Pension Fund Hedging and the Bond Market

The Bank of England had to step into purchase gilts yesterday after the bond market looked like collapsing totally. Some £65 billion was spent to do it. This has created panic and uncertainty in the financial community and even affected equity markets.

I will give my comments on these events although I certainly do not claim to have any knowledge of pension scheme management and bond markets. So please correct me if I get it wrong.

Defined benefit pension schemes buy gilts (Government issued bonds) so as to match future liabilities to pay pensions. In recent years they have not only been increasing the amount invested in gilts as opposed to equities but have also been using liability driven investment strategies (LDIs) by using derivatives.

In essence they have been hedging their positions and using derivatives to maximise returns so far as I understand it.

What happened apparently was that the Chancellors announcements last week caused government bonds to fall in price and that resulted in margin calls on the pension funds. That caused bond prices to fall further as funds sold holdings to meet the margin calls. A vicious down trend resulted.

Derivatives are always dangerous. Warren Buffett called them “financial weapons of mass destruction”. The FT reports that Lord Wolfson warned the Bank of England that LDI strategies “always looked like a time bomb waiting to go off”. Pension funds using LDI strategies have risen to £1.5 trillion to give you some idea of the massive size of these operations.

What was the Financial Conduct Authority (FCA) doing to ensure that pension funds were not following risky strategies? Nothing at all it seems. So this looks like yet another failure by the FCA in their regulatory role. There is also The Pensions Regulator (TPR) which has a role in regulating workplace pension schemes who seem more interested in ensuring diversity in pension scheme trust boards and climate change reporting rules than ensuring financial risks are not excessive if you look at their web site.

It would seem that derivatives have been sold to pension schemes by clever City whizz kids with disastrous results and we are all paying for it now.

FT Articles worth reading on this subject: and

Roger Lawson (Twitter:  )

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Currency Impact on the Stock Market

I have been wondering why certain stock market sectors have been falling for no very obvious reason of late. For example UK property companies and alternative energy funds. I suspect one reason is that the majority of UK listed shares are now held overseas – 56.3% at the last reported figures in May 2020 which was a record high.

The pound against the US Dollar has fallen by 14% in the last 3 months. So if you are an investor sitting in the US you will have seen your UK shares fall in price in your local currency by that amount. When shares are falling for no obvious reason, people tend to sell them – at least I know I do. So it’s quite likely that the UK market is being affected by US shareholders dumping their holdings as a defensive reaction to falling prices.

Some people have suggested that UK companies are being affected by the high inflation rate, by labour shortages, by higher interest rates, by logistic issues or a looming recession but in reality the reported results have been OK of late.  Yes some companies might be directly affected by a falling pound – exporters positively and importers negatively. But there is no simple correlation with a company’s share price.

In reaction to the falling pound the Bank of England is buying UK bonds to calm the market. But they surely need to raise interest rates further and soon.

The rising proportion of UK listed companies held by overseas investors is exacerbating the bear market. Exchange rates can be very volatile and this makes for a very unhealthy stock market.

Roger Lawson (Twitter:  )

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Abrdn UK Smaller Companies Trust and Property Companies

red apples on tree
Photo by Tom Swinnen on

I took the time to read the Annual Report of Abrdn UK Smaller Companies Trust (AUSC) today. It makes for interesting reading for those of us who invest in small companies. The performance last year (to the end of June 2022) was dire. NAV Total Return down 27% and the share price even worse. This wiped out all the gains in the previous year.

This is the main explanation given by the Manager: “The period was a challenging one for performance for the Company, particularly during the second half of the financial year, with our style being out of favour in the market as “top down” global macro factors have taken the lead over “bottom up” stock picking. Smaller companies markets have been difficult, seeing dramatic falls during 2022 after having been relatively stable in the second half of 2021”.

Their best performing holdings were Telecom Plus (TEP), Safestore (SAFE) and Alpha Financial Markets (AFM) and I hold the first two directly also. But they have both fallen back sharply recently.

