefit from the retreat of the major banks into a “computer says no” disengagement from their clients. Investors can use the MTNs to generate cash and whilst of course they are not gilt-edged or rated we continue to monitor the issuers closely, ensuring that security arrangements are indeed secure and that covenants are met.

We believe investors should see bonds as buy-and-hold investments. Profits from trading liquid bonds if and when rates drop are to an extent illusory given that the bond reinvestment opportunities will have also become less attractive. And the assumption of even a few months ago that we were returning to the super-low rates of the last 15 years does now seem to have been seriously questioned.

Short duration and high yields in the corporate market offer an attractive trade-off against the lower net of tax returns available in government securities (for example, the UKT 0.625% Jun-25 currently yielding 4.63% would offer a net return of 4.35% to a 45% tax payer who would only be charged on the coupon but not on the capital appreciation), as part of a tiered portfolio, and a range of high quality corporate bonds is updated weekly on LGB Deal Hub. These are the yields (pre tax) for longer maturities:

It is always worth remembering that government bonds are to a large extent bought by investors who are not paying tax on the coupons (pension funds, insurance companies managing pension funds, banks offsetting the yield against their own funding costs) and that the playing field is in that sense not even – although they can be held in ISAs and SIPPs by private investors – and gilt issues trading at a discount benefit from a CGT break on the accretion to par.

Finally, and for comparison, German Bund Euro yields are between 2.95% for two year to 2.49% for ten year. The ECB seems to have forgotten its origins as a successor to the Bundesbank and is happy to keep yields longer than a strict interpretation of their mandate might require. There seems no obvious reason to look at these markets save for those with euro liabilities to match.

Conclusion

While investors need to make their own decisions on diversification, this can be very challenging in a market environment which exhibits a mixture of optimism and caution. Maintaining a balanced portfolio of fixed income holding with varied risk profiles and duration can provide a solid starting point. Longer duration instruments such as government bonds provide a core fixed income portfolio which protects against swings in inflationary expectations. This can be complemented by shorter and higher yielding private credit, such as MTNs, to enhance yield, provide diversification and insulate the portfolio from the public markets’ volatility. The LGB investment accounts allow access to a very wide range of markets and securities and we are always happy to discuss them with you.

Sources: Bloomberg Markets, Factset, Marketwatch

LGB & Co. is very pleased to announce that Simon Lough has agreed to join as an advisor to its Board of Directors. Simon has extensive experience in debt capital markets, wealth management and the City, which will be very relevant to the further development of LGB’s business.

Simon began his career in the debt capital markets of Kleinwort Benson in 1984.  He was seconded to Tokyo where his responsibilities included private placements of MTNs with institutional investors.  He moved to Banca della Svizzera Italiana in Tokyo and then in 1996 Simon transitioned to wealth management. He opened the London office of Heartwood, where he ran both the client and investment teams before becoming Chief Executive in November 2008. He led Heartwood through a period of sustained organic growth before its acquisition by Handelsbanken in May 2013. Simon remained at Heartwood for a further three years.  During this period, he represented the wealth management sector on the FCA’s Smaller Business Practitioner Panel.  Between 2019 and 2023 Simon was a non-executive director of WH Ireland, becoming chairman in 2022.

Simon balances commercial and not for profit activities. He is Deputy Chair of the Haberdashers’ Academies Trust South and Chair of Haberdashers’ Knights Academy, one of the Trust’s schools in Lewisham. He was Chair of the charity Envision from 2015-2023.

Simon Lough commented: “I am very pleased to join LGB & Co.  I enjoy the challenge of helping to scale businesses of its size.  I believe LGB addresses a real market gap:  as the wealth management market becomes increasingly commoditised, I think there is a real opportunity for specialist firms like LGB to offer differentiated investment opportunities to sophisticated private clients, particularly in fixed income.”

Andrew Boyle, Chairman of LGB & Co. commented: “My colleagues and I are delighted that Simon is joining us as we are sure we will benefit from his expertise in the capital markets, wealth management and corporate governance.  We now have a well-established business and are in a position to engage more actively with strategic partners and larger issuing and investing clients.  Simon’s advice will be invaluable in this regard.”

 LGB’s Market Commentary for Q4 2023

A Forecast Free Zone  

This is the season of forecasts. A bit like midges in the Scottish Highlands, they come around every year, and are about as much use. At the beginning of 2023 these were the forecasts of five major investment firms for the S&P 500 at year end from a starting point of 3,839.5: Barclays 3,675; Morgan Stanley 3,900; UBS 3,900; Citi 3,900 and BlackRock 3,930. The outturn was 4,783 (+24%). And who now remembers the confident and widespread forecasts of Sterling breaking parity with the dollar in Autumn 2022? Certainly not Goldman Sachs who were forecasting 1.30 in December. Forecasting is inherently problematic. Clarity as to where we are now may be as much as we can hope for – and understanding what different classes of investments offer us now, and some of the risks attached, may therefore be useful.

Fixed Income 

We can start with the sometimes mislabelled risk-free assets, government bonds. Here is the five-year price chart of the UK 30 year gilt:

(source: FT)

Ouch. With prices having fallen from high to low by well over a half, it is a reminder that lending to governments may mean you get your money back, but your holdings can be subject to massive swings in valuation along the way, particularly for bonds with longer duration.

