Capital Gearing Trust p.l.c (CGT) Earnings Call Transcript & Summary

Good morning, and welcome to the CG Asset Management Q4 quarterly update investor presentation. Througout this recorded meeting, investors will be in listen-only mode. [Operator Instructions] I'd now like to hand you over to Sophia Sednaoui, Head of Investor Relations. Good morning.

Good morning, Paul. Well, thank you all for joining, and Happy New Year. This is, as Paul said, the Q4 webinar from CG Asset Management, I am here with Chris Clothier and Emma Moriarty from the Fund Management team. Firstly, I'm just going to draw your attention to our disclaimer. Now the value of investments can go both up and down and nothing you say this morning should be taken as investment advice. So Chris and Anna are going to talk about what's happened over the past quarter, changes to positioning and as well as outlook that we can expect as we move into 2025. The data we show through the presentation refers to Capital Gearing Trust, but I would like to remind everyone that, of course, we run more than just that fund. So you can see our full fund range here. The views and macro views, et cetera, that expressed through this presentation, obviously, refer to both our multi-asset and fixed income strategies. One last thing before I hand over to Chris and Emma, we are hosting a seminar on index-linked bonds towards the end of this month. Professional investors who either are new to the area or just want to rush up on everything index linked. So if you haven't had an invitation from us and would like one, please do let us know. Now Chris, Emma, over to you.