This is what they say about those two which is a good exposition of their merits:

· Telecom Plus 118bps* (shares +72%): supportive end market conditions given the exit of low-priced competitors from the industry, and the strong position the nPower contract has in Utility Warehouse’s pricing offering. Sales force fully engaged again post Covid-19. Strong cash generation and dividends. An investment case study for Telecom Plus is included on page 42.

· Safestore 90bps* (+12%): solid demand in the selfstorage industry with the constant of the 3Ds (divorce, death, dislocation). Rate increases and strong utilisation have ensured consistent earnings and dividend growth”.

One of the biggest fallers in the year was GB Group – down 52% which has been the subject of a takeover bid subsequent to the year end. They exited a number of holdings and it’s worth reading the Annual Report for details of the portfolio changes.

The company has no plans to change its investment style and processes and I agree with that although the company is surely going to come under pressure if underperformance continues (the discount to NAV is currently 15.6%).

Safestore is of course a property company although it does not just rent out space so should ideally be valued in a somewhat different way. But it has participated in the rout of property company prices which continued today. Safestore is also held in some property trusts which has compounded the problem.

There is an interesting article in this weeks Investor’s Chronicle headline “The Sorry State of the London Office Market”. It explains how landlords are concealing a surplus of space and declining rents by offering rent-free periods and other incentives. However average lease lengths have been falling and are now less than 7 years which is far cry from when I was looking for office space 20 years ago. The additional flexibility is surely to be welcomed.

This perceived poor market for offices in London seems to be affecting all property companies when they frequently have a very different customer bases. It’s a typical bear market in essence – the good is sold off with the bad.

But the market seems to be reaching a point in my view when it will be worth picking up the big fallers in property and small cap companies soon. Those sectors are irrationally out of favour. For example some small cap companies have a large proportion of US$ earnings so will benefit from the falling pound in due course.

A falling pound should stop the lunacy of importing apples from New Zealand which Sainsburys just delivered to our house in the peak of the English apple season. Making imports more expensive does have some benefits!

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Dividend Tax Rate Cuts and VCT/EIS Schemes

Two little noticed changes in today’s Chancellor’s announcements are reductions in dividend tax rates and support for enterprise schemes. I quote from the announcements:

“In addition, the government will reverse the 1.25 percentage point increase in dividend tax rates from April 2023. This will benefit 2.6 million dividend taxpayers with an average saving of £345 in 2023-24 and additional rate taxpayers will further benefit from the abolition of the additional rate of dividend tax. This will support entrepreneurs and investors across the UK to drive economic growth”; and:

“The government is supporting companies to raise money and attract talent by increasing the generosity and availability of the Seed Enterprise Investment Scheme (SEIS) and Company Share Option Plan (CSOP). The government remains supportive of the Enterprise Investment Scheme (EIS) and Venture Capital Trusts (VCT) and sees the value of extending them in the future”.

Does this mean that the “sunset” clause for dividend tax relief on VCTs will be removed after 2025? It is not clear.

See for details of the Chancellor’s Announcements.

There have been some adverse comments on the removal of the additional income tax rate of 45% but simplifying tax rates and structures has clearly been a priority so that is welcomed. The net cost to the Treasury of that change in 2023-24 is only £625 million. Not that I will personally benefit it is worth stating as I have very little “earned” income.

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Interest Rate Sanity and Chancellor’s Announcements

The Bank of England’s announcement of an increase in base rate to 2.25% was just one step in a return to sanity. With inflation nearing 10% why would any idiot lend money at 5% or less as many mortgage providers have been doing. In reality the last few years have seen lower interest rates than have been available for the last 5,000 years.

This has been possible because of Quantitative Easing (QE) to keep the economy afloat. A misguided policy that has resulted in horrendous side effects. It has resulted in property price bubbles and stock market bubbles. When you can borrow money at 2% and use it to buy houses which have been rising in price at 8% or more (as they have done in 2022), people will buy houses as an investment – and the bigger the better. This is one key reason why house prices have been rising to levels that make them unaffordable to those not yet on the bandwagon.