At the time of writing the UK 10 year gilt are trading somewhere around the middle of their recent range, at a yield to maturity of 3.8%, having hit a high of 4.75% in the autumn, and a low of 3.5% around Christmas. This compares with one month sterling T-Bills yielding 5.15%.  US ten year rates hit 5% in October, retreated to just over 3.75% around Christmas and are now at c. 4.05%. Four week US T-Bills yield 5.4%. German 10 Year bonds yield 2.185%, after reaching almost 3% in the autumn and just under 1.9% late last year, whereas short term Euro bills yield around 3.7%. All these markets, with so-called “inverted yield curves” are implying that rates will fall and indeed, inflation does seem to be falling – at least at consumer level (CPI annualised 0.6%, 2.7% in the eurozone and 1.9% for the equivalent US measure). Hence, on the face of it, lending to governments – disregarding of course their regrettable tendency to tax the interest they pay – would seem a reasonable way to safeguard money. And if rates do indeed come down there will be a capital gain as the prices rise.

In the UK, taxpayers can (given the large stock of bonds outstanding issued when rates were much lower) escape much of the tax on interest by buying low-coupon older bonds, government and corporate, which trade on a discount, using the “Qualifying Corporate Bond” exemption: the accretion of the bond to par at maturity is tax free and only the coupon is taxed.

Please note that investors with accounts on the LGB Investments platform have access to UK T-Bills, Gilts and a corporate bond list with suggestions of bonds trading at a discount to par. 

However, low CPI, helped down by energy prices in the latter part of 2023, is not the whole story. Central banks (outside the Eurozone) have to worry about the tightness of the labour market, and the danger that inflationary expectations are now baked in. They have seen inflation fall without the recessions they had anticipated but having by common consent waited too long to raise rates, they may well overshoot on the downside. Continued disruption to energy exports, whether from the Gulf via the Red Sea or due to the Ukraine conflict, could reverse the trend. The assumption that current rates are abnormally high is only true if your definition of normality starts with the Global Financial Crisis. But if you believe the inflationary pressures have been vanquished then Gilts and investment grade corporate bonds will offer a reasonable if unexciting return. If normality is indeed a sub 2% rate then longer dated bonds will offer substantial capital gains too. If central banks fail to get inflation down then sub-4% longer term rates do not make much sense.

Investors looking for safe short-term homes for their cash could consider the weekly UK T-Bill auctions. At last week’s auction the 6-month yields were quoted 5.17%-5.21%. Contact us for guidance on how to participate. 

There is no consistent way of tracking Sterling sub-investment grade bonds. The US High Yield Bond Index has recovered sharply in the last few months as fears of recession have fallen away and is at an all-time high. Quoted UK high-yield paper has also recovered somewhat (e.g. the Bruntwood 6% 2025 which is trading at 96.5 vs 92.5 in October).

Yields on LGB’s MTN issues have not yet started to fall back and can offer a decent real return in this environment. For example, Lendco Limited, a solid specialist property lender with an outstanding track record and significant private equity backing, is currently offering 11% p.a. for new 2 year notes. 

Forecasts for the property market, following some extreme pessimism earlier this year, are now starting to rise (e.g from Pantheon Macroeconomics), and the market continues to be resilient on the back of a 4 million home deficit in the UK, vs. 60,000 build-to-let units in process and total housing unit construction not much over 200,000 per year.

Equities 

The US equity market is notoriously dominated by the “Magnificent Seven” tech stocks, which had doubled to mid-December 2023, pulling the rest of the market up (the NASDAQ 100 was up 52% last year, the S&P 24%) – though outside of the seven it was down for the first three quarters of 2023. European markets are the opposite. The UK underperformance (up 1.6% last year) has led to a degree of existential angst but to a large extent reflects the heavy weighting of miners, oil stocks and financials. A recovery of China and a Shell bid for BP (frequently rumoured) would change the statistics somewhat. Smaller stocks have languished and AIM itself has been woeful- it is not yet clear whether the Mansion House reforms will redirect any meaningful amount of pension money into the market, which badly needs some institutional support: small cap and AIM-specialist funds have seen outflows. The consequence has been exaggerated moves on news as market makers try to avoid trouble, and particularly poor performance of companies with clear needs for further funding, whether or not this is for growth or for shoring up balance sheets. The AIM All Share fell almost 10% last year, AIM technology 17%.

Whether a change of government in the UK will make any difference is unclear. On the positive side there have been no stories about ending the Enterprise Investment Scheme (EIS) though IHT relief must be theoretically vulnerable.  However illogical the IHT relief on unquoted and AIM stocks might be considered, the effect of removing this for AIM would be dramatic and unpalatable. Influential commentators on the left such as Will Hutton have started calling out the illogicality of a regulatory system which has driven the UK’s pension funds to shun the UK equity market. Changing that will take a while.

We do seem to be seeing some green shoots in AIM and some positive share price reactions to news. But there is no obvious reason for there to be a rebound into sunlight uplands. We continue to focus on restricted areas of the market.

• In life sciences- and this applies to medtech as much as biotech- we are finally seeing management teams realise that they need to become self-reliant, and if that means partnering earlier than they might otherwise like and for less cash, that is still a better alternative than coming cap-in-hand back to the equity market.
• In the world of digital transformation, whilst AI is the buzzword, for small companies it is more a question of finding applications for proprietary datasets and using machine learning to improve process efficiencies, whether of human or of mechanical processes. Central government agencies are major spenders on digitisation but their budgets are under pressure and projects can easily be pushed back.
• Decarbonisation continues to be an important theme, and given 2023’s evidence of climate change, interest and investment in this area is not going away. Small companies with emerging technologies can struggle both to overcome engineering challenges and to find routes to market- we are attracted to those with strong partnerships and sponsors. Not all superior technologies make it to market alas.
• And in consumer health we continue to look for companies that have identified clear needs and defined routes to market.