Thank you very much. Good morning, and happy new year, and I'll get straight into it. So 2024 was not a vintage year. We delivered an NAV total return for the 12 months for Capital Gearing Trust of 2.6%, which was pretty much in line with U.K. CPI. I'm actually going to, sort of, slightly take a view as to the -- as to what happened over the year as a whole rather than over the quarter. And so I guess the big asset allocation changes at a high level was that over the year, holdings of industry bonds fell from 50% to 38%. And commensurately, dry powder rose from 22% to 31% while that looks pretty dramatic, I guess, in reality, maybe it's slightly less dramatic and that a lot of that was a result of short-dated U.K. index-linked bonds rolling off, and we then elected to reinvest those into treasury bills. Our risk assets rose over the course of the year from 26.5% to 31%, reflecting the scale of the opportunities that are going on in the investment trust market, and though we remain cautious for our equity markets, as I think Emma will explain later. So going into detail a bit more as the asset allocation changes. So within the dry powder category, overall, it grows as the investment bonds were reinvested into treasury bills. But also the other key feature was the fall in credit from around 13% to 8% over the course of the year, and that was in response to credit spreads, tightening very dramatically. Coupled with the fact that we were concerned that markets were too optimistic about the path of rate cuts, and therefore, we were trying to keep duration pretty short, and that's favoring treasury bills over anything else. And within our index linked holdings, our TIPS holdings actually rose from 16% to 22% over the year. Though our duration fell from about 10% to about 7%, and that was -- effectively, we were adding to short-dated U.S. TIPS, which we thought were particularly good value over much of the year, both from a yield perspective and from a breakeven perspective, and from a currency perspective. Our equities rose modestly from 14.5% to 16% in our infrastructure from 6.5% to 7%. So what went well and what went badly over the course of the year. Let's start with the things that went badly. So our exposure to the Japanese yen was unhelpful. Our aggregate exposure to Japanese equities and Japanese bonds was about 8% over most of the year. Roughly half of that was in equity half of that in short-dated bonds. And obviously, there or essentially just a pure currency play and the Japanese yen depreciated by about 7.5% against Sterling. So that was a bit of [indiscernible]. The other main drag on performance and perhaps I'll click on was the -- our infrastructure holdings within our risk assets. And these gave a negative return of 7% over the year. And the weighting of them rose modestly over the year from 6.5% to 7% on better values. Now at one level, outperformance relative to the investment trust benchmark of infrastructure holdings was actually pretty good because the index fell by 13%. So we did rather better than that. But clearly, this is an unhelpful drag on fault. While it is obviously frustrating for this to happen because of the fact that our infrastructure holdings have highly structured, quite mechanical cash flows. And we have no reason to believe that the certainty of those cash flows has in any way diminished over the course of the year. And so therefore, if prices fall, that means the prospective returns provided that you still expect those cash flows have risen. And so we do think that these assets offer fantastic prospective returns from here, but clearly frustrating in the year itself. The final area of slight over-performance in our risk assets was that we continue to be overweight energy equities, which unfold global benchmarks. And then I would add to that, that there were probably two -- if those are all sins of commission, we had 2 sins of omission. The first was that we didn't have enough gold and maybe Emma will touch on that later. And we did not own the Magnificent Seven. And we definitely unfortunately, did not own NVIDIA. As I'm sure you've seen, [indiscernible] the contribution to global equity markets, essentially 100% of it came from U.S. equities and within U.S. equity substantially, all of that was from tech over the year. So what did we get right over the year? If we flick on here, you can see that in the year, our investment trust actually slightly underperformed with the Investment Trust Index over the year. But you can see that over the longer term, our outperformance remains quite extensive. Our bond portfolio outperformed sterling aggregate quite materially over the year to plus 2% versus minus 2%, so about a 4% outperformance, which was pleasing and helpful. And our credit portfolio returned 6.5%, which, given that it was a pretty short duration portfolio, that was very pleasing, likewise our jump bonds, in which we don't hold the very large weighting returned over 17%. So that was reasonably helpful. And other than the yen, we actually got essentially all of our other currency calls correct. So