March 2017

March 2017

Going back a few years to the relatively immediate aftermath of the global financial crisis of 2008/09, I recall having a conversation with a team of people from a large and active institutional investor with an on-going interest in the housing association sector. Being slightly flippant, I enquired as to why they were busy hoovering up bonds issued by housing associations at fixed rates of 1 – 1.5% over gilts, when they could acquire the entire asset on which they were securing their lending for say a 3% real return.

Of course, the question was somewhat theoretical given that no structure or vehicle existed for them to acquire the assets in question from a housing association. Nonetheless, the response was that bonds were being acquired by the fixed income investment team whose returns were benchmarked to other corporate bonds, whereas what I was referring to was an unleveraged equity investment. Not only would this fall into an entirely different investment area but the returns would be considered substantially below those on offer from alternative equity investments in areas like property or infrastructure. Moreover there is development risk within the housing association mixed-economy model.

Since then, record low interest rates and compression of investment yields through quantitative easing have become the “new normal” and investors have been left trying to chase stable and reliable income streams, which provide a premium over “risk free” assets (gilts) and which are preferably linked to inflation or at least provide them with a strong proxy for inflation protection.

While some investment funds have latitude to take higher levels of risk in achieving the desired returns, others take a more conservative approach and have more modest returns expectations as a result. We know for example that certain types of pension fund are happy to accept ungeared equity returns on high quality and well managed assets with infrastructure (stable cashflows with a reliable underpinning of demand) like characteristics of as little as 2.5-3% real. Returns which the same investors may well have considered rather too paltry for their liking as recently as 2010-2012.

This throws up some interesting questions in relation to affordable housing – an asset class which conventional wisdom has always claimed to be unattractive in terms of equity investment because the returns are simply too low compared to the alternatives.

The returns from different forms of affordable housing haven’t changed a great deal over time, but wider investment returns have declined to such an extent that the market has “caught up” (or should that be “caught down”) with the assets typically produced by our housing clients.

Logically this makes sense. For example, PRS in the UK was once considered to throw off insufficient yields to be attractive to real estate investors, yet now there is more money than you can shake a stick at trying to find a home in UK private rented sector assets. And it isn’t a huge downward leap from PRS asset yields to those thrown off by affordable or shared ownership type assets, particularly when you factor in the lower risk associated with these tenures from a demand perspective. Moreover the challenge for the PRS industry has partly been about delivering investable assets, whereas in affordable housing the assets already exist.

In an era in which housing associations are looking for new ways of financing their capacity objectives without overly weakening the financial strength of their core regulated businesses, equity sourced from long term and socially responsible investors may provide them with a very deep set of pockets to reach into. Clearly, much detail needs to be worked through in order to create a fully investable solution, but fundamentally, the economics may be aligned for the first time ever for those organisations willing and able to exploit the opportunity.

February was a busy month for UK macroeconomic data releases, with:

  • UK Q4 GDP being revised upwards to 0.7% in the month (ahead of expectation);
  • The upward trend in inflation rates continuing as data releases for January 2017 showed the YoY RPI and CPI inflation rate measures both creeping up to 2.6% and 1.8% respectively (fast approaching the Bank of England’s 2.0% target!);
  • An unemployment rate of 4.8% being reported for January, an 11 year low for the UK; and
  • Annualised wage growth for the 3 months to December 2016 was reported at 2.6%, ahead of CPI inflation although slightly lower than the 2.8% recorded for the 3 months to November 2016.

The month saw a sharp reduction in Gilt yields across the curve – by c.40 basis points to 1.7% for the 30 year Gilt. It was a similar story for 6ML LIBOR swap rates which also fell across the curve – from 1.7% to 1.4% at the 30 year tenor.

The surge of western economy stock markets in 2017 continued in February with the FTSE 100 reaching near all time highs in the month, closing at 7,263 points. The S&P 500 index in the US surpassed its all time high in February with Snap Inc, a California based technology firm famed for their disappearing picture and video messages, taking advantage of the high stock market valuations to IPO on March 2nd at a colossal $33bn valuation.

February was a mixed bag for the UK banking sector as 2016 financial results were published. Barclays and Lloyds Bank both recorded significant improvements in their financial performance, respectively tripling and doubling their pre-tax profits in 2016. However, HSBC’s pre-tax profits dropped by 62% in the year whilst RBS’s losses widened to £6.96bn for 2016 (almost triple their 2015 loss) – losses primarily related to further provisions for legacy misconduct legal provisions as well as further restructuring costs.