We have seen some evidence of consolidation in AIM as elsewhere, much of it in-industry deals, often backed by private equity but rarely pure PE transactions. The private equity industry is still readjusting to the repricing of debt round the world, and the difficulty of making lucrative exits into public markets- perhaps the institutions have worked out that the bones have often been picked clean by the time the offering comes. As a result, quoted PE vehicles have been trading on perhaps unjustifiably large discounts.

Lastly- in a market ultimately led by the USA, which is intensely inward-looking and arguably becoming more so, it is easy to think that what is going on elsewhere does not matter too much, and that markets are all about economic indicators. Geopolitics matters too. The extended Middle East conflicts- Gaza/Yemen/West Bank/ Lebanon – have the potential at the very least to disrupt the energy markets. Chinese ambitions to seize Taiwan are not going away and arguably look to the day when the US is too self-absorbed to care, but the knock-on effects would be very significant. A Russian victory in the Ukraine – even a ceasefire on current lines – will give the message to Putin that aggression can work, and the temptation to test NATO in the Baltic States at some time in the not too distant future. Volatility on the US VIX measure is more or less at a five-year low – intuitively that does not seem to make sense within the wider context….

Conclusion

LGB continues to believe that laddered portfolios of bonds, ranging from gilts and T-Bills to MTNs, are an appropriate way to invest for income. Whereas until recently the rates offered on government-backed debt were negligible, they now offer greater potential. We continue to scan the AIM market for interesting longer-term opportunities, conscious that investors need to assume that they will get more than one bite of the investing cherry, so not to overcommit at the first opportunity, and that not all companies will succeed- but that at least EIS and related reliefs provide a degree of protection. We feel ETFs and Index Funds are the most appropriate ways of gaining exposure to major markets. Investment Trusts and other closed-end funds can be useful for gaining exposure to specific niche areas- and at the moment many are trading at very large discounts to their underlying asset value, a recurring problem for the sector, but also potentially an opportunity as discounts are closed.

Wherever you do invest we wish you all the best for 2024.

We are pleased to announce the establishment of a £20 million secured medium term note (“MTN”) programme for specialist property lender Lendco Limited (“Lendco”).

Lendco provides lending to experienced property professionals through buy-to-let (“BTL”) and bridging mortgages. The company was established in 2018 and is backed by private equity firm Cabot Square Capital and is led by a highly experienced management team.

Lendco’s “can-do” approach to lending and manual underwriting approach allows it to underwrite risks that larger lenders with scorecard criteria are not able to. It has originated over £1.3bn of mortgages since inception and never experienced a capital loss due to its robust credit policy and underwriting expertise.

The programme will provide Holdco-debt style funding to Lendco, allowing it to leverage the significant value it has generated in its public securitisation programme and continue its strong growth trajectory.

Adrian Scragg, Director of Treasury, Capital Markets and ESG, ‎Lendco Limited, said: “This programme represents another strategic milestone for the business. We’re really pleased to have launched the MTN Programme and successfully navigated our first issuance under the programme. We really appreciate the support LGB gave us in the run-up to launching the programme and we look forward to working together in the future as we establish ourselves as a programmatic issuer.”

Fergus Rendall, Director, LGB Capital Markets, said: “It has been a pleasure to work with Lendco to establish its £20m MTN programme. LGB and our investor base have been impressed with Lendco’s robust business model and the calibre of its management team. The programme has further expanded our presence in the specialist property lending space. We expect Lendco to become a programmatic issuer of notes going forward.”

Lendco’s new programme now brings the total value of programmes arranged by LGB to £395 million. More information on our MTN programmes can be found here.

LGB’s Market Commentary for Q3 2023.

Fixed Income.

Bonds Back in Fashion.

Over the last year there has been a slow reawakening of interest from private investors and wealth managers in investing in bonds – though most UK wealth managers have painfully little expertise to offer, and even the major investment platforms are having to rediscover how to deal in these instruments. The instinct is of course to push investors into funds, but in the UK bond funds come with the significant disadvantage of not offering the capital gains tax exemption that can be available through investing in qualifying corporate bonds (QCBs) trading at a discount to their redemption price – which is most of those issued since the global financial crisis. In addition, the damage done to bond prices by rising yields and therefore to the performances of bond funds, which usually have durations of around 5 years, has obviously discouraged those whose wealth managers persuaded them that long debt was part of a diversified portfolio. The Financial Times (FT) last weekend reported UK retail outflow from debt funds (£356m in August) as well as a small net inflow (£29m) in money market funds.

In the US the response to uncertainty has been the emergence of what has been dubbed the “T-bill and Chill” strategy. The FT reported Jeffrey Gundlach, a US bond investor as saying that as well as being able to get over 5.5% in (US) T-bills “You can get 9% in bank loans. You can get 7.5% from floating-rate triple-A assets”. The emergence of retail trading platforms such as ‘Public’ has accelerated inflows into money market funds, which amount to $880Bn this year, bringing the total value of these funds to $5.7Tn.