we reduced the exposure to the Swedish krona and to the euro earlier in the year, and that was the right thing to do. And we added exposure throughout the years in the U.S. dollar and the U.S. dollar continued to appreciate over the course of the year. And then within the Investment Trust space, we had a number of successes. So for instance, there was some small infrastructure investment trust that performed very well for us. So according to digital infrstructure, Pantheon Infrastructure and in that instance, we built a position in April. We've realized it over Q4. We generated a 30% return. So that was quite pleasing. Flicking on some of our larger positions. BH macro, this is the Breven Howard Master Fund. You can see on the left-hand side is the share price on the right-hand side discount. The bigger circle is the period of time when we were building our position in each case. And the smaller circles -- where we started to trim that position. And you can see that here, we were able to trade a highly volatile discount. We started building a position at around a 12% discount. It went all the way out to an 18% and then we carry on building on good terms over the year. And then as it's narrowed in, we've now started trimming that back. And so I think when I last checked, our IRR on that position was running at 60% the absolute returns are somewhat lower. Flicking on another position that we were able to harvest fully was AVI Global. And again, you can see that we have built that on sort of roughly 12% discount. And there, we had good underlying NAV performance as well as good discount performance, and we were able to exit that. We're really excited by a number of our positions in the Investment Trust sector. As I'm sure you're aware, discounts and Investment Trusts are wide. As you also know, if you follow us, wide discounts are not in and of themselves, things that we find attractive. But rather, we're interested in discounts where we have reason to believe that they will close. And I'll just highlight two of those that we've currently allocated to. And the first is Polar Cap Financials, which is a portfolio of large cap financial services businesses, banks, insurers and so forth. And that is trading today on a little over a 7% discount. And that is a vehicle that has a fixed life, which winds up at the end of June this year. And so provided that the manager delivers roughly the underlying index and need -- we're hopeful that they might do a little better. We will significantly outperform that global portfolio of financial stocks. A similar situation, which we also own in quite large size, is Mobius Investment Trust. This is an emerging market manager with a good track record and a good process. And again, this one offers as the vehicle has a fixed life or an opportunity rather to exit an NAV, which comes up in Q4, and that trades on an 8.5% discount today. And so our expected excess return over its portfolio is of the order of 4% to 5% in absolute terms between now and then. So there continues to be lots to go out in the investment trust market that we're very excited about. And finally, on that note, I'll draw your attention to an activist situation where we are involved. This is PRS REIT. And we have owned this for -- since -- in a large way since COVID. We built our position after -- in the crash after COVID. And we then started building it aggressively over the course of the summer as we and a number of other shareholders became increasingly frustrated with the Board. And obviously, as you can see, the share price has performed incredibly strongly over that period. However, we continue to think that there is real value there. A new Board has been put in place -- or sorry, rather the new blood has come on to the Board. And they -- and the Board has decided to put the entire portfolio up for sale. And the NAV per share is 133p. The share price today is at about 199.5p. So that's still at an 18% discount to the NAV. We think the quality of the assets is incredibly high, just kind of 1 minor data point. The like-for-like rental growth over the last 12 months is 11.5%, which I think gives you -- and that's clearly ahead of kind of wider rent benchmark. So I think that gives some idea of the quality of the portfolio. And as I'm sure you've read in the papers, there's any number of large private equity players are looking to own multifamily rental properties. Also rental properties in general. And these are actually individual houses, which is the asset class within private rented accommodation that seems to be most in favor among private equity. So I guess, also to say -- that we've had some satisfactory results from positions that we've exited. And then we are pregnant with a number of other positions -- which we're pretty excited about. All of which leads us to be reasonably optimistic that our risk assets would to be able to deliver some outperformance over the coming 12 months. And with that, I will stop and hand over to Emma, and she's going to give you, I think, a little bit about our views on the macro and on the outlook.

