QD view: The budget has been dominating headlines this week. We set the scene and covered the big changes in the budget earlier in the week. The question is, what effect will this have on the UK economy and the trusts that are exposed to it?

National Insurance hit to big employers

This week’s interview with Job Curtis, manager of The City of London Trust (CTY) also covered the budget impact. He noted the potential impact of higher National Insurance charges on big employers such as retailers. Hospitality and leisure companies may also be hit, although smaller firms will be cushioned from the worst of the effect and will also benefit from a reduction in business rates.

The other thing that Job highlighted was the uninspiring forecasts for GDP growth in the budget. He is not convinced that increases in public spending will feed through into improved productivity and economic growth.

Gilt yields jump

Job also referenced the jump in the UK government’s cost of borrowing. When the Chancellor began speaking, the yield on 10-year UK gilts was 4.24%, they then moved sharply higher, peaking at around 4.53% on Thursday afternoon, before falling back to about 4.47% this morning. These levels are the highest they have been since October 2023.

The market seems to be concerned about the sheer volume of gilts that it will be asked to buy over the coming years. There may also be unease that, based on the analysis carried out by the Office for Budget Responsibility, inflation is not forecast to return to the Bank of England’s 2% target for some years yet, which underpins the argument that interest rates need to stay higher for longer.

This is not great news for infrastructure and renewable energy companies but their share prices, while down, have not been hit too hard. In my view they were already way too cheap and the yield premium that these funds offer relative to gilt yields is more than high enough already. This week, we published research on Bluefield Solar Income Fund (BSIF – which currently yields 8.3%) that sets out our thinking on this.

BSIF’s manager, James Armstrong, highlights the government’s commitment to its Clean Power 2030 mission, which includes a promise to treble the UK’s solar power capacity. The success of the latest Auction Round (AR6) of support for UK renewable energy projects is encouraging in this regard. BSIF secured some of this for projects in its pipeline.

Higher gilt yields are generally not great for funds focused on growth stocks either. However, again many of these already look oversold. Part of the problem for growth capital and private equity funds has been that the past couple of years have been a slower period for exits. However, it has been looking for some time as though IPOs will be easier to achieve next year (although not necessarily in the UK – see below).

That spells potential good news for the likes of Chrysalis (CHRY), which flagged a potential IPO of Klarna this week and the significant effect that this would have on its financial position, noting that it has £109m of liquidity (from the sale of Graphcore) and the drawdown of its new £70m loan facility. To come, it has the proceeds of the sale of Featurespace, but crucially it also expects a Klarna IPO in due course, saying the next potential window is in the first half of next year. It thinks this could boost its NAV and leave it with around £200m of potential liquidity, equivalent to about 38% of its market cap.

Takeover activity continues

It was also noticeable this week that Oryx International Growth (OIG) announced two takeovers (here and here) in two days, of companies within its portfolio, and Augmentum Fintech (AUGM) announced another. NB: OIG’s NAV in our Morningstar data is as at 30 September, so it does not yet reflect those two sales. Elsewhere, in our sector, we saw another merger announced – this time between Invesco Asia (IAT) and Asia Dragon (DGN).

Corporate activity has had a big impact on UK small cap returns and this is really evident in the performance league tables where more activist trusts such as Crystal Amber (CRS), which has been dismembering its portfolio, and Rockwood Strategic (RKW) sit at the top in NAV terms over the past 12 months (up 57.6% and 45.7% respectively).

In fact, given the general doom and gloom of headlines, it is remarkable how well UK small cap trusts have done over the past year, with abrdn UK Smaller Companies Growth (AUSC +33.3%) and Rights and Issues (RIII +29.0%) occupying third and fourth place.

The budget has had a massive impact though on those trusts that had exposure to AIM stocks. These have been selling off in recent weeks on fears that IHT exemptions on holdings in AIM stocks would be removed entirely. In the event, the loss was of half the IHT exemption, and the relief sent the AIM market sharply higher. RIII was one of those affected by this rollercoaster ride.

Other changes to IHT exemptions in the budget, such as the removal of agricultural and business property reliefs for assets above £1m, make AIM stocks, with their now 20% relief, look relatively attractive.

We did not get any change to tax-free savings vehicles beyond the big one (that inheritance tax will apply to unused pension pots from April 2027 – transfers to spouses and civil partners are still not taxed, however).

Savings limits for ISAs and similar vehicles are unchanged, the EIS and VCT schemes have been extended. However, the British ISA has been abandoned as unworkable.

So, rumours about how the government might encourage/force savers to invest in the UK seem unfounded. Although we have not heard the last on this as the Chancellor will make her first Mansion House Speech on 14 November and has promised to use this to set out “how we will support our world-leading financial services sector to grow, innovate and finance growth around the country”. It may be that there is more to get excited about then.