Investment Opportunities

The choice of assets in the UK is different and more limited. LGB is able to offer access to the weekly UK T-Bill auctions via its platform with the latest rate indications around 5.40% for 6 months. The minimum investment is £50,000 (subject to other investors enabling us to submit a minimum auction bid of £500,000).  LGB also provides access to investment grade corporate bonds via its platform. Our weekly bond list is available to investors interested in building fixed income portfolios.

For those looking for higher rates, whilst they are not rated or liquid, Medium Term Note (MTN) issues arranged by LGB effectively create a high yield investment category for our clients.  New issues this quarter offer between 9% and 12% depending on the issuer and security arrangements. The LGB Fund, which is invested in a selection of both LGB-originated and other issues offers the advantage of diversification and liquidity. The LGB Fund has delivered consistent returns since 2018 and currently has an implied yield of just under 7%.  The duration of the fund is less than two years.

Looking Ahead

While we have seen a partial return to what those of us with grey hair think of as investing normality, we are back in the world of bond vigilantes. With central banks no longer absorbing apparently endless issues at remarkably low interest rates, the market is back in the driving seat. This has been evidenced by the high level of volatility and the extreme market moves seen so far in this transition period to a higher rates paradigm. One of the lessons of the market’s response to the brief Truss/Kwarteng administration was that you cannot buck the market indefinitely. Are rates now high enough for it to be sensible for investors to invest long term? Historically a 1.5 percentage point yield premium over anticipated inflation might have been thought adequate. Your view on future inflation has to be a key driver as to whether you think a 5% 30-year annuity (i.e. a 30 year Gilt) is a good deal or not. The Fed and the Bank of England both have 2% target rates over time. Critics suggest 3% or 4% is more appropriate. If the Fed gets back down to 2% (or even the Bank of England to 3%) and markets believe they can sustain those levels then there are going to be some huge capital gains on long bonds. If….

(Index linked Gilts and US TIPS, both with their own peculiarities, are a subject for another day. Both failed to protect investors from the surge in inflation over the last two years, as the negative effect of rising yields outweighed the inflation protection effect – if we are indeed near the top of the rate cycle that should cease to be a problem).

A comparison of the yield curves now and a year ago in the US and UK is instructive (source Marketwatch):

The market is offering an additional 100 basis points of yield at the long end as well as 250 basis points at the short end in the USA.

The dynamics of the US market are influenced by the increasing supply glut. With so many developed market governments needing to boost issuance, yields are tending to be forced up across all markets. The US Treasury is issuing more long-term debt – expectations are for it to reduce the amount of its net supply to the market met by T-bills as opposed to bonds from c. 60% to perhaps 15% next year. This may represent more pressure on the middle and longer end of the US bond market.

Slightly different dynamics are at work in the UK, and of course a huge amount of damage was done a year ago. Reversal of quantitative easing is providing supply of bonds as in the USA – in the UK it was put on hold in the wake of the gilts crunch of September 2022, but here too it is very much back in place now.

Equities

In the Doldrums

Equity markets have by and large offered a meagre alternative. Over the third quarter the Nasdaq Composite index dropped 4% and the S&P 3.3%, both apparently as a result of the Fed’s increasingly aggressive rate hiking cycle. YTD the S&P is up 13% and NASDAQ is up 38%.  However, the apparent strong performance of the US market this year is in any event really a function of the strong performance of a small number of very large companies – The Seven big tech stocks, which represent 28% of the market cap of the S&P500. Gains have ranged YTD from 35% (Apple and Microsoft) to over 200% (Nvidia) (the others are Amazon, Alphabet, Tesla and Meta). Equally weighted, the S&P is flat and the NASDAQ is up 18% this year.  This year NASDAQ has just made up for last year’s underperformance against the S&P (minus 33% v minus 19% respectively).  The gravitational pull of the big stocks has dragged investors into ETFs and index funds which are not concerned with concentration risk – more orthodox strategies such as value investing have shown low single-digit returns.

In the UK the FTSE 100, more or less bereft of technology, is flat YTD. The AIM All-Share index has dropped 18% since January.  New issue activity is subdued.

IHT

The AIM market is caught to some extent by the attraction it offered of being a haven to IHT: the press (mostly the Daily Telegraph so far) has run stories suggesting either that the current government will commit to the abolition of inheritance tax entirely, which would render the use of AIM as a shelter pointless, or that an incoming Labour administration would review the various current business reliefs (including agricultural land and private companies) in their entirety. The betting odds would suggest that the return of a Sunak administration is unlikely, and the abandonment of IHT anyway feels like kite-flying. Would a Labour government follow the advice of the IFS and the Office of Tax Simplification or might it nibble away at the edges and duck full-scale reform when it realised the damage that this might do to small company funding? Hard to say. In the meantime, uncertainty is not good for markets.

M&A

So far bids have not started to bolster valuations. The supposed “dry powder” held by private equity firms has proved a little damp as higher interest rates have constrained them from gearing up to make acquisitions. Plus, their discounting assumptions will have changed, so deals have largely been in-market.

Brokers Cavendish recently published an interesting piece on acquisitions in the tech sector on AIM since 2017 (51 companies taken out, of which ten this year, for a total value of £23.3bn). They noted that takeout valuations have fallen relative to deals done pre-pandemic, even though the margins of the businesses were not materially down. Despite the general assumption that the cheap UK market was attracting foreign buyers, UK and US buyers were paying similar valuations. They see software companies as being the most popular areas for buyers. In our universe there have been two small cybersecurity companies taken out (ECSC and Osirium) and one delisting (the telco services company Pelatro).

