In the Eye of the Storm


This is the second and concluding part of the blog ‘In search of what’s normal’


The first part of this blog discussed the epidemic of risk aversion which has the financial markets in its grip, and the distortions which have arisen as a result.

This second part will look in detail at the value opportunity that has arisen in the shares of UK domestic-facing companies – ones that make most of their sales in the UK, as opposed to exporters, which make most of their sales overseas. It will explain how we have positioned the fund TB Wise Multi-Asset Income to take advantage of this opportunity for the benefit of our investors (and ourselves as co-investors).

In thirty-five years as a professional investor – someone who is authorised to invest other people’s money – I have seen a large number of value opportunities, but three stand out – the undervaluation of ‘old economy’ shares in the winter of 1999-2000, the distressed pricing of whole swathes of the financial markets in early 2009 following the financial crisis, and the priced-to-go-bankrupt valuations of much of the UK market today.

It needs to be said that great value opportunities are always extremely unpleasant except afterwards in hindsight. We now know that ‘old economy’ shares and the value style out-performed the broader market every year from 2000 to 2007, and we know how powerfully the market recovered in 2009 following the central banks’ adoption of the policy of quantitative easing, which aimed to underpin the values of financial assets. What we don’t know and won’t know till afterwards is how the current situation will play out. There is a strong urge to wait on the side-lines until the crisis is resolved, even though experience tells us that markets have always recovered before that moment comes.

Investors who are considering selling their UK assets, and the funds through which they invest in the UK, before things get even worse, might like to consider just how much bad news is already priced in. This will become clearer as we go on.

We are not the only ones to see the mispricing of UK assets. Two of the companies in which we invest, Tarsus and Telford Homes, have been taken over in the last couple of months. On Friday 16th August Cheung Kong announced an agreed takeover of the brewer and pub owner Greene King. The striking detail in the announcement was the agreed price – a premium of 50% to the previous day’s closing price. This transaction confirms that rational investors are prepared to pay vastly above current market values for the long-term returns on offer. It would not surprise us if a kind of feeding frenzy in depressed UK assets were to develop. It is also worth noting that Cheung Kong hasn’t bothered to wait for clarity on the outcome of Brexit.

The economic backdrop

During the second quarter of the year (April to June inclusive) the UK economy shrank by 0.2%. A recession is defined as two quarters of negative growth, so if there is as much as a 0.1% contraction in the current quarter (July to September inclusive), then the UK will be officially in recession. However, the cause of the slowdown is well known. It’s the uncertainty surrounding Brexit, which has led to consumers postponing major purchases, and businesses postponing investment. This hiatus has developed over the last three years since the referendum. The uncertainty is at its highest now because the three main outcomes – no Brexit, no-deal Brexit, and some form of compromise, all remain possible, but the direction has to be decided over the course of the next few weeks. In the circumstances one might say that a 0.2% contraction of the UK economy in the second quarter is a robust outcome.

The prospects for the UK consumer are surprisingly positive. Employment is strong. The current workforce, 32.8m, is at a record level. This number has grown steadily from 31.1m in the fourth quarter of 2012, a net job creation of around 250,000 a year. The UK employment rate (age 16-64, seasonally adjusted) at 76.1%, is at its joint highest level since comparable records began in 1971. Unemployment is now just 3.9%. Not only are there more people in work, but they have more money to spend. The latest figure for wage growth, 3.7%, is the highest for over a decade, and is accelerating. With inflation at just 2.0%, real wage growth is 1.7%, again the highest for a decade (1)

The opportunity

TB Wise Multi-Asset Income is a multi-asset income fund, with the flexibility to invest in any asset, anywhere in the world, and with no restriction on the proportions invested. With such a mandate we could avoid the UK altogether. The reason why we have chosen to invest an unusually high proportion of the fund in the UK, and in particular into sectors which serve the UK consumer either directly or indirectly, is because of the complete and growing disconnect between our estimates of the values of these assets, and the much lower values the market currently places on them. We are also attracted by the very high rates of dividend yield these assets are offering us.

