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BACIT’s sterling hedge limits benefits from sterling depreciation

BACIT has announced its interim results for the six months ended 30 September 2016. During the period, the company’s NAV total return was 4.82%, thereby underperforming the FTSE All-Share Index, which returned 12.85%. Reflecting a widening of the discount during the period, the company’s share price fell by 4.2%.

The trust’s chairman, Jeremy Tigue, says that he main market event during the period was the UK referendum, which led to a sharp fall in sterling. He says that, although the long term implications are unclear, within BACIT’s portfolio most of the long equity and equity hedge holdings did well but several credit and macro funds had a more difficult time.

The manager says that the devaluation of sterling had the immediate effect of increasing the Sterling value of 33% of the portfolio which is held in unhedged US Dollar denominated share classes, and the US Treasury Inflation Protected (TIPs) portfolio which is sterling denominated, but unhedged. However, the portfolio’s Sterling gain was curtailed by a risk reduction exercise undertaken in late February 2016 when a little under half the portfolio’s exposure to the US Dollar was hedged at 1.394. The goal was to mitigate the impact of any sharp exchange rate move back to, or beyond, fair value, at the time believed to be above $1.50/£. The opportunity cost to the portfolio during the period was approximately 3% of NAV.

In terms of portfolio developments, the maanger’s added one fund to the portfolio during the period: Chenavari European Deleveraging Opportunities. This provides exposure to the credit of small and medium sized companies in Continental Europe. The managers say that these are typically conservatively run but have nevertheless struggled to access the credit markets since the Financial Crisis. In the manager’s view, the risk-reward characteristics are attractive from a lender’s perspective, but changes in regulations around bank capital risk weightings are forcing at least some of those historic lenders to pass on the contracts to unlevered parties, such as this fund.

Equity Funds represented 22.7% at 30 September 2016, unchanged from 31 March 2016. The manager says that the five funds in this group returned 12.3% during the period, with equities recovering on a 16% rise in the oil price which drove Russian equities higher, and the devaluation of Sterling against all major currencies, which boosted UK equities. Both Japanese managers outperformed their indices, one significantly.

Equity Hedge Funds represented 35.1% of the portfolio at 30 September 2016, up from 32.9% at 31 March 2016. The managers say that the eleven funds in this group expose the Company to Europe, sub-Saharan Africa and the broader Emerging Markets, as well as to gold miners. Their NAVs collectively rose 9.9%, taking the 12 month contribution to 13.2%. The manager says that Africa and Emerging Markets remained challenging, as did some European elements, but these were more than offset by contributions from elsewhere in Europe and the gold miners, the latter being noteworthy for the lack of volatility of returns.

Commodity Funds represented 4.9% of the portfolio at 30 September 2016, down from 5.7% at 31 March 2016. The manger says that these funds expose BACIT to globally traded agricultural commodities; European and North American power, natural gas, coal and oil; and Australasian power. The manager says that asset prices in this subset are volatile and these funds’ risk management is of critical importance. The managers’ performances are reportedly uncorrelated to one another and to the wider market. BACIT’s managers say that this was a difficult period for the funds which gave up much of the gains of the last 12 months.

Fixed Income and Credit Funds were 14.4% of the portfolio at 30 September 2016, down from 16.0% at 31 March 2016. Although there is also an undrawn commitment of 3.0% of NAV. The manager says that the seven funds in this group had diverging experiences. The US Treasury index-linkers benefited from rising inflation expectations, European small and mid-cap credit performed solidly, as did the convertible arbitrage manager. The credit positions relating to property, both securitised and private, had a tougher time, though the former recovered strongly in the second half, and the latter position is almost fully harvested.

Global Macro Funds were 3.1% of the portfolio as at 30 September 2016, down from 12.4% at 31 March 2016. The manager says that this group includes three funds which pursue global macro opportunities, and whose trademarks include profiting from bursting bubbles. Themes they are expressing include the QE bubble through airline over-extension, China slowdown recommencing, and Central Banks’ growing credibility challenge. The manager says that one fund made a small profit and the other two made a small loss during the period.

Other Strategies were 9.2% of the portfolio at 30 September 2016, up from 7.8% at 31 March 2016, although there are undrawn commitments 6.2% of NAV. The manager says that this group includes commitments to four longer-life opportunities. Amongst these is BACIT’s commitment to the CRT Pioneer Fund, the vehicle through which the Company is investing in early drug discovery and medtech candidates with a pipeline deal with Cancer Research UK, and listed as “BACIT Discovery”. The managers say that, although just 29% drawn, CRT Pioneer has now made nine investments. As the fund announced during the period, they have commenced clinical trials with one drug, which has been optioned by a North American biotech company.

Looking forward, on 7 November 2016 BACIT announced plans to transform itself into a ‘life sciences investment champion’. If approved by shareholders on 15 December, the company says that the change in policy will be implemented gradually so the current funds’ portfolio and any additions to it will be the main determinant of performance in the rest of this financial year and possibly for several years to come.

In terms of outlook, the manager says that geopolitical risks have grown, and with them the likely volatility of markets. It is too soon after the UK Referendum and Donald Trump’s election to be definitive as to the probable impact on asset prices, but in the manager’s view, the policies he has revealed thus far support an increase in the base case assumptions for inflation and interest rates.

BACIT’s sterling hedge limits benefits from sterling depreciation : BACT

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