Hardman & Co. Economist Keith Hiscock discusses the plight of the UK economy in the aftermath of Brexit and considering global monetary policy tightening. Host Guillaume Roux Chabert digs for investing insight surrounding key British sectors of legal firms and real estate.
Summary – IBKR Podcasts Ep. 62
The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.
Guillaume Roux Chabert
Welcome to our podcast. My name is Guillaume Roux Chabert and our guest today is Keith Hiscock who is the CEO of Hardman and Co. and today’s topic is about the UK economy. Welcome, Keith.
Guillaume Roux Chabert
I have a couple of questions and we’re going to have a crack at it immediately. So, one of the first questions I wanted to ask you actually, Keith, is that we always hear about the negative impact of Brexit to the UK economy. So, could you tell us what are the positive impacts to it and what were the unexpected outcomes?
OK, so my first approach to this would be to quote from a well-known comedian in the UK called Al Murray, who recommends when if you get asked a question or somebody expresses an opinion about Brexit to say, “no, no, it’s much more complicated than that”, and I think that’s probably the case here, and I think he’d probably also say, “well, it’s too soon to say.” I think there is some academic evidence that says that Brexit has perhaps reduced GDP by 2% or so but you’re asking what are the positives about it. So, I guess if I were on that side of the debate, I’d be saying look at how quickly the UK got vaccines through its approval process for COVID and [pushed] out into the market. Would we have been able to do it as quickly if we were still in the EU? I think the proponents of that view would say we’d have had to sign up to some EU initiative and that would have slowed things down. So that would be one positive. The second one is the ability to sign our own trade treaties. They’ve been a bit slow coming frankly. Basically, all we’ve done is to just roll over the Treaties we’ve already had as part of the EU. Next one would be – this is a very particular one – we’ve got control of our fish stocks and that certainly has happened.
But I think to some extent the proponents of Brexit were as interested in sovereignty as they were in the economic impact of it and lots of people who voted for Brexit probably hadn’t benefited very much from the EU over the years and so they weren’t really bothered about leaving it. But I think to finish on a positive note, I think that what the proponents would like to see is London turning to Singapore-on-Thames and would argue we’ve got many of the attributes necessary for doing so – and even an island.
You say what are the unexpected outcomes? Well, I think we’re all surprised about how difficult it has been to resolve the Northern Ireland Protocol and to get that working but I think both sides are probably now of a mind to get that and everything else working rather better. We’ve gone through that period of where people are angry at each other. Whatever side of the debate you might be on where governments were angry with each other, and I think, particularly with the Ukraine war going on, I think we’re all minded to say, “Well, actually there’s a much bigger principle here at stake, and let’s just try and sort these things out.” So, there were some unexpected outcomes, I think it was largely in Northern Ireland. I think overall it’s probably too soon to say what the positive, what the full positive impacts are, but what people were looking for was sovereignty and to create Singapore-on-Thames.
Guillaume Roux Chabert
Understood, yeah, that’s a very interesting perspective. I just wanted to rebound on what you just said to play a bit of devil’s advocate. As we know the IMF expects the UK economy to shrink in 2023, and to be even worse than Russia, that was the quote. And what would you keep? And what would you be cautious about the IMF conclusions?
Well, so first of all, I think for all economies the outlooks are getting better as we move forward. So, the Bank of England at the beginning of February revised their view to say that the economy wasn’t going to shrink as far as they previously said and that the recession wouldn’t go on as long. So, all the revisions are getting more positive. It is certainly true that the UK has suffered more. We can argue about why that is. If you’re a Labour politician, you’re going to say it’s because of the Conservative Party’s policies, but I think you have also got to bear in mind that the UK is a different kind of economy to many European ones in the sense it’s got a much bigger service sector. So, for example, tourism is a bigger percentage of the economy, legal services, all those sorts of things are larger percentages of the economy. So, there are some different things. So, whilst obviously it’s completely valid to compare the UK with these other economies there are particularly good reasons why it might perform on a different path.
