Following the Bank of England’s decision to cut interest rates last week (1 August), attention has turned to the sectors likely to benefit from falling rates.
Since November 2021, the BoE raised interest rates 14 times, culminating at 5.25%. Over that period, the average investment trust discount (excluding 3i) widened from 2% to 18.5% at its widest point.
While industry commentators anticipate a slow journey back from the rate hiking cycle, Peel Hunt analysts have backed infrastructure, private equity, debt and real estate investment trusts as potential beneficiaries as rate rises begin to unwind.
See also: ‘A tentative start’: Bank of England cuts interest rates to 5%
Infrastructure
Listed infrastructure has been one of the worst hit sectors by the introduction of higher interest rates.
However, analysts Anthony Leatham, Markuz Jaffe, and James Carswell said they see “near-term potential” in infrastructure investment trusts, particularly from investors adjusting their income expectations.
Within the renewable energy infrastructure sector, the trio highlighted the £3.3bn Greencoat UK Wind and the £432m Octopus Renewables Infrastructure Trust (ORIT).
ORIT trades at a 26.7% discount, despite the analysts describing its portfolio as robust and the trust offering an 8.1% dividend yield.
Meanwhile, they pointed to Greencoat’s inflation-linked dividend policy, strength of cash flow generation, share buybacks and funding flexibility as reasons for its inclusion as a potential winner.
The trust currently yields 6.9%, based on target dividends for the current financial year, and trades at an 8.2% discount, according to the Association of Investment Companies.
Private equity
Listed private equity trusts have also suffered from the higher rate environment. Between January 2022 and October 2022, the sector average discount (excluding 3i) rose to 44% from 13%.
“This is perhaps unsurprising, given the nervous reaction from listed equity markets, the perceived impact on relatively opaque and infrequent valuations of long-duration, private growth companies, and the implications of a rising cost of debt on leveraged structures,” the analysts said.
However, they added that the outlook is much improved today.
“It feels like there is a disconnect between speculation on impending interest rate cuts at a time when the Private Equity sector average discount is still wide at 25% and the performance of both direct private equity trusts and private equity fund of fund strategies has been more robust than many anticipated.”
The trio highlighted Oakley Capital Investments, which is trading on a 25.6% discount, within the direct private equity sector. The trust focuses on consumer, tech, education and business services across Europe.
Analysts also favour HarbourVest Global Private Equity as their fund-of-funds private equity pick, while flexible investment trusts such as RIT Capital Partners and Caledonia Investments also offer exposure to the sector.
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Private debt
Within private debt, Peel Hunt’s Jaffe, Carswell and Leatham suggested £1.3bn Sequoia Economic Infrastructure Income’s (SEQI) 8.4% yield could be an attractive option.
The trust offers diversified global exposure to infrastructure debt across power, transport and renewables.
“We expect Sequoia to benefit from falling rates as the pull-to-par gets accelerated on fixed-rate loans. Decreasing interest rates also helps to de-risk the portfolio, particularly for borrowers with floating-rate loans.
“SEQI’s yield premium is likely to look even more attractive as risk-free rates normalise. It is also worth noting that SEQI was able to make attractive debt investments at high yields, even when base-rates were low.”
Real estate
Real estate investment trusts should also receive a welcome boost, with Jaffe, Carswell and Leatham suggesting London-centric Shaftesbury Capital could be well positioned to benefit from falling rates.
Over the last year, the REIT has generated 8% growth in gross annualised rental income.
“With interest rates falling, we anticipate that the portfolio and its rental growth prospects will likely receive renewed interest from investors, especially given the relatively wide discount of 25% to NAV that the shares trade on,” the analysts said.
They added that the share price of Primary Health Properties has seen an especially high correlation to interest rates, with many viewing the trust as a bond proxy.
Primary Health Properties has increased its dividend continuously for 28 years.
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