In the life science area the only take-out in our group has been of Yourgene, bought by the cash-rich Novacyt. There have however been some acquisitions of larger life science companies – notably Dechra Pharmaceuticals, for £4.5bn in the first half of the year. The challenge for small drug development companies is to get large companies to take their products seriously, and to derisk them so that a buyer can deliver growth rather than have to invest more.

There has been – rightly – more focus on companies’ needs for further financing. Many companies will have come to AIM assuming, or having been told by their advisors, that delivering on plans and good news would lead to ever rising share prices and easy access to more equity when needed. That certainly is not the case at the moment. Companies with limited cash runways are being priced down on the basis that they will have no choice but to accept low and dilutive issues when they do have to come to the market. We are seeing managements cutting costs, cutting developments plans, and selling off the rights to non-core projects, and no doubt more of all these will come. Small and particularly pre-revenue companies do not always succeed in delivering. On the other hand, providing finance at low valuations and particularly being there at the last time a company needs to raise equity (or before it is taken over) can be rewarding.

In Conclusion

An overall repricing of the AIM market awaits some new sources of demand. It would be nice to think that the various discussions taking place around encouraging pension fund managers to invest in less-liquid areas of the market will bear fruit, but this is a hope for the medium term not the short term. In the shorter term our sense is that in-market consolidation is more likely to be the route to any repricing. But we have no reason to think it is arriving soon. Holders of AIM shares should be clearsighted about their holdings future cash requirements and not overcommit.  On the other hand there are going to be bargains when companies are forced to raise money and have to raise it cheaply.

In this context, we continue to encourage our investors to build laddered portfolios of fixed income that provide regular income that can either be reinvested for the future or drawn down as income. This approach is highly cash generative and flexible in managing this very uncertain market environment. In addition to helping achieve one’s changing financial needs over time, it also provides a strong base from which other riskier equity opportunities can be considered.

We are pleased to announce the establishment of a £15 million secured medium term note (“MTN”) programme for specialist property lender Roma Finance (“Roma”).

Roma focuses on providing lending for property bridging, development, and buy-to-let loans in the UK for property and construction professionals. The company was established in 2010 by its existing management team following extensive careers in the property lending sector.

Roma’s approach to lending is fast, flexible, simple and trusted. These are pillars for the Company’s approach to business and its personal service, speed of delivery and commercial mindset. The company has continually invested in its operational platforms and systems to ensure its loan process is as fast and simple as possible whilst maintaining robust levels of underwriting.

LGB Capital Markets completed its first issue of notes in conjunction with the establishment of the MTN programme in July. The programme will provide funding subordinated to Roma’s senior funders to enable the company to further expand its own book and continue its strong growth trajectory. It is expected that the funding will enable the company to grow its loan book to around £200m by May 2024.

Scott Marshall, Managing Director, ‎Roma Finance, said: “We are delighted to be working with LGB as we continue to grow our loan book, develop innovative market-leading products, support UK property entrepreneurs and invest in both new technology and talented people. LGB is a like-minded and refreshing organisation to partner with which has added value to our business and we look forward to a strong long-term working relationship. ”

Fergus Rendall, Director, LGB Capital Markets, said: “We are pleased to have established this £15m programme for Roma, which is a profitable, growing business with an exceptional track record. Investors were impressed by the experience of Roma’s management team and the company’s robust processes and prudent approach to credit underwriting, and we look forward to engaging with new investors through regular note issuance.”

Roma’s new programme now brings the total value of programmes arranged by LGB to £375 million.

More information on our MTN programmes can be found here.

Q2 2023 Market Commentary

Ivan Sedgwick

Overview

We thought it might be interesting to address three current topics: structural issues in the equity markets, housing and artificial intelligence. But first let us take a look at the performance of the main equity markets year to date:

The above table shows the YTD (to 30 June) and Q2 performances of some of the major market indices (source JP Morgan). It is very clear from this table that the UK is lagging and we would suggest that part of the reason for this lag is currency. Part is the lack of institutional interest. Part is political insecurity. Part is a sense that the Bank of England has lost the plot and that inflation is now set in for the duration – though even the inflation bears have not so far found a way consistently to beat it. Inflation bears were arguing that the commodities focus of the UK would be helpful but in fact this has not worked as a hedge (see also the performance of the Australian market).

UK Market – Structural Issues

With regards to the lack of institutional interest – there are currently a plethora of studies on the UK listing regime and on other aspects of regulation, in an attempt to find a magic wand to wave to restore activity to the UK market. They largely miss the point. Listing in the US is harder and more expensive than here. The differentiating factor is the availability of large pools of capital. The UK has systematically discouraged pension funds from investing in private and illiquid assets, and in domestic equities. There were good reasons for the first (assorted pension fund scandals) and less good for the second (EU rules preventing the favouring of domestic investment). This has extended to private investment where tax breaks are extended to investment in overseas assets (ISAs – the old PEPs at one stage were UK-only). Indeed there is no shortage of EIS qualifying companies with a trivial presence in the UK. The net result was and continues to be to drive pension funds into investing in gilts however low the return. This is convenient for the Treasury but lamentable for the economy. The opposition’s one suggestion so far – pooled pension funds – has now been seized by the government, and in any event does not seem that significant. Until the problem is cracked, no amount of tinkering with listing rules, dual share classes etc. will make a difference. Kate Bingham’s recent Times article (paywall) nailed the problem in an article bemoaning lack of UK investment in her sector:

“Two decades ago more than 50 per cent of British pension assets were invested in UK-listed equities and yielded a return of 9 to 10 per cent per annum, according to the institute’s research. Now, that figure has fallen to just 4 per cent invested in UK-listed equities, with a far greater proportion invested in government bonds instead with average actual returns of 3 per cent over the last ten years. Last year the Bank of England even had to bail out pension funds that had heavily invested in gilts. A lose-lose-lose situation for pensioners, businesses and taxpayers”.