Fantastic. Thank you, Chris. So yes, I will spend the majority of the time on the macro outlook, speaking about the main 2 economies that our funds are exposed to the U.S. and the U.K. And what the outlook means for our views on the different asset classes and for our asset allocation, particularly across the multi-asset funds. And then I will spend the last few minutes of the outlook -- speaking about one of the issues which has come before after the U.S. election, which has been the relationship between the gold price and the U.S. dollar. And how this has shaped the thinking behind our asset allocation most recently. So beginning with the U.K., the major developments of the outlook for the U.K. economy in Q4 last year was starting to get some more detail on the labor government's economic policy. You'll recall that this was coming in two parts. On one side, a stronger industrial policies supported by more expansionary fiscal policy, and a loosening of the government's fiscal rules. And the second side of that coin is going to be a supply-side reform focused more specifically on the planning sector and on financial services. So far, we've seen the first of those two things, which is encapsulated in the budget. And this is what has characterized our outlook for the U.K. to date. I think a few features to draw out from budget. First is it has increased spending and it has increased taxation. And because it has increased spending by more than taxation, it's also increased government borrowing. There are a few implications of this. The first is obviously the budget deficit and the stock of government debt and GDP in the U.K. will continue to increase. The effect of this thing to keep interest rates higher for longer. The second feature of this, obviously, is that our outlook for inflation in the U.K. is higher than it had been without the budget. This is both as a function of the rate of share of consumption spending in the project being significantly greater than investment, but also specific features of the budget, such as the increase to employers national insurance contributions and the 6.7% increase to the minimum wage, which we expect to be passed through to prices. And the third thing is we expect it to weigh it growth. And the chart which is shown on the slide shows the office for budget responsibility to forecast that essentially over the horizon of the government's term the OBR expects that government spending and government investment will more than crowd out private consumption and private investment. The implications of this for our investment views in our asset allocation is sort of twofold. First, on U.K. interest rates, we expect that the higher deficits will lead to sort of higher for longer interest rates, particularly at the long end of the gilt curve. And as such, despite the fact that values have improved. We expect to keep duration short particularly in our build rate portfolios. The second implication is we are more cautious on our outlook for corporate profits in the U.K. And as such, we have particularly in the last part of the year, taking steps to reduce risk assets, particularly in the U.K. and expect to remain cautious on these assets. So in all of this, where is the opportunity in the U.K., well, one potential source of opportunity is the fact that there is now quite a wide gap between markets expectation of short-term interest rates and policymakers expectations of where they should be -- so, for example, in the U.K., market expectations over the course this year for 2 to 2.5 interest rate cuts. Meanwhile, Andrew Bailey, the Governor of the Bank of England last commented in December potential for 4 interest rate cuts over the year, which is similarly Bloomberg economics expectation. So beyond that, The Bank of England Monetary Policy Committees latest estimates of the neutral interest rate for the U.K. economy. So for when it's not in recession, range between sort of 2% and 3.5% in the terms. So we think that there is a definite potential for upside in U.K. short-term interest rates, which is consistent with what Chris was saying earlier on about a shifting asset allocation over the course of this, which is that particularly in our multi-asset funds. We have continued to emphasize exposure to short-term interest rates, particularly in our dry powder portfolio. Turning to the U.S. while there remains a wide range of uncertainty around the exact detail of the Trump economic plan, the rough contours of it are essentially that it will be low tax for individuals and corporates that it will be expansionary and that it will be protectionist with broad-based tariffs on imports into the U.S. and with a higher proposed rate on imports from China. Think banks in the U.S. have now started to quantify the impact of these policies on the U.S. economy. The summary charts on this slide are from Tax Foundation. I suppose at a high level, what do they expect from this? Well, they expect sort of growth in GDP per capita, they expect growth in the accumulation of capital stock and wages. But they also expect debt to GDP to grow and they expect the share of the U.S. government deficit that goes towards paying interest expense on government debt increase, and that drives the difference between the change in GDP and the change in GNP that you see on the chart. There's one other feature of the Trump economic plan, which is interesting -- which is the distributional impact that it has. And the reason why this is interesting is it exacerbates a trend that we've seen over the course of the monetary policy tightening cycle in the U.S., which is that interest rates have disproportionately impacted the bottom quartile of U.S. households and the Trump economic plan appears to be on course, as expected to continue this trend. I guess the key point from the Trump plan is that in the short term, it likely continues the momentum and economic growth that we have seen to date and the momentum that we've seen across a range of U.S. asset classes including both the S&P 500 and the U.S. dollar. That said, it is important to take note of where relative valuations are at the moment. So if you look at the differential in the sort of real, cyclically adjusted yield on the S&P 500 and the real yield on tenured TIPS. This differential is at the narrowest that it has been for a really long time. And so given this combination of features, growth momentum, stretch valuation in equities and elevated real views on TIPS. We continue, one, to hold the U.S. dollar as our second largest currency exposure in the multi-asset funds, but also we continue to favor TIPS which are about 22% of the multi-asset funds asset allocation at the moment over U.S. equities. The final thing to talk about having gone on to the subject of the U.S. dollar is the U.S. dollar gold price relationship. I think one of the trends that received a lot of attention over the past 12 months was the increase in gold price. And this speculation that this has come as a result of increasing demand in central banks, particularly Eastern block Central Bank that felt they might be at risk of sanctions from the West. However -- and this supported an increase in gold price over the course of last year. However, one thing that happened following the outcome of the U.S. election is that the U.S. dollar started to appreciate quite rapidly. And at the same time, this sort of meant that the gold price lost a bit of support. This one reason for this, which has been sort of proposed in that, essentially, this created an issue for Central banks managing their foreign exchange reserves because if you were in a situation of being an Eastern block Central Bank, part of your reserves essentially need to be allocated to U.S. treasuries. And as the dollar appreciated, these became more expensive to purchase, which left fewer reserves available to purchase gold one additional dynamic, which is now taking place is that in an environment where account administration may be imposing tariffs on a wide range of countries, an option that these countries then have us to devalue the currency in respect of the U.S. dollar. But to be able to do this over a sustained period of time, it also requires them to gradually in a sustained way, have built up U.S. dollar reserves to do that. So as long as U.S. dollar continues to appreciate or continues to sort of trade at these more elevated levels relative to recent times. This will mean that the gold price perhaps sees less support than it has done recently. That said, the geopolitical fundamentals do remain unchanged that we do expect to see this continued demand from central banks for gold. What does that mean for our asset allocation? Well, sort of, as mentioned, we continue to prefer U.S. dollar assets in particular U.S. TIPS. That said, our view, we continue to allocate 1% of gold. This reflects our view that gold has the most value to a portfolio in a tail risk scenario. But in any larger size than that, we believe it creates a volatility to return that isn't consistent with an absolute return on capital preservation mandate for our portfolios. So I will leave the outlook there and hand back to Paul, and then I think we'll do some Q&A.