Yes it will mean the cost of mortgages will rise thus making some people poorer for a while. But it is a necessary step to return the UK economy to a rational position.

It is still some distance from enabling savings rates to return to a situation where savers can obtain a real return. This has encouraged speculation in alternative investments that might promise a higher return. This was one reason why small cap AIM shares have been popular in the last few years. But that bubble is now bursting – the AIM index is down 31% so far this year.

In summary, I welcome the rise in bank rate and it should preferably go further to match inflation rates or more.

Chancellor’s Announcements

Kwasi Kwarteng has today announced a number of things including tax cuts.

The 45% top rate of income tax is scrapped and base rate reduced by 1% earlier than planned. The planned increase in National Insurance is scrapped and stamp duty reduced, while the planned increase in Corporation Tax is also cancelled.

The chancellor confirmed that the scheme to protect households and businesses from rising energy prices is expected to cost £60bn for the first six months. With the aforementioned tax cuts, the resulting likely increase in Government debt has caused a sharp drop in the price of gilts (and rise in their yield).  

It has also meant a falling pound which will not help the cost of living but will help exporting companies and those with revenues in dollars. By making imports more expensive it should stimulate UK production – for example of food and make us less reliant on imports.

A surprise announcement is the winding down of the Office of Tax Simplification (OTS) and revision of the IR35 rules. These are sensible moves as the OTS has been totally ineffective in simplifying the tax system which is horribly complex while IR35 rules have been incomprehensible and impractical to apply in the real world without adding massively to bureaucracy.

More reforms to planning laws are promised to stimulate infrastructure building and aid the Government’s growth agenda but we have heard that before. Unfortunately planners just love complex regulations as they generate work for planners and there will be resistance from nimbies so I expect this will see major objections and delays.

There will be new anti-strike laws for essential services and there will be encouragement for 120,000 people on universal credit benefits to “take active steps to take more active work or face having their benefits reduced” (the number of inactive people in the workforce has been rising while jobs go unfilled).

In summary, my personal opinion is that that these are positive moves on the whole. In the short-term, we might all be poorer but some of these reforms were well overdue.  

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Property Trusts and Supermarket Income REIT

Commercial property investment trusts should be a good defence in a market downturn – at least that is what the investment pundits have been saying. As the market heads south I have been selling overvalued tech stocks and retail stocks vulnerable to a recession and reduced consumer spending. Property trusts should be less volatile as although the property market has been changing in some regards, property companies have longer term leases with their customers in general. So long as I avoided the London office market and retail shopping centres I expected to be OK.

I have therefore been holding on to several property REITs but that has not proved to be a great success. For example generalist trust TR Property (TRY) is down 34% since last September. Even companies such as Segro (SGRO) and Urban Logistics (SHED) who have been doing well by providing warehouses for internet delivery operations have fallen back substantially. They also provide buffers to supply chain disruptions which have become a big problem of late. But in a bear market, which we are definitely in, everything is sold off regardless of sector or performance.

Supermarket Income REIT (SUPR) published their final results this morning for the year ending June. Like other property companies their shares have been falling – down about 15% from last summer and I am losing money on a fairly recent purchase.

But the results were positive – EPRA earnings per share up 5%, assets per share up and dividends up – yield now over 5% on the current share price. One particular point to note in the announcement was that 81% of leases are inflation linked. As people have to eat and supermarkets are both retail stores and internet delivery operations now, this company should be a good defence against a prospective recession.

There are some interesting comments from Justin King in the SUPR  announcement – for example in response to a question on what supermarkets should do: “… you need to remember that in a recession the first change the customer will make is a shift away from expensive calories and the most expensive are those consumed out of the home in restaurants and takeaways. Rarely will a customer’s total calorie consumption change through the economic cycle, instead what you observe is a shift in the discretionary additional spend of their calorie consumption from eating out, to eating in. In a recession, that favours the supermarket. So, the net impact of a customer shifting towards perhaps lower margin value range is often offset via an increase in overall volumes across all price ranges”.