The figures shown below for the potential upside on shares we hold in TB Wise Multi-Asset Income are our estimates of how far the share prices would have to rise to return to what we believe is the lower end of their fair-value ranges. In all cases, the shares have traded above these higher levels in the last couple of years.

When discussing the opportunity that we see in UK assets, two questions always arise, so it may be worth addressing them here.

What happens if there is a recession?

There are two answers to this question.

  • a)It depends what you mean by a recession
  • b)A deep recession is already fully priced into the financial markets

As mentioned above, the UK would be technically in recession if growth were to be negative in the current quarter. The shrinkage over the six-month period would be in the order of 0.3%. This level of recession is altogether different from the crisis a decade ago, where in an 18-month period between the first quarter of 2008 and the third quarter of 2009 the UK economy shrank at a rate of 4.0% per annum, or 7.2% altogether. The earlier recession was caused by a worldwide failure of the banking system. No one is predicting anything similar at the moment.

Before and during recessions investors sell risky assets and buy safe ones. Safe assets are already much more expensive relative to risky ones than they were in the extreme depths of the Global Financial Crisis of a decade ago.

Another question we are often asked is

Won’t the markets collapse when Brexit occurs?

We can’t know how the future is going to unfold, but what business is continually telling the government is how difficult is it to plan anything in an environment of complete uncertainty, such as we are currently experiencing. Brexit is the moment when we will finally know what’s going to happen, for better or worse, and company managers, together with the rest of us, will once again be able to start making plans.

While we don’t know what’s going to happen, we do know what has happened. Over the last three-and-a-bit years sterling has continued to fall, putting ever greater pressure on the UK economy which relies to a large extent on imports. The rest of this blog goes into detail about just how cheap some of these assets have become. Many of them have fallen in value by 50-75% from their pre-Brexit levels. How much more bad news does the market need to discount?

Finally, it is worth remembering that markets always pick up before the end of a crisis. A good example is the 2008-9 recession, mentioned above. Though the economy didn’t begin to expand until the 4th quarter of 2009, the stock market begin its vigorous rally in March, anticipating the economic recovery by several months.

Don’t just take our word for it

The disconnect between the valuations of ‘cyclical’ assets and the rest of the market worldwide, and most strikingly in the UK, is well-documented. On August 16th the Economist’s lead article ‘Markets in an Age of Anxiety’ concluded with the following comment

‘When people look back, they will find plenty of inconsistencies in the configuration of today’s asset prices. The extreme anxiety in bond markets may come to look like a form of recklessness…a sudden easing of today’s anxiety might lead to violent price changes – a surge in bond yields; a sideways crash in which high-priced defensive stocks slump and beaten-up cyclicals rally’ (my italics).

TB Wise Multi-Asset Income is well-positioned for such an outcome. George Soros said that as an investor, when you see an exceptional opportunity, the worst thing you can do is not take full advantage of it. We have heeded his advice. And while waiting for prices to recover, investors in the fund are being paid a dividend of 5.9%.

Retail property

Over the last few years, retail sales have rapidly migrated online. The UK is the world’s leading country for online sales adoption, with 20% of all retail sales transacted through digital channels. Naturally, this structural shift has placed extreme pressure on physical store operators, already challenged by the weak pound which has raised the cost of imported goods, by high business rates, the apprenticeship levy and the National Living Wage. Many retailers have gone out of business in the last couple of years.

The plight of the retailers has had a direct effect on the owners of retail property. In these circumstances, rents fall at each review. Company Voluntary Arrangements (CVAs) are a new threat. Under a CVA, the landlord acknowledges that the tenant can no longer pay rent at the agreed rate and has to accept what is deemed to be affordable, usually at a much lower level.

Investors have responded to the trend by avoiding retail assets, focussing instead on internet-related buildings such as last-mile logistics depots. However, within the physical retail sector clear trends are emerging. Some retailers are flourishing in the current environment. The high street appears to be the most challenged location, shopping centres less so, while many out-of-town retail parks, particularly ones that are well-let with a good spread of tenants, are holding their own. This is partly because rents are much cheaper out of town. £12-15 per square foot can work well where £30 a square foot is unaffordable. Our landlords report occupancy rates well above 90%. CVAs can work for the landlord too. Once a CVA is in place, the tenant has no security of tenure, and can be evicted as soon as the landlord has found a better tenant, who in some instances has been prepared to pay a higher rent than the original tenant paid before the CVA.