[Operator Instructions] So far, as you can see, we've had a number of questions come through, and thank you to all the investors who have submitted those. If I may, just hand over to you just to read out the question where appropriate to do so. Direct it to the team, and I'll pick up from you at the end.

Brilliant. Thank you. Well, a good question to start with. 2025 New Year faced with the same old problems, their valuations, narrow markets, politics and geopolitics. Can you provide positives for the year ahead? I don't know which you would like to start with your 2025 positives?

Why don't And you start Emma?

Sure. I guess, I'll start with the U.S. market. I think one thing that is a really positive feature of U.S. valuations. This really on TIPS are now very elevated relative to recent history. And the narrow yield different with the S&P 500 effectively allows investors in these longer-dated TIPS to achieve a real yield, which is very attractive on a risk-adjusted basis. So that's something we're definitely taking advantage of in our portfolio. I mean turning to our home jurisdiction -- think the outlook for -- there are some favorable features on the outlook for short-term interest rates -- where the markets are pricing and higher interest rates, and we think there is -- there are scenarios in which we see more interest rate cut. And so these become a more attractive asset class. I think we're also taking advantage of in our portfolio. And I suppose the more medium-term thing to be potentially optimistic about is that -- in terms of our government current economic plan, we've usually seen the fiscal side of it. We've heard some of the supply side reform prior and things like the [indiscernible] but if we were to get really tractable planning, reform or financial services reform, this is something that could materially change the growth trajectory for this economy and the part of sort of risk assets and U.K. equities and corporate profits. So that would be my start of the...

So first of all, what I would say is that we're doing really badly at CG today. The reason is that outside on Gresham Street, they're taking up the rate. And then underneath me, they're fitting out some new office space. So that strange noise in the background is not my stomach rubbing. It's somebody drilling. Sorry about that. Now, so I think my positive is that Emma, I think I spent my whole life looking for one of these things. And I think you've identified a [indiscernible]. And it's the U.S. dollar. So the pricing of the U.S. dollar goes up and reserve managers are forced to buy even more of it. So kind of something that has been theorized in economics, but I've never actually witnessed in the work seems to be there. No. So my -- this is a slightly silly positive -- which is that. There is the most all mighty CapEx movement going on in the U.S. to build out the infrastructure for AI. Now if you came to our Investor Day, you would have heard that I'm somewhat skeptical the benefits of that AI overstated. But on the other hand, just as we found with the telco boom in late 1990s. And while there was a fairly gross misallocation of capital at the time, it did leave in place some incredibly useful infrastructure, which society has then enjoyed sits. And so perhaps the AI boom will be the same. That's my positive.

Well, thank you both. A cheer way to start. Now we've had a number of questions around the sort of investment trust sector. So I'm going to start with how do you see the infrastructure investments being impacted if we see higher interest rates? And with the increase in risk assets, will this be a trend we can expect to see increase through 2025?

I'll probably take that one. That's a great question. Thank you very much. And I guess, clearly, infrastructure assets are interest rate sensitive and -- but they are also sensitive to other things. And the thing that's been really observed in the investment trust sector is that there has been a total dislocation between the market price of infrastructure assets and the private prices of those infrastructure assets, which in turn is a function of the fact that capital is on average, leaving the investment trust sector. In addition to which we heard anecdotally from a number of brokers that wealth managers were, shall we say, window dressing their portfolios in the run to Christmas and we're essentially wanting to expense anything infrastructure from their client portfolios. And so obviously, what we are trying to predict is the interaction between those two different factors. And so kind of [indiscernible] if interest rates are rising, then yes, NAVs would continue to come under pressure. But I think there's a reasonable chance that the capital flight from the sector is abating, and therefore, the threats of while you could see NAVs ticking down a little bit, you could also see share prices rising and coming to meet those NAVs as essentially as that capital flight unwise.