Here it is in graphical format:

Chancellor Jeremy Hunt’s Mansion House speech appears to have taken some of this on board, but his commitment to persuading pension fund managers to commit 5% of funds (which funds is unclear) to unlisted equities raises questions about quantum, timing and for investors in AIM, whether unlisted includes the AIM market. Technically it does – a quotation on AIM is not, under UK regulation, a listing – but whether that is what the Chancellor intended we do not yet know. Clearly it would be a welcome development for LGB investors if it did. Hopefully we shall see more detail over the summer, and none of this feels likely to be reversed by a future Labour administration. We do not think a new administration will be tempted to tinker with the Enterprise Investment Scheme (EIS), but the AIM  business relief inheritance tax exemption.

Meanwhile in AIM we see a slow but steady disappearance of companies we have watched, whether to industry consolidation (Yourgene, ECSC), or the USA (Spectral MD) though not in any number to private equity. Companies are running increasingly tight ships, painfully aware of the difficulty of raising fresh equity, cutting costs and non-core R&D, and extending cash runways. Our own investors are showing an increasing interest in the Gilts, Sterling treasury bill market and high-grade corporate bond markets, taking advantage of the rate rises, the tax breaks on bonds trading at discounts, and trying to mitigate against the effect of inflation. After years in which these assets offered negligible yields, they are now a useful counterpart to the relatively short-dated debt accessible through LGB’s MTN programmes.  

Housing

We have been taking a particular interest in the housing market having recently established an MTN programme for Roma Finance, a specialist property lender with an impressive track record and management team. The housing market is something on which everyone has an opinion, usually formed through the prism of their own situation, experience and aspirations. So for example journalists tend to be negative, often focussing on one metric (the house price to income relationship, usually) which reflects both the imperatives of writing a press article (keeping it simple) and perhaps also the long-term erosion in journalists’ pay over the last few decades (which may bring us on to AI – of which more below). It is intuitively obvious that house prices cannot be the outcome of a single variable. Indeed the price/income relationship was only a useful guide for a relatively short period starting some time after WW2. House prices are the outcome of – on the demand side income; the incidence of income tax; the increasing proportion of households with more than one earner; tax on property; land prices (itself driven by planning restrictions and property taxes); the tax treatment of interest payments; trends in household size; life expectancy; net emigration (up to the 1970s) or immigration; and on the supply side state intervention in housing provision (and destruction – the 1950s housebuilding boom was accompanied by mass slum clearance); the availability of capital and land for house builders. Other variables include changes in working patterns and regional shifts in employment (there is no shortage of affordable housing in East Lancashire or West Cumberland); and of course there are within this expectational effects and feedback loops.

There are of course a plethora of models. The OBR’s 2014 model which was informed by data back to the late 1960s and therefore included the sharp fall in prices in the early ‘90s and showed a reasonable fit for the period from 1980, presumably informed government policy to at least some extent. The Bank of England has generated various models, including this one, a model that shows “the rise in house prices relative to incomes between 1985 and 2018 can be more than accounted for by the substantial decline in the real risk‑free interest rate observed over the period….changes in the risk‑free real rate are a crucial driver of changes in house prices — the model predicts that a 1% sustained increase in index‑linked gilt yields could ultimately (i.e. in the long run) result in a fall in real house prices of just under 20%”. On which basis the swing in real yields evident in the Index Linked Market over the last 18 months will certainly doom the market. Perhaps we should be relieved the Bank’s forecasting record is so lamentable.

Oxford Economics published a useful paper in 2016 with a pleasingly sophisticated model looking not just at the usual inputs, but also disaggregating renting and owning, and focussing on the first time buyer (FTB) as the marginal player:

It also tried to allow for the feedback loops (using Structural Equation Modelling) between the direct and indirect effects of different factors. The conclusions for house prices were:

• a one percent increase in real rent raises prices by 1.03 percent;
• a one percent increase in housing stock or one percent fall in household numbers lowers prices by 1.78 percent;
• a one percent increase in real earnings per household raises prices by 2.2 percent in total—partly directly and through its effect on rent;
• a one percent increase in the mortgage interest rate lowers prices by 0.19 percent; and
• one percent more mortgage lending than expected increases prices by 0.09 percent.

Interesting that upward pressure on rentals raises prices, whereas the increase in the mortgage rate has a rather subdued effect. But of course this is only one model.

The point of this is not to try to find the best model, which would be a protracted exercise and one for which I have neither the time, energy or expertise, but to try to formulate a way to conceptualise what is going on. It is a City truism that “the trend is your friend”, as it is corollary..”till the end of the trend…”.Trends tend to continue till something important changes – waiting for mean reversion can be an awfully long wait, and whilst it is happening the mean converges on the trend rather than being a constant. However, something important has changed – the trajectory of interest rates. Is that enough to derail the housing market or is it different this time? Whilst I may not be an econometrician I am at least a sometime economic historian. Let’s look at the recent past (back to the mid ‘70s):

(I presume the scowling face in the top right hand corner is that of someone expecting to see a clear inverse relationship. And failing).

