Why pensions are not so ‘boring’ after all
In recent years, the UK equity market has been plagued with low valuations and uncertainty due to faltering attitudes on interest rates and inflation. But Gresham House’s Ken Wotton has identified one area of the market where demand does not seem to be waning anytime soon: pensions.
Wotton, who manages the Strategic Equity Capital trust, is so confident in the concept that top holding XPS Pensions accounts for over 20% of its portfolio. In total, the trust has just 15-25 holdings and as at the end of 2023, over 80% of its net asset value was within its top 10.
Wotton said he trusts XPS Pensions with such a large holding because, despite the subject matter sounding “a little boring”, the three-pronged approach of the business across investment advice, actuarial tax and regulatory advice, and administration gives the company a variety of opportunities.
One of the benefits Wotton sees in investing into pension schemes is the ongoing need for the sector, as an abundance of clients and changing regulation keeps the business relevant.
“It has multiple decades of activity, even though defined benefit schemes tend not to be open to new members these days. There are still lots of assets, members and pensioners that need to be serviced for the next multiple decades,” Wotton said.
“And there’s a regulation re-driver behind all the activity. If you’re a trustee in a pension scheme, there are various regulatory obligations, and you need someone to give you your valuations, pensions and assets; and you need to be able to take advice on changes to regulation.”
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Wotton references the Guaranteed Minimum Pension (GMP) equalisation ruled in 2018. Because state pensions used to pay out to men at 65 and women at 60, men and women accumulated their GMPs at different rates, making some GMPs unequal. While the 2018 ruling set in place an equalisation of these pensions, the schemes now must determine how to equalise them. For situations like this, Wotton said, XPS comes in handy.
“(XPS has) nicely protected markets, it’s not cyclical and it does have regulatory tailwinds to it which we believe can underpin growth for the next few years, even though the economy might be ebbing and flowing. This sector is quite insulated,” Wotton said.
Though Wotton recognises there are multinational players in this space, he calls XPS the “leading tier-two player”. “XPS is the largest of the next tier, and they’re taking market share. They’re winning industry awards, doing a good job operationally and, importantly in the current environment, they have contracts which are index-linked.”
Wotton explained the company is also protected from changes in inflation due to contractual price increases linked with inflation.
For companies like XPS and across UK small caps, Wotton recognises the importance of paying attention to private markets as well as public ones, especially as private equity brings bids to the space.
“It’s really clear at the moment that there’s a big gap between the multiples that public, strictly small-cap companies are trading on in the UK, and the prices that private equity or corporate buyers are prepared to pay for that whole business. We do that benchmarking, and that gap buyers can see when they look at public companies is about as wide as I can remember it being in the 17 years I’ve been doing this.”
Chikara’s Aston spots an exciting dynamic in Japan
With Japan’s ageing demographic creating an increasingly tight labour market, Chikara Japan Growth & Income manager Richard Aston is seeking opportunities in companies that offer potential solutions to the shortage.
“There are a large number of companies that are in a strong position to help facilitate job mobility, such as recruitment and outsourcing-related businesses,” he said.
“We are particularly interested in outsourcing companies, such as engineering firm Technopro, and construction businesses.
“These companies are very focused on an important dynamic within the Japanese economy.”
With Japan exiting its era of negative interest rates in March, Aston is also focusing on financials set to benefit from policy initiatives in the region.
While the market benefits of Japan’s corporate governance reforms have been well documented, a push from the government is also underway to improve job mobility and encourage the population to change its monetary habits.
“People have been fearful of the equity and real estate markets. The government is trying to do what it can to encourage that mindset to disappear,” he said.
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While in western markets, investors tend to save to get on the property ladder and invest in equities at a younger age, Aston said the opposite is true in Japan, with household assets typically placed in savings accounts rather than investments.
“We are thinking about the opportunities that creates for financial companies and different swathes of the financial sector that will be potential beneficiaries, alongside the changing interest rate environment.”
At the end of March, the trust had an 11.7% weighting to banks, with names such as Sumitomo Mitsui Financial, SoftBank and Mitsubishi UFJ Financial among the top 10 holdings.
Meanwhile, Aston sees growing geopolitical tension between the US and China as a macroeconomic driver for the Japanese economy.
“There are some notable new production facilities being established in Japan, reversing the trend of the past 30 years. Companies like TSMC, Samsung, Western Digital, IBM and Micron are all establishing production facilities in Japan because of concerns around the supply chain.
“On top of that, I think Japan is also seeing this as an opportunity to regain competitiveness and create national champions. Rather than having a lot of smaller companies with small market shares, there is evidence that points to companies consolidating to ensure Japan can maintain strength and leadership in a number of areas, and semiconductor-related sectors in particular.
“That’s an exciting dynamic, certainly for someone like me, who’s covered Japan for quite a period of time where the momentum has definitely been in the opposite direction.”
RTW is following the science
Following its recent acquisition of venture capital firm Arix Bioscience, the $500m (£399.8m) RTW Biotech Opportunities investment trust has sold the public positions of its new purchase and reinvested the proceeds into its portfolio.
While fund manager Rod Wong reinvested the $128m extra cash received into companies such as BioAge Labs, Obsidian Therapeutics and Mirador Therapeutics, the performance of major holding Avidity Biosciences has caught the eye.
The Nasdaq-listed stock’s share price has risen 181% for the year to date (as of 1 May), though it is still down almost 10% from the IPO price. In the space of two months between the end of January and March, RTW’s position in Avidity Biosciences has grown from 1.9% to become the largest name in the portfolio at 12.7%.
Avidity is a late-stage RNA (ribonucleic acid) therapy company, which is developing treatments for several forms of muscular dystrophy. While it floated in the US in 2020, RTW invested in the company before it turned public. “Avidity has a proprietary platform that delivers RNA molecules into muscular tissue, the first of its kind to be able to do that. It has three assets in clinical development, focused on three different types of muscular dystrophy,” says Woody Stileman, RTW Biotech Opportunities’ managing director.
“It has multiple de-risking events in 2024. It has two shots on goal for blockbuster potential therapies for two of those diseases, and one of those has already happened.
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“In March, Avidity announced positive long-term data for its DN1 (myotonic dystrophy one) across multiple endpoints. DN1 is a progressive, muscular disease currently with no approved therapy. There are 40,000 people that suffer from DN1 in the US alone, and the phase-two data provided clear proof of concept.
“We think the odds of them succeeding in their phase-three trials are very good. They’ve got plenty of cash to see through their clinical development programme, and actually raised capital just the other day after the data,” says Stileman. “We’re a significant shareholder in it and initiated our investment in the private markets.”
RTW Biotech Opportunities currently trades at a 33% discount, according to the Association of Investment Companies.
The trust is also optimistic on the prospects for M&A deals in the biotech sector going forward, according to Stileman, despite being underwhelmed with the number of deals in Q1. “For the first quarter, we were slightly disappointed from an M&A perspective. That’s because last year was so exciting. Last year was the second best-ever year for M&A in our sector with roughly $140bn of deals done. And if we look at the deals that were over $1bn, the average premium paid by large pharma companies for those assets was over 70%.
“It’s being driven mostly by the loss of exclusivity – or patent cliffs – that these large pharma companies are going to face from 2025 onwards. They need to fill those revenue holes – and the only way they’re going to do that is through acquisition.”
This article originally appeared in the May issue of Portfolio Adviser magazine