It’s worth reading to get an impression of what supermarket retailers are thinking at present. 

SUPR is still expanding by buying more properties but they acknowledge that rising interest rates on debt are having a negative impact. They have hedged their debt at an effective fixed rate of 2.6%

It was noticeable that the shares perked up this morning along with a number of other property trusts I hold. Dividend yields have been rising as share prices have fallen. Perhaps they are coming back into favour?

Roger Lawson (Twitter:  )

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Queueing Solutions and Queen Elizabeth’s Lying in State

I won’t be joining the queue to see the Queen’s coffin because, unlike most English people it seems, I have no urge to join a queue if I see one, but always walk away from them.

But it is allegedly the longest queue in the world and can take 24 hours to reach the end. This is badly organised. A company called Accesso (ACSO) has a product called Lo-Queue that eliminates physical queues by providing a virtual queue. It advises you when you have reached the end of the line and should turn up to access the venue.

Queues can also be managed by rationing. One way is simply to charge a fee for access, with busy times requiring a higher fee. A charge in this case could have been used to support the Queen’s favourite charities or to support the enormous heating bills of Buckingham Palace. Business opportunities have been missed!

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Earnings Per Share and Is It Well Defined?

Most investors rely on Earnings Per Share (EPS) as a measure of the performance of a company. In theory it’s a simple calculation based on post-tax earnings divided by the number of ordinary shares in issue as defined by the IAS 33 accounting standard (see link below).

But the number of shares can be affected by the future exercise of options, convertibles and warrants so in addition to the “basic” figure a “diluted EPS” figure is also required to be published. The EPS figure is also calculated not on the simple number at the end of a period but on the average over the time period to reflect the fact that earnings accrue over the period. This can create complications when there has been restructuring of a company involving share issuance or consolidation.

Another point to note is that only profits or losses from “continuing operations” are included in the basic EPS figure so as to reflect the fact that only those operations will be generating profits in future.

The Financial Reporting Council (FRC) has recently undertaken a thematic review of EPS to identify any possible issues in how EPS is calculated and reported – see link below.

They have identified some problems in practice and say “Certain requirements of IAS 33 appear to have been overlooked or not well understood by companies” and they are concerned that as judgements are sometimes used on share reorganisations the lack of disclosure on how EPS has been calculated is of concern.

EPS can also be used as a performance measure in bonus or LTIP calculations but it seems that sometimes EPS is calculated in a different way for that purpose. The FRC suggests any difference needs to be explained.

They also discuss the problem of “adjusted” EPS which are commonly reported. The FRC expects these to be reported in accordance with the ESMA Guidelines on Alternative Performance Measures – see link below. But what adjustments are included and how tax is taken into account can often be unclear. What is a reasonable adjustment is also often a subject of management opinion and this is surely an area where tougher standards could be introduced.

Companies where adjusted earnings are wildly different to basic figures should be viewed with suspicion in my opinion and a close examination of the adjustments is worthwhile in those cases (usually given in the Notes to the accounts).

The FRC Review is worth reading to get some understanding of the issues but a detailed study may be of more interest to accountants and auditors.

In summary, EPS can be a useful measure but it is only one measure of the performance of a company. It should not be relied on alone to judge the quality of a business and it is necessary to have some understanding of how it has been calculated.

Roger Lawson (Twitter:  )

IAS 33 Standard:

FRC Thematic Review:

ESMA Guidelines:

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Dunelm Results and Pay at Safestore

Dunelm (DNLM) published their preliminary results this morning (14/9/2022) – I no longer hold them. They were surprisingly good bearing in mind they are a homeware retailer – sales up 16% and EPS up 30%. Clearly the anticipated vulnerability to rising inflation and consumers being hit by a recession has not yet come to pass although forecasts for next year are lower.