Guillaume Roux Chabert
Understood and it’s great that you mentioned about the Bank of England, so I’d like to drill down a bit on this and to talk about of course, interest rates. It seems there is a strong consensus around the Bank of England indeed keeping the rates very high. Is that also your view and why?
OK, so beginning of February, the Bank of England raised rates – the base rate they call it – by another half percent to 4%. I think the general feeling is that this might be the last increase. There might be one more, but that’s about it. And that’s the message the Bank of England is giving out. So, I think we are pretty close to the top and obviously, interest rates have an impact over time. It’s wrong to measure their immediate impact because there are lots of people that are insulated from it for a while. Say for example, if you’ve got a fixed rate deal for two years for your mortgage, then today’s interest rate, yesterday’s interest rate, tomorrow’s interest rate rises won’t make any difference until you get to the end of that two-year period. You know there’s a danger in being too aggressive on pushing rates up, so I think the Bank of England is feeling that we’re pretty close to the top now. There might be a little bit further to go. How quickly does it [get there]? Are they going to cut it? Well, I think at the moment that is very much dependent upon how quickly you can get inflation down. You know they’re going to want to see that coming down now. We’ve seen the peak and we’ve seen a small decrease in deflation in the UK so far. I think quite critical to it is what happens to labour rates. So, there’s a labour shortage in the UK, which is partly a reflection of Brexit, but there are also quite a lot of strikes in the public sector, which the government and employers are resisting at the moment. I think the government’s fear, perfectly validly, is that if we give everybody a 10% pay rise, then inflation next year is going to be 10%. Then again, so they’re going to want to see, I think the Bank of England and the government are going to want to see their way through that before cutting rates and I want to see inflation falling away. And if anything, that might take longer than many people think.
Guillaume Roux Chabert
Indeed, yeah, and it’s true. We’re thinking like strikes were something from continental Europe but we see that it also expands quite much in the UK. To come back on your point regarding interest rates and mortgage [rates], of course, which is very correlated, would you be able to explain a little bit more and describe the landscape of the real estate industry in the UK, its main players and its current market trends?
OK, so historically UK property has been very attractive to overseas investors because there’s a very stable, solid legal basis to it. If you look at what’s quoted on the London stock market, there are two broad groups. There’s a group of companies that are fairly generalist, and then I’ll come on to some specialists. So, if I look at the biggest players, so there’s a business called Segro (Symbol: SGRO) which has got a market cap of £10 billion and which is about 2/3 in the UK and 1/3 in Europe and essentially, it is in warehouses and distribution assets. Obviously, investors have become quite interested in that space, as the importance of online purchasing has grown in the UK, obviously Amazon’s the biggest player in that market. Next, what I’d look at is a company called Unite Group (Symbol UTG). It’s got a market cap of £4 billion and it specializes in student accommodation in the UK. So the UK is one of the most attractive places for students from around the world to come to get a degree. Partly because of those degrees, partly because it improves their English, which is important in many environments. This company provides accommodation to 70,000 students. That’s a way of playing the growth in higher education in the UK and its attractiveness overseas.
The next one I’d look at is a business called British Land Group PLC, (Symbol: BLND) £4 billion. It’s a generalist property company, so it’s got offices, retail parks. It owns, you might know Broadgate in the City of London. Of similar size is Land Securities PLC (Symbol: LAND) and this is another generalist, so it’s got leisure assets, retail assets, retail parks, bit of office space, all that kind of stuff. So, there are those quite large, some of them quite generalist things.
And then we come to the world of REITs, real estate investment trusts, and there is a whole range of specialisms here, some of which I think are unique to the UK. For example, there are some – I’ll call them funds – because that’s effectively what they are. There are funds that specialize in General Practitioner surgeries, doctors’ surgeries. So, they own the surgery and they rent them to a consortium of doctors to use. There’s a big growth going on in that space because our National Health Service wants to encourage doctors to move into better purpose-built facilities. There are still quite a lot of doctors who are working out of an old Victorian house for example, so the attractions of that area are the fact that the government is effectively the tenant and many of these are inflation proofed, so that’s one area.