New River REIT

New River REIT is a relatively new holding in the fund. New River owns retail parks and around 600 pubs. Aware of the threat from online retail, the managers identify successful retailers as being those who can offer convenience, value or service, and actively look for tenants who demonstrate these qualities. Retail assets have become so cheap now (well below the cost of rebuilding) that new investors are being attracted into the sector. New River offers a third-party management service to these new owners and has signed three management contracts in the last few months, with more to follow. Around 96% of the company’s floor space is let.

In the 2018 Report and Accounts, new Chair Margaret Ford said of the management team ‘In forty years in the property industry, I have never seen more accomplished asset managers than the team at New River’.

New River REIT is astonishingly cheap. At the time of writing, the net asset value per share is £2.61, while the share price is £1.52. The net asset value per share is the amount that would be realised if all the assets were to be sold, and the debt paid off. The property values have been determined, not by the company, but by independent experts, all fully aware of the challenges the retail property sector faces. New River’s discount to net asset value is above 40%, meaning that the stock market considers the trading value of the shares to be worth minus £1.10 per share. The dividend yield is 14.2% (not a misprint). This level of yield isn’t completely covered by earnings, but the directors ‘see a clear path to dividend cover’.

The valuation of New River REIT can be explained partly by the current antipathy towards UK assets, and to retail property in particular, and partly by the fact that Woodford Investment Management, until recently a holder of 20% of the company’s issued shares, is said to be selling its holding in order to create the more liquid portfolio that the company has committed to offering its investors when its Income fund re-opens.

Dividend yield 14.2%. Potential upside on the share price 50-60%

British Land

British Land’s property portfolio consists of roughly 50% prestigious offices, arranged on campuses, mainly in London. 45% is in retail property, mainly shopping centres in and around London. British Land also owns a 53-acre regeneration site at Canada Water in London’s Docklands, with huge development potential. This project is in its very early stages. Gearing (the ratio of debt to the asset value) is conservative, at around 25%.

British Land’s net asset value per share is £9.05, and its dividend yield is 6.62%. At the current share price, £4.72, the discount to net asset value is 48%. That’s right – a company that could wind itself up and return close to £9.05 per share to shareholders is trading at just £4.72.

Of course, the retail part of the portfolio is the problem. A friend of mine, who manages one of the UK’s largest and best-respected property investment trusts, told me a couple of weeks ago that he believes British Land’s retail property portfolio to be around 10% over-rented, meaning that the rents currently being paid by the tenants are around 10% above where they would be if the agreements were made today. Accepting this point, it would be prudent to write the value of the retail portfolio down by 10%, and to be on the safe side, we should probably make it 20%. On this basis, British Land’s net asset value becomes £8.23, and the discount to net asset value drops to a mere 43%. Another way to look at this is to say that the current valuation of British Land assumes that its entire retail property portfolio is worthless, which, in view of the fact that its properties stand on prime land which could be redeveloped, looks a little harsh.

Dividend yield 6.62%. Potential upside on the share price. 30-40%.



Lookers is a car distributor which makes its sales entirely in the UK. The company sells cars and vans, both new and second-hand, and provides after-sales service, the most profitable of its business segments. Results for the first half of the year, announced earlier this week, showed that profits had fallen by almost 30% since the corresponding period of last year. New car sales were down by 1.2% and profit margins had dropped in used car sales.

Worse, the company recently announced an investigation by the Financial Conduct Authority (FCA) into its sales practices. The issue appears to relate to the way the company was selling finance packages. Around 80% of new car sales in this country are made using finance, and of that 80% around 85% use a newish form of finance called a Personal Contract Purchase, or PCP. The FCA’s best practice rules stipulate that customers should be shown all alternative options so as to be able to make an informed decision. It appears that Lookers’ sales staff had not made the alternative hire purchase option sufficiently clear to their customers. Lookers have remediated the situation and are co-operating with the FCA in every way they can. However, the company is overshadowed by an investigation of unknown duration, which is likely to end with a currently unquantifiable fine.