They say trading in the first ten weeks of the year has remained robust and they remain on track to deliver FY23 results in line with expectations. With increased market share and a strong balance sheet they should survive any recession. A company to keep an eye on I suggest.

There was an interesting article in last week’s Investors Chronicle on directors pay at Safestore (SAFE) – a self-storage company. It was headlined “Safestore’s incredible largesse” and explained how the CEO received £17 million last year. That’s one of the largest pay-outs for UK listed companies and is way more than forecast in 2017 when some nil-cost share options were introduced.

I commented negatively on pay at this company after attending the AGM in 2019 – see . Even institutional shareholders revolted at the pay scheme and changes were promised. I have been voting against their Remuneration Report ever since as I still hold the shares – they still got 27.8% against it in March this year.

The company has been producing good returns for shareholders as have other self-storage companies. It’s a growing market as houses get smaller, more people are renting flats and people accumulate junk they are unwilling to dispose of. One cannot complain about the management for exploiting this market well but the rewards are simply too generous.

I hate nil-cost share options and LTIPs that pay out multiples of salary and always vote against them. I wish more people would do so. 

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Adjustments, Adjustments and Adjustments at Abcam, Oil+Gas Companies and FCA Decision on Woodford/Link.

Abcam (ABC) published their interim results yesterday (on 12/9/2022). I have commented negatively on this company and its Chairman before despite still holding the shares.

The same game continues – revenue up but reported operating profit down and cash flow from operations down. But adjusted operating profit up. What are the adjustments? These include:

£2.6 million relating to the Oracle Cloud ERP project (H1 2021: £2.0m); £6.0 million from acquisition, integration, and reorganisation charges (H1 2021: £3.5m); £9.0 million relating to the amortisation of acquired intangibles (H1 2021: £4.0m); and £13.0 million in charges for share-based payments (H1 2021: £6.7m).

The ERP project costs continue and I very much doubt that they are getting a justifiable return on the investment in that project now or in the future. Together with the acquisition, integration and reorganisation charges it just looks like a whole ragbag of costs are being capitalised when they should not be.

The company also announced there would be a webinar for investors on the day and a recording of it available on their web site later. Neither was available on their web site on the day or at the time of writing this. More simple incompetence!

The share price of Abcam has been rising of late which just tells you that most investors are unable to look through the headline figures and the sophistry of the directors.

As a change from investing in technology companies such as Abcam who of late are massaging their accounts, and not paying dividends, my focus has turned to commodity businesses. I have even been buying oil/gas companies such as Shell, BP, Woodside Energy and Serica Energy plus several alternative energy companies. There is clearly going to be a shortage of energy worldwide for some time while institutional investors have been reducing their holdings in some oil/gas companies simply from concerns about the negative environmental impacts and long-term prospects as Governments aim to reduce carbon emissions. But in reality the progress on carbon reduction is slow and I feel oil/gas companies will be making good profits for a least a few more years. Energy has to come from somewhere and these companies should do well and can adapt to the new environment easily. In the meantime, they will be paying high dividends and/or doing large share buy-backs.

I am generally not a big holder of commodity businesses as their profits can be volatile and unpredictable as they depend on commodity prices. These can be moved by Government actions or political disruptions such as the war in Ukraine. Will the war end soon? I have no idea. But even if it does there is likely to be a new “cold war” if Putin or other hard line Russian leaders remain in charge. I never try to predict geopolitical changes but just follow the trends in the stock market.  

The partially good news for Woodford investors is that the FCA has formed a provisional view that Link Fund Solutions may be liable for £306 million in redress payments to investors for misconduct rather than losses caused by fluctuations in the market value or price of investments. In other words, it may be nowhere near covering investors losses in the Woodford Equity Income Fund. They have announced this simply because Link is currently subject to a takeover bid which they have approved subject to a condition to commit to make funds available to meet any shortfall in the amount available to cover any redress payments. I suspect this is going to make gaining a full recover for investors somewhat problematic.

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