We’ve got some businesses that specialize in owning supermarkets, that are let out of supermarket groups. We’ve seen a boom in warehouse and logistics specialists. It’s coming off the top because of the boom in online retailing – you know that now COVID is over in the UK and across Europe – you know that’s sort of quietening down.
We’ve got funds that specialize in social housing. So that’s housing let out to other people who would have lived in government-owned accommodation or people who are vulnerable, might have mental health issues or things like that, and again, that’s backed by the government.
We’ve got funds that specialize in ground rent, so in the UK we have this distinction between freeholders and leaseholders of some properties, and the freeholder collects a ground rent and owns the property and when the lease runs out, you know the lease could be from starting from 100 years to 999 years, it reverts, all of it reverts to the freeholder.
We’ve got some funds in the UK that specialize in nursing homes or care homes, there’s a couple of those. They build and own care homes that is then let out for old people to live in when they can’t live at home any longer.
And then we’ve got some regional funds, so you know, there’s a fund specializing in property in Germany. There’s a fund specializing in property in Macau. There are lots of little specialists, and so there’s a whole range of things there. You know, some investors want to say, “I’d like to have a broad exposure to property”. So, a Land Securities with leisure, retail, or retail parks, that sort of thing might be appropriate. Others say, “well, actually I’d like to really drill down and just own things that are rented out to the government, so I’d like to buy companies that have got GP surgeries”, for example. So, there are lots of options about, you know for investors, depending on which way they want to go.
Guillaume Roux Chabert
Excellent, that’s really interesting too. A little bit more in-depth insight on this real estate industry in the UK and related to the industry, of course, one of the impacts that could be generated is the tax change. Given that you have a brand-new Prime Minister who is like clearly oriented to develop the economy and claim many times that they will be there to slow down the increase of the tax or maybe like a cut on tax. Do you still foresee a significant increase in tax in the coming month?
OK. No, not under this Prime Minister and Chancellor. We’ve just had a round of tax increases. I think that’s it, and those tax increases were largely freezing of thresholds and something economists called fiscal drag. So, for example, there’s an amount of income you can earn in the UK free of tax, £12,500 basically. And that would normally go up in line with inflation, but it’s not going to go up in line with inflation this year. So, more people are going to be caught paying some tax and that’s as I say, that’s called fiscal drag, so that’s largely what it is. In fact, what the Chancellor is, what we call our Finance Minister, what he’s signaling is that the next move is going to be down and there’s a political reason for that. We have to have a general election by January 2025. In reality, it’s probably going to be in the autumn of 2024 and so, it would make a lot of political sense to cut taxes in the spring of 2024, so that has some impact that makes people feel better, has an impact by the autumn of that year. And that helps the chances of the Conservative government getting reelected, and I think that’s what is probably going to happen, and that’s certainly what the Chancellor is signaling.
Guillaume Roux Chabert
Understood, that’s great. Maybe I’d like to talk a little bit about a different industry, which is maybe less impacted by tax than the real estate industry, that’s the law and legal services industry in the UK, which is very well represented amongst the listed companies on the London Stock Exchange. Could you give us a little bit more insight on this specific sector? Because that’s a bit of UK specificities, and could you provide some interesting insight on this industry please?
So, in all countries law is quite an important industry, but in pretty well every country, it’s very difficult for investors to participate in because most law firms are partnerships owned by their own partners and there’s no option for investors to invest in it. If we step back and look at the legal services market globally, it is growing faster than GDP. If you were to look at the correlation between the wealth of a country and its legal services, you’d find the wealthier you get, the bigger the percentage of the GDP is accounted for by law firms. There’s a particular reason why London is most interesting, because London is probably the center of the International Legal services space and there are lots of cases that in reality, have happened outside London that end up being tried and settled in London and it’s because people trust what happens, there’s no corruption around it, et cetera. So, London is a very important space. It’s only in the last, I guess 10 years that you’ve been able to invest in law services in London. You can do a little bit of it in Australia. You can do a little bit of it in the US. Essentially all the sorts of things you can invest in fall into two parts. There are legal services firms, so these are solicitors or attorneys you might call them in other countries and you can now invest in them. And London has got firms such as DWF Group PLC (Symbol: DWF), Knights Group Holdings PLC (Symbol: KGH), Gateley Holdings PLC (GTLY), quoted. There are several of them. They’ve got slightly different business models. So, Gately is a kind of quite a generalist service. Knights Group is more of lots of high street lawyers, so that’s one area that you can invest in and say Gately’s has got quite a bias towards the corporate space. And then the other area that you can invest in is in the cases themselves. So, it is possible to buy a stake in a law case through a litigation funder.