Further ahead lie the structural challenges of electric and autonomous cars.

Analysts see no improvement in Lookers’ prospects in the foreseeable future. Recently, the Investors Chronicle rated Lookers a straight sell (IC August 16th 2019).

You couldn’t help agreeing with this judgement…until you look more closely at the facts.

We believe that negative sentiment towards Lookers ignores its fundamental strength as a company, and in particular its balance sheet. Lookers is an old-established company, selling cars for 31 different manufacturers from 110 different locations around the UK. The company appeared again this year in the Sunday Times Best Companies to Work For list and has an award-winning apprenticeship scheme. Lookers is known to be one of the best operators in the sector. The decline of 1.2% in its new car sales in the first half of 2019 compares well to the UK’s total decline of 3.4%. In the half-year just gone after-sales revenue – the most profitable sector – rose by 6.2%.

Lookers’ problems are short-term in nature. The reason for the decline in new car sales – Brexit – is well understood. The regulatory issue and eventual fine is unfortunate, but is one-off in nature.

The dividend yield at today’s share price, 45p, is 9.0%. The company has stated that it will review the dividend before issuing its final results next March, which probably means that should conditions remain as turbulent in six months’ time as they are today, then the dividend will be cut.

A glance at Lookers’ balance sheet shows just how cheap the valuation has become. The company owns property worth £312m, or 80p per share. The net assets on the balance sheet are worth a total of 99.25p a share. The company’s assets are worth more than twice its market valuation. The share price has already fallen by three-quarters from its pre-referendum level. This extreme movement tells you that this is either a bad company, or a good company in a bad market. We believe the latter to be true.

Dividend yield 9.0%. Potential upside on the share price 100-150%.

Insurance companies

Legal & General

Legal & General, established in 1836, is the UK’s largest asset manager, with over £1 trillion in assets under management. L&G is one of the UK’s few genuinely world-class companies.

These days, L&G makes most of its profits from pensions, mainly company pensions. The company is the UK leader in Pension Risk transfer, where an insurance company takes over the management of a company’s pension fund. This is a large and growing business. L&G wrote £6.7bn of new PRT business in the half-year, including the transfer of the Rolls-Royce scheme, at £4.0bn the UK’s largest ever. In July, nearly another £1bn of new business was transacted, with a further £20bn being quoted on. So far, only 8% of UK company pension assets have been transferred to insurance companies, so the potential remains vast. In the US, where L&G is also a market leader, that figure is just 5%.

Legal & General’s other world-class business is the management of tracker funds, which it has grown from scratch over the last decade. Legal & General is the world’s 15th largest asset manager. In the past five years the international fund-management business has grown its assets at 28% per annum compound.

The company is also growing in other areas – lifetime mortgages, housebuilding, lending to small and medium-sized companies and infrastructure development. In the last few weeks, Legal & General has been awarded a £4.0bn contract in partnership to develop a housing scheme for tech-sector workers on the outskirts of Oxford.

From 2011-15, the company grew its earnings by 10% per annum, and since then the rate of growth has accelerated to 11%. The dividend has been increased each year by at least as much as the earnings have risen. But the share price hasn’t responded, and at its current level of £2.24 is exactly where it was in November 2013, almost six years ago, and lower than it was in 1999. As the dividends have grown, and the share price has stayed flat, the dividend yield has grown steadily to its current level of 7.5%. This is nearly 25 times the return you could expect from the five-year government bond, Treasury 5.0% 2025.

Legal & General’s balance sheet remains strong, with the capital required by the regulator covered 1.7 times.

Dividend yield 7.5%. Potential upside on the share price 30-50%.


Legal & General is a growth company with two world-class businesses, which is given a low rating because it is in the insurance sector. Aviva, in our view, is a lower-quality business, a ‘sleeping giant’ but with considerable potential.