We have had two sharp falls in the housing market in recent times: the sharp 2007/8 fall in prices of roughly 25% triggered by the Global Financial Crisis, which was accompanied by a sharp fall in rates, and the similar percentage fall in the early ‘90s, (roughly from summer ’89 to early 1993) which was triggered by very high interest rates – as well as a recession. But looking back it certainly does not look as if interest rates are the sole or even a consistent driver.

Thinking about what is going on in the UK at the moment, we have continued upward pressure on household formation driven by strong net immigration (and bolt-hole purchasing, e.g. from Hong Kong), as well as the secular trends towards smaller households. We have a constipated planning system and no sign of a material increase in the supply of new housing (and no reason to think that an incoming Starmer administration could change this quickly). We have dislocation in the rental market which is driving rents up. Existing home owners will in some cases be forced to sell due to higher rates, but many are older, debt free, and benefitting from index-linked pensions and higher nominal returns on savings (incidentally the Bank of Mum and Dad will be doing as well as other banks in the current environment). High frictional costs of moving discourage downsizing. On the other hand interest rates are certainly hurting (particularly first time and recent buyers), and inflation is eroding real incomes. Plus expectations for capital gains must already have evaporated. The brakes are on but we are not yet in reverse gear. Anecdotally we are hearing that the London property market is quite active, a reflection of pent-up demand and potential buyers having savings, and managing to negotiate discounts. So an adjustment down but not a downtrend.

It is certainly possible to see how the housing market could be much more seriously dislocated. UK property tax is remarkably low by global standards, and houses are a non-portable target for Chancellors looking for new sources of income (though not to the extent of endangering banks’ balance sheets – and so far a major change in domestic property taxation seems to be more something for Labour think-tanks than mainstream policy). A recession affecting employment would feed through to real incomes, as does sustained inflation. The banks may have already started restricting credit. From a credit point of view a few years of inflation may be no bad thing: the real price of housing can fall with the nominal price not moving, but the debts are not inflation-linked and this does not trigger defaults. Dislocation can create opportunity: certainly the management of Roma see their borrowers as having many profitable opportunities – but at the same time are ensuring that their credit exposure is to the borrower’s assets in the round, not to single projects.

In conclusion – you pays your money and you takes your choice. It does not feel to me like we are on the edge of a precipice. But there is certainly some slippage. Hopefully these are not famous last words!

Artificial Intelligence

I had a go at getting Chat GPT and BARD, Google’s version, to write this report for me. I have to say I was pretty unimpressed. Maybe you would have thought otherwise. Indeed so far my limited dealings with AI engines have not impressed me that much, but it is clear that they are improving quickly, will get better and presumably produce less anodyne (and maybe more factual) responses. AI as trumpeted by companies claiming to use it is in many (most) cases really just machine learning – which is not particularly new. I asked ChatGPT to explain the difference and to be fair it did quite a good job (of regurgitating Wikipedia, I suspect…) – the concluding paragraph was “In summary, AI encompasses machine learning but goes beyond it by incorporating additional components such as reasoning, decision-making, knowledge representation, adaptability, and autonomy. AI systems aim to simulate human-like intelligence and perform complex tasks that require understanding, context, and a broader range of capabilities”.

We have had AI-related excitement before. There was a rash of AI-enabled drug discovery companies listed a couple of years ago. Here is one, the UK-based, Nasdaq-listed Exscientia. So far it would be fair to say it has not delivered.

Renalytix, a diagnostics company listed on AIM as Renalytix AI, dropped the AI when it re-listed on Nasdaq, the CEO conceding that really what they did was machine learning. The wheel has turned quickly – Spectral MD which is moving to Nasdaq in a SPAC deal is going to appear there as Spectral AI. Undoubtedly though the application of AI to diagnostics and to drug discovery will be transformative over time. And the effective use of machine learning in itself is not to be sniffed at.

So – what to do? There is clearly going to be a huge buzz around this and many companies will claim that they have the secret sauce. Applications as well as healthcare will include gaming, finance, robotics (autonomous vehicles that work?), entertainment and no doubt many more. Claims will run ahead of delivery in many cases. The theme is not correlated with the wider economy, and promoters will suggest it offers exponential returns.

One interesting angle is to consider who can supply something to feed these LLMs (Large Language Models) with something to differentiate the responses. The LLMs are trained by their owners (Microsoft, Google etc) on the internet as a whole as well as on their own data. They are therefore looking more or less at the same thing. Companies that own proprietary information in quantity may therefore be in a position to monetise it. Unsurprisingly, Bloomberg (which has quite a clunky interface, still recognisable from its early days) is already boasting of its capability (e..g “Using AI to sort through market-moving news”) with its BloombergGPT. Scientific and academic journals, which largely sit behind paywalls, may become more valuable and publishers such as RELX (the old Reed Elsevier) may benefit. Thomson Reuters like Bloomberg has a huge bank of data. And more specialist data curators (such as AIM-listed Global Data plc) may find new ways to monetise their products.

The LLMs demand bigger and faster chips, and this will create incremental demand for integrated circuit (IC) design houses – the one UK-listed company is Sondrel PLC. The challenge here is to bring AI out of the cloud and into users own devices or networks (so-called Edge computing), which could create huge incremental demand.