So, what has happened is that if you’re a partner in a law firm and you might have a case that could take 10 years before it’s going to be settled and it might be that your client says, “well, actually I can’t afford to pay you along the way. I’d rather give you a share of the outcome if we win.” The difficulty with that, of course, is that if you’re the lawyer, you’ve got costs and expenses along the way. You know the children need new shoes, don’t they? And so, you can’t really finance that or you’re unwilling to finance that. Well, there are now a group of firms that can now provide finance for that sort of thing. So, the best-known one probably is Burford Capital Ltd. (Symbol: BUR). So, if you invested in Burford Capital, what you’re doing is investing in court cases. You’re taking the view that the people that run Burford Capital decide what court cases to invest in, are experts in this field and they can understand what are the chances of this case succeeding and if it were to succeed, what are the chances of getting the money off the other side. That’s their specialization. So, what Burford Capital does, is it provides funding for these cases along the way. So, the solicitor gets paid, but in return the solicitor gives up his right for that share of the fee at the end. So, this is a very interesting asset for some investors, because the success of Burford Capital has nothing to do with what’s going on in the stock market, or the economy, or bond markets, or anything else like that. Its success depends upon it finding cases, making the right decision, to invest in the ones that are most likely to win, and then collecting the money at the end. So, investors think of that as an uncorrelated asset, i.e. it’s not correlated to the economy or the stock market or anything like that. That’s a very interesting asset to have.
There’s another one rather smaller than Burford Capital, I mean Burford Capital market cap is about just under £2 billion. Another example would be a business called Manolete Partners PLC (Symbol: MANO). This does the same sort of thing, but this is a specialist essentially in liquidation. So, when a company goes under, and the receivers are called in to wind it up, there are sometimes people who got a claim and say that the company or its management have done something wrong. So, you know, a typical example would be that they’ve bought an asset. Let’s say they bought a brand-new Rolls Royce and then sold it to themselves at 10% of the cost at the expense of the business. So, what Manolete will do is pursue them for that money. So, it’s not uncommon, for example, for a business, for the owners of a business, rather than take a salary or remuneration to make themselves a loan. And in doing so they postpone paying any income tax and something they might even avoid it, but they can’t. When that company goes under the management and the directors sometimes think, “Oh well, the company’s gone under. Therefore, I don’t need to repay the loan”. Well, no, that’s not the case snd so, what Manolete does is to pursue those claims. Now, again its success is related to those claims. You know, are they going to win it, et cetera? But there’s a difference here between Burford Capital and Manolete, so Burford Capital has quite a lot of long-period cases that throws up the issue about how you know if a case is going to take, let’s say 10 years to settle, how do you value it along the way? Manolete, specializing in this space, typically, these cases take nine months to resolve, so there’s less of that issue. So, it’s another litigation funder, but it’s in a very specialist area, so there’s lots of different options to go and these different sorts of businesses have got different investment attributes so that the investor has the choice of deciding which way he wants to go. But most importantly, it gives the investor the opportunity to invest in legal services, which is pretty well impossible to invest in on most other markets.
Guillaume Roux Chabert
Indeed, absolutely, and it’s quite impressive to see how diversified this industry is. Well, we are reaching the end of our podcast, so I just wanted to thank you Keith for joining today. I think we have several take away for today about the UK economy topic that deserves more attention. Especially it seems, we