Aviva is a conglomerate, formed from the merger twenty years ago of three large UK insurers, General Accident, Commercial Union and Norwich Union, together with quite a few smaller ones. Unlike Legal & General, which has quit general insurance (cars, buildings, house contents etc) to concentrate on pensions and investment, Aviva still has a sizeable general insurance arm, and does its fair share of medical insurance.

Aviva’s problem is that its component parts have never been fully integrated. New Chief Executive Maurice Tulloch admits that Aviva investors have been told many times before by previous CEOs that integration is going to happen, only to be disappointed, but he believes that integration is the essential first step to progress in other areas, and has set hard targets – to reduce the company’s expenses by £300m a year, and to reduce its debt by £1.5bn by the end of 2022.

Aviva’s balance sheet is solid, with the capital required by the regulator covered 1.94 times.

Meanwhile the company is very cheap. Its net asset value per share is £4.32 per share. The current share price is £3.60, meaning that the market believes that the company is worth 17% less than the assets it owns. This seems grudging for a company which is relatively non-cyclical – people go on paying life and health insurance premiums and saving for their retirement even in recessions.

Dividend yield 8.4%. Potential upside on the share price 50-75%.


The UK construction sector has proved a graveyard for investors over the last few years. Victims of the harsh environment have included Kier, Interserve, and most notoriously Carillion. Many investors and commentators believe that the sector is un-investable and will avoid it at all costs. TB Wise Multi-Asset Income has invested in the sector and has lost our investors money. However, we believe we have learned from these painful experiences and now know what we’re looking for.

The root of the problem has been the public sector procurement process. Government issues large contracts and awards them to the lowest bidder. Typically, these contracts stretch out over multi-year periods and with all payments fixed, so that when anything changes, such as an increase in wages or materials, the wafer-thin profit margins quickly turn into losses. Why then did companies accept work on these terms? For several reasons. It was comforting to have good visibility in the order book, the contracts were often high-profile, attracting useful publicity and the executives underestimated the many ways in which their costs could rise.

The public sector has outsourced construction risk to the private sector and has managed to get away without offering adequate rewards to compensate. This phenomenon is not confined to the UK – a recent article in the FT (‘Australian infrastructure boom on track for trouble’ August 13th) describes an identical dynamic in Australia.

Construction companies diversified in an attempt to move into more profitable lines of work. Kier was a case in point, buying first a service company, May Gurney, then a road maintenance company, Mouchel, and then a consultancy, McNicholas. In doing so the balance sheet became overstretched, and even as the company attempted to work towards a stronger balance sheet through its ‘Future-proofing Kier’ strategy, the banks decided to reduce their lending, forcing the company to rush into an unsuccessful share issue. Its future currently hangs in the balance.

However, the next ten years are likely to better for certain construction companies than the last ten. This is for several reasons.

The construction sector can be sub-divided into infrastructure, civil engineering, maintenance, and house building. The most perilous segments is large infrastructure projects such as HS2, where the highest level of construction risk is combined with the lowest returns. The companies which have survived the last decade are no longer prepared to accept these large, multi-year, low margin fixed-price contracts, and some companies never were.

Central banks have exhausted the potential of monetary policy to stimulate their economies (‘they have broken the handle on the money pump’ as a company director put it to me recently). The remaining lever is fiscal policy, which means, among other things, infrastructure spending. The government needs the collaboration of the construction companies who will no longer accept work on the old unprofitable terms. Either the terms are improved or the infrastructure projects won’t happen.

Companies have learned, and some always knew, that the only way to manage a construction business successfully is to run it with net cash on the balance sheet through the cycle.

House building, particularly affordable housing and urban renewal, are strong markets and will continue strong, supported by buyer demand and government policy (the need for higher rates of housing development is one of the few things that all political parties agree on).

In the light of the above, we believe that there is a place in an investment portfolio for construction companies so long as they are diversified, prudently managed, cash-rich and involved in housebuilding, including affordable housing. The two companies that best fit these requirements are Morgan Sindall and Henry Boot.