Thinking back to the TMT boom of the beginning of the century, there were many rash claims and many absurd valuations. A lot of money was made (early on) and lost (later). However, we can now look back at the graveyard of false hopes and of businesses that failed to transform, faced with the internet – anyone remember Yellow Pages? There were in the end more losers than winners, and the winners won very big indeed. Schumpeter’s theory of Creative Destruction is worth keeping in mind!

LGB Capital Markets has arranged an increase to the Medium Term Note programme of Simply Asset Finance to £65 million from £39 million.

Simply Asset Finance is a top 50 UK asset finance provider with a well distributed customer base across the UK and diversified asset classes. It offers finance products as a secured lender to SMEs to fund the purchase of business-critical equipment and to free up working capital. Simply has been recognised as one of the fastest growing companies in Europe by the Financial Times, making the top 50 from a total of 1,000 companies.

LGB first established Simply’s £20 million MTN programme in March 2020. The programme allows Simply to access funding from a diversified network of private investors managed by LGB Investments. It is subordinated to senior funders and contributes towards book growth by partially funding new business while reducing the company’s blended cost of capital.

With £35 million of notes having been successfully issued under the programme – and Simply having delivered a record performance in FY22 – the company’s management was keen to ensure it had additional capacity under the programme to facilitate growth and utilise its flexibility. The programme increase was completed in May 2023 following strong support from existing noteholders.

Stefan Wolvaardt, Chief Financial Officer of Simply Asset Finance, commented:

“The increase in the programme from LGB comes at a crucial moment of Simply’s growth. Over the past year we’ve celebrated some significant milestones, including £1bn lent since the business’ inception, and a successful FY22 which saw our loan book increase by 36% year on year. The funding increase will help us to continue growing and support even more UK businesses. The team at LGB are a pleasure to work with and we look forward to continuing our strong relationship.”

Fergus Rendall, Director, LGB Capital Markets, commented:

“The continued success of the programme has highlighted the strength of the investment proposition, particularly the quality of Simply’s management team and shareholders, and the attractive terms available to institutional and sophisticated private investors. We look forward to working with Simply and providing an important source of capital as it continues to grow.”

More about the LGB MTN Programmes here.

More about Simply Asset Finance here.

SRT Marine Systems plc Press Release: £20m Increase to Medium Term Note Programme Capacity

May 2023

SRT Marine Systems plc (‘SRT’), a global provider of maritime domain awareness systems and technologies for security, safety and environmental protection is pleased to advise that it has secured a £20 million increase in capacity on its existing SRT Secured Note Programme (the ‘Programme’). This programme is arranged and managed by LGB Capital Markets.

The Programme enables the issue of notes to LGB’s private investors with varying terms and provides SRT with a flexible source of working capital. The increased headroom provides working capital flexibility in anticipation of some significant new system contracts in the future which have initial working capital requirements during their first few months to fund equipment purchases prior to first deliveries and subsequent receipt of customer payments. Notes currently outstanding via the Programme stands at £7.7m and the increase in capacity does not increase SRT’s debt outstanding. However, it will enable SRT to issue new notes and refinance existing notes in future.

Simon Tucker, CEO of SRT Marine Systems, commented:

“The note programme is an excellent flexible source of working capital for our business. With several pending new contracts, one of which is very significant and subject to a recent LoI, we felt it prudent to take early steps to secure a proven route for the initial working capital requirements.”

LINK to original press release

Sir Win Bischoff 1941 – 2023

Andrew Boyle

My colleagues and I were saddened to read of the death of Sir Win Bischoff on 25^th April. He was an inspiration to the founders of LGB when they worked at Schroders. He also supported the development of our company by becoming a shareholder when we raised capital in 2013.

Here is a link to his obituary in the Daily Telegraph. It correctly emphasises his status as a relationship banker. This appeared to come naturally but probably took considerable effort to achieve. He was an outsider in the City when he became Schroders’ Group CEO at a relatively young age. His secretary told me that she had to cajole the great and the good to accept his invitations to lunch and dinner. In later years he would spread his arms along a meeting room sofa and give people he met an insight into the world of international finance. He was impressive. I am sure his presence inflated the price Citigroup paid for Schroders’ investment bank in 2000. This was around 45 times Schroders’ market cap in 1980. What an extraordinary period it was.

My first encounter with Sir Win in 1986 was a disaster. I had to coordinate a meeting with a Japanese company whose chairman was in London for the closing ceremony of a bond issue. I sent a memo with the briefest of details. Sir Win was furious when he arrived and the meeting was terrible. He didn’t know who the clients were. Afterwards, my director was called to his office to be admonished severely. He passed this on to me. As a consequence my meetings notes became the most diligent in Schroders and I arranged many successful meetings for him during my ten years in Japan in the 1990s. After one meeting at a Japanese life insurance company, I received a call the same day with a mandate to arrange a $100m medium term note private placement. I followed Sir Win to Citigroup but I was definitely not one of the 18 colleagues mentioned in the obituary. Still being in Tokyo, I literally had to sing for my supper. I was pleased to make it back to Citigroup in Canary Wharf and observe him in what looked like a sinecure. What happened after I left to establish LGB in 2005 was bewildering for everyone. I admired his stamina throughout the chaos.

My colleagues and I are pleased to have been associated with him and hope that putting the client first is also the core component of LGB’s DNA.