Perfect. I think probably sensible to go on to the next one, which is around activism in the trust sector around discount. So do you see the portfolio benefiting further from the increased activism we're seeing in trust with wide discounts. Touched on it already somewhat.

Yes. I mean, short answer, yes. we have seen -- obviously, as I'm sure you're aware, [indiscernible] is an activist investor, that has requisition of a number of AGMs for a number of trusts including trust that, I guess, you would say we're kind of highly regarded and where there wasn't perceived to be a corporate governance problem. And so I think in that context, every single Board is going to be looking over their shoulder and saying, if I am going to discount -- or greater than, I don't know, let's say, 10% in there is a risk that they will become the next target of [indiscernible]. So I think that means that also are going to be more active about addressing their discounts and probably more receptive. Now to someone like ourselves, who tends to operate at a slightly more kind of behind the scenes quiet constructive way and perhaps they'll be more receptive to our suggestions given that the alternative is a sort of a slightly more life or death issue with an activist.

Thank you, Chris. Now also on the topic of wide discounts, but specifically in renewable energy. Are the continued wide discounts in Renewable Energy Trust, a reflection of the outlook for U.K. interest rates? Or are there more fundamental issues in that sector?

I think that the issues are, as I have described, which is to say a disconnect between kind of public market investment trust valuation of these assets versus private valuations. There's nothing to suggest if you look at private transactions and the values that are being paid, there's nothing to suggest that these portfolios are mismarked. And indeed, if anything might be marked somewhat conservatively. So I think really, it's what we've seen. And it's probably taken longer to come to an end than we had expected is that whereas for many years, alternative income in all its forms was incredibly popular in the investment trust sector. And then as you have been able to earn 4% after tax on a short duration nominal guilt. People are finding their income elsewhere. And so really, it's that supply/demand mismatch rather than there being fundamental issues.

We've had -- there are lots more questions on the trust sector, but I'm going to ask Emma one. Just to give you a break, Chris. So we've had a question about real yield. So is there a level of real yields that would encourage you to extend bond duration for TIPS and/or index linked gilts?

It's a really good question. I think -- when we look to extend duration, we're sort of looking at two things. One is just sort of value versus recent history. And so obviously, seeing real yields in index in gilts and in TIPS go higher, is encouraging in that respect. But the other thing is obviously direction of travel. So at the moment in the U.K., we've seen real views on the sort of CPI adjusted basis, touching 2% in the sort of longer-term issues. But -- well, two reasons why we're cautious about that. The first is the direction of travel, which is we see budget deficits continuing to increase and without sort of any catalyst -- or the direction of change we can't be comfortable extending duration when we know that these real yields are sort of going to increase, and that will take capital losses before we take capital gains. And the second thing of it is basically just the size of the market. And one thing that we sort of [indiscernible] episode didn't really show about the index in gilt market, particularly in the long-duration -- is that because it is a smaller market -- than the U.S. market, it is quite prone to large yield shifts and yield volatility if there is a loss and investor conference. So that's the U.K. The U.S. is a slightly different consideration. Obviously, there's a very wide funnel of uncertainty around what the Trump economic policy looks like, and question marks around the ability to sort of adjust the deficit back to 3% as the proposed over 3 years. But sort of going against that, when we look at TIPS from the perspective of the sterling-denominated investor. It's both a U.S. rate and inflation exposure is also a U.S. dollar exposure and it's a much larger and more liquid market. So we also look at that in the round in terms of what does that do for a sterling denominated investor portfolio. And there is obviously some negative correlation for a sterling denominated investor having non-duration U.S. TIPS. So the level of real yield that would prompt an extension in the U.S. sanction duration of the U.S. is probably lower that is possibly lower in the U.S. than in the U.K. But at the moment, we still remain extremely cautious given the outlook for the fiscal situation in both economies.