August CPD Newsbrief — Investment principles and risk
Commercial property stands strong
The latest statistics from Investment Property Databank (IPD) show an equity-beating return from UK commercial property.
The May 2014 monthly numbers from IPD came with a grand headline: ‘UK Commercial Property Sees Largest Value Growth of 2014’. The capital growth figure for May was 1.1% − not as high as some of the monthly results in the pre-crash era, but still a respectable number. More importantly, it was the 13th month of consecutive growth according to IPD, suggesting that capital values have regained upward momentum after a difficult few years.
All three sectors contributed to the figure, with values in retail, the laggard of the last year, rising by 0.9%. Retail rents also grew in May, with central London standard shop rents rising by 0.7% and those in the south east adding 0.1% respectively. IPD says that shops in the rest of the UK and retail parks also experienced some rental growth.
Total returns including rental income for the month were 1.6%, bringing the annual figure up to 16%, just about double the corresponding UK equity return. However, that annual IPD number hides a large difference between the sectors: 11.1% for retail, but 20.7% for industrial and 21.4% for offices. Can the performance continue? Average equivalent rental yields are still 6.9%, according to IPD, which compares favourably with a yield of about 2.8% from 10-year gilts and 3.2% from UK equities. The gradual rise in base rates promised by Mr Carney does not look to be a threat to property, not least because it will only happen if economic growth remains buoyant.
Investor demand remains strong; witness the way that the banks are now successfully offloading their crisis-derived property portfolios. To reinforce the point, the IMA statistics for May showed property as the sector with highest net retail sales (at £490m).
UK economic progress
We now know that the UK economy has grown for five consecutive quarters. The Quarterly National Accounts report, compiled by the Office for National Statistics (ONS), has confirmed that growth in the first quarter of 2014 (at 0.8% quarter on quarter) was in line with earlier estimates.
Almost all of the output lost during the financial crisis, measuring 7.2% from the peak in Q1 2008 to the trough in Q3 2009, has been recovered. While early gains were driven by an expansion in household spending, recent growth has been bolstered by higher business investment as well as ‘investment in dwellings’. All of this is undoubtedly good news, but a degree of caution is warranted.
The UK population has grown since the outset of the downturn, and that alone can reasonably be expected to create an increase in output. Having adjusted for the likely population growth, the ONS estimates that GDP remains around 5.6% lower than a peak in mid-2005.
The ONS also notes that “relatively large increases in house prices … [raise] … questions about the extent to which the economic recovery is dependent on the UK property market”.
An analysis of household debt presents an interesting picture too. The ONS indicates that since 2008 the ratio of long-term debt to Gross Household Disposable Income (GHDI) has fallen from 133% to 118% today. The ratio of short-term debt to GHDI has fallen from 24% to 16%.
The ONS describes the reduction in short-term debt, which is now close to its 1997 level, as “marked”, and contrasts it with the still-elevated levels of long-term debt.
Analysts anticipate rise in gold price
The price of gold is expected to rise over the coming months even if the US Federal Reserve goes ahead with plans to tighten its monetary policy, according to analysts.
Fed chair Janet Yellen recently suggested that the central bank could move to raise interest rates sooner than the market expects, assuming US economic indicators continue to show sustained improvement. Any tightening of US monetary policy would act as a negative for the gold price ‘at face value’. Rising interest rates would be expected to hurt the price of gold and other non-yielding assets.
However, one macroeconomic forecasting consultancy predicts that any US rate rises are likely to come at a time when inflation pressures are moving upwards. In addition, the European Central Bank and Bank of Japan are likely to continue loosening policy, which should offer further support to gold.
Additional support is likely to come in the form of geopolitical tension, with the situations in Ukraine, northern Iraq and Gaza all having the potential to send investors running to safe havens. Investors had already started to buy gold again before Malaysian airliner flight MH17 was shot down over Ukraine, and further tension could see more money head placed in gold investments.
Gold prices rose over the course of Q2, with gold ending the second quarter at $1,308 an ounce, up from $1,208 at the start of the year.
Analysts say the MH17 tragedy, which killed all 298 people on board, could see investors retreat further into gold as more attention is focused on the relationship between Russia and the Ukrainian separatists widely blamed for the downing of the aircraft.
Social investment tax relief and social impact bonds
The government launched the social investment tax relief scheme (SITR) in the 2014 Budget to encourage private investors to support social enterprises and help them access new sources of finance.
A social enterprise is an organisation that applies commercial strategies to achieve improvements in human and environmental wellbeing, rather than maximising profits for shareholders. Social enterprises can be profit making or not for profit. Tax reliefs have been available on charitable donations for years, as have venture capital reliefs for small and start-up businesses in the form of EISs and VCTs. Until recently, tax has not been used as an incentive to encourage socially useful behaviour.
SITR levels the playing field, aiming to make investments in charities and other social enterprises as attractive as investing in small private companies. From 6 April 2014, individuals making an eligible investment can deduct 30% of the cost from their income tax liability for that tax year. Furthermore, individuals with chargeable gains for that tax year can defer their capital gains tax liability if they invest their gain in a qualifying social investment. There is also no CGT to pay on any gain made on the investment itself.
Social Impact Bonds (SIBs) attract social investment tax relief. They are a form of ‘outcomes based’ contract with the public sector that makes a commitment to pay for improvements in social outcomes, such as reducing the number of people classified as morbidly obese or the number of hospital admissions in a certain area.
An SIB contains an agreement between a charity or social enterprise and a public body or government department to try and solve a problem. Then if the strategy succeeds, that body or department will make a payment to the bondholders. Because payment is based on results rather than process, the theory is that there is more room for innovation and greater freedom to demonstrate solutions that work. The result is intended to be better outcomes for the public and reduced costs for the government. Investors in the SIBs will lose out if the programme fails and they stand to gain if it succeeds − the charity or social enterprise will remain financially secure whatever the outcome.
SIBs have the potential to achieve a lot of good, but much can go wrong with them. For example, the pilot SIB came to a premature end because rehabilitation services in Peterborough will be handed to a private contractor from 2015. Also, such arrangements are only ever going to be short term; once certain activities or interventions have proven to be effective, it is sensible and economical for the government to fund them through long-term contracts, or with grants.
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