Henry Boot

Henry Boot has been in the TB Wise Multi-Asset Income portfolio continuously since 2012 and is a company we have got to know well. The company’s share price has fallen over 35% since the start of 2018, driven entirely by adverse sentiment, as there has been no bad news.

Henry Boot’s principle activity, Hallam Land, takes development land through the planning process and then sells it to housebuilders. Over the years, the land bank has steadily grown in size and the acreage sold has increased every year. Despite Brexit, demand for new houses remains strong, and sales of land continue at a high level. Land is held on the books at its cost price, and profits are not booked until a sale completes. On this most conservative valuation methodology, Henry Boot’s net asset value per share, which includes development land in the planning process and investment properties, stands at around £2.45 per share. The company’s current share price, £2.30, gives the ongoing business a valuation of minus 15p a share.

The company has almost no debt.

On the construction side, Henry Boot avoids large and unprofitable contracts. It builds development properties, always either pre-let or pre-sold, and undertakes construction work for third parties. This work is of a very high standard. Recently, Henry Boot was awarded Phase 2 of a development called ‘The Glass Works’ in Barnsley. Following the award, Sir Stephen Houghton, CBE, the leader of the Barnsley Council said ‘Henry Boot have already delivered fantastic results, so we are pleased to have them on board for the next phase of the scheme. Their commitment to not only the project but the local community is outstanding and they have made a significant impact in terms of employment and educational opportunities’.

Henry Boot’s housebuilding subsidiary, Stonebridge Homes, serving the area between Leeds and York, has grown from nothing in the last few years and now sells around 150 houses a year. Build quality is high and the company can sell as many homes as it develops.

A combination of Brexit and a wider global market panic have pushed Henry Boot’s share price down to its current depressed level. Apart from the very short term, the fair market price for the company’s shares lies in the region £3.50-4.25.

Dividend yield 3.9%. Potential upside on the share price 50-70%.

XP Power – Trump trumped

XP Power is a global company producing power solutions for a number of different industrial segments. It’s the kind of company we like to invest in – managed by experts for the long-term and a market leader in most of its niches. XP Power has invested intelligently in manufacturing – the company has completed a second factory in Vietnam and is about to move production there from China. Production in Vietnam is just as efficient as in China and significantly cheaper, while quality isn’t compromised. XP Power’s share price was £37.50 as recently as April 2018. Today it is £22.00.

There are two issues. The first is the semiconductor cycle, which is currently in the trough of demand. This weakness has affected XP, but not unduly as they are prepared for cyclicality. The semiconductor segment only represents 15% of total sales and will eventually pick up. The other problem is the trade war, which imposes tariffs on goods shipped from China to the US. However, XP Power have neatly side-stepped the issue, as henceforward their shipments to the US will be made from Vietnam and exempt from the tariffs.

Dividend yield 4.0%. Potential upside on the share price 50-100%


TB Wise Multi-Asset Income fund. Dividend yield 5.9%. Potential upside to the share price 25-40%

The valuations described above are anomalies and are unlikely to last long. The share prices of these assets will either recover as political anxiety subsides, or they will be taken private by financial buyers such as US hedge funds, who will offer substantial premiums in order to induce investors to part with their shares.

It is natural for investors who have suffered losses to want to shelter their capital from further losses, but in so doing they may avoid the recovery which is likely to occur following three years of steady de-rating.

My late mother Dorothy owned shares in a fund called Discretionary. She had owned the fund for almost twenty-five years before she discovered, in a casual conversation with me, that the share price could move up and down and that her holding was worth twelve times what she had originally paid for it. She had gone through the bear market of 1974, during which the UK market fell by over 80%, without realising that anything was happening.

What Dorothy hadn’t failed to notice, however, were the dividends which appeared in her bank account twice a year, and she had also noted and was grateful for the fact that they continued to increase in size.

Perhaps today’s investors could take a leaf out of my mother’s book, to use her own phrase.

Please note – this blog contains the personal opinions of Tony Yarrow as at August 22nd 2019, and is not intended as financial or investment advice.

  • (1)All the statistics in this section have been taken from the ONS website
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