Discretionary global macro
The investment objective of the Fund is to achieve capital appreciation, while limiting risk of loss, by investing globally long and short mainly in quoted securities, government bonds and currencies, but also in commodities and other derivative instruments.
Performance attribution summary
- In another challenging month for global equity markets, the Fund generated a positive return of +0.6%, bringing the year-to-date performance to +10.6%.
- After a shaky start, European equities surged higher as the deadlock was eventually broken in Greece, returning +3.0% in aggregate for the Fund. Almost all of these gains came from “micro” strategies, with pharma holdings making +1.3% and German property stocks adding a further +0.9%.
- With a deal of sorts seemingly made in Greece, focus switched to China, where the interventions of the authorities proved insufficient to prevent the Shanghai Comp from sinking -14.3%. The Fund gave back -2.5% on Chinese equity positions, reducing the year-to-date contribution from our China strategies to +3.4%.
- A tactical short position in gold was initiated during the month as the commodity’s failure to rally, despite an abundance of potential catalysts, left investors to question gold’s role as “portfolio insurance.” The position has since been closed out, having banked a +0.8% contribution to July P&L.
- Fixed income positions lost -0.6% in aggregate. The biggest single drag came from our short versus Italian BTPs (which formed one side of a cross asset RV, along with a long position in MIB futures). The strategy was however cut from the book early in the month thus preventing a more meaningful loss.
- Elsewhere within fixed income, gains from our eurodollar call spreads were insufficient to offset losses incurred on eurozone inflation swaps and Mexican receivers.
Manager commentary
Sometimes the global macro world can prove fascinating and exotic, with the manager's mind free to roam from the towering nominal rates of South American sovereign bonds to the puzzle of China's growth rate and its policy interventions. But sometimes the best opportunities are found much closer to home.
We think this might prove to be the case with the U.K. house building sector. There are several compelling reasons to be long at present. However let me start first with a health warning. The "experts" that monitor the minutiae of the sector are less convinced and are mostly cautious on the prospect for further stock price outperformance. This grumpiness owes much to the sector's valuation on a price-to-book basis. The present level of around 2x constituted a valid sell signal previously.
However, the good news for investors like us is that the U.K. is building far fewer houses than the growth in new household formations would dictate. It is reckoned that the U.K. needs about a quarter of a million housing starts annually. We are nowhere near that level. And with three decades of the Thatcher policy enabling council tenants to buy their council houses, as well as the present government's austerity program that has capped regional funding, the local authority building sector has almost vanished. Indeed, without exaggeration, housing completions in the U.K. haven't matched household formations in over 25 years; one might legitimately argue that the supply situation augurs well for a lengthier and more profitable cycle.
But it is not just the local authority building sector that has all but disappeared. The hubris of the previous boom-and-bust cycle left some of the major construction players in financial jeopardy and vulnerable to take-over. For one who was indoctrinated into the charms of the sector at an early age it is simply stunning to note that consolidation has removed previous stalwarts such as Beazer, McAlpine, Wilson Connolly, Wimpey and Wilson Bowden. Trust me, there must be many old-timers in the Edinburgh investment community turning in their graves.
So the industry has consolidated at the mass volume producer end. The situation is even starker at the mom and pop segment of the market owing to the severity of the credit contraction from the banking sector in the aftermath of 2008. From 2000 to 2007, small and medium-sized builders delivered about 38,000 houses annually; by 2013 this had fallen to just 14,000. Clearly this is all to the benefit of the surviving larger groups.
Nowhere can this be seen more vividly than in the land bank market where prices have remained remarkably muted despite the rally in house prices in recent years. Typically the land cost represents between 20% and 25% of revenues for these types of businesses. With less aggressive competition for land this time around, and hence less cost inflation, margins are high. Barratt, for example, enjoys EBIT margins of 17%. The bears would contend that this represents peak profitability. Land prices would be expected to rise from greater competition and inevitably with Murphy’s Law this would coincide with interest rate hikes and slower demand which would crimp margins and force the builders to write down some of their land holdings.
Nothing of the sort seems imminent today.
First the deflationary global macro winds seem set to confer the most muted form of interest rate hikes (if any). Second, while the British housing market has rebounded strongly post the crisis, this seems more in terms of price than volumes. Prices may be back to the peak but mortgage approvals are still running at around half the peak level, and some 30% to 40% below the 10-year average preceding the crash. Indeed, transactions would need to rise 20% just to recover to the long-term average. And third, with prevailing low interest rates, mortgages nationwide are more affordable than they have been for most of the last decade. Finally, encouraging home building has very much become a pro-public policy for the British government with the “help-to-buy” scheme that effectively allows people to buy new homes up to a value of £600,000 with just a 5% deposit and an interest-free government loan (for the first five years) having been extended to 2020. The U.K. government, it would seem, is determined to underwrite a longer more profitable housing cycle.
Perhaps we need to fear the pessimism of the experts and that their bearish prognosis will huff and puff and blow our home stocks down from their lofty price to book ratios. However it is no fairy tale when I tell you that our basket of U.K. house builder shares is trading profitably on 12x earnings, yielding 4% and has the capacity to enhance this return with special dividends. Indeed owing to the peculiarities of this enhanced cycle one could possibly contend that this is not the time to be afraid of the big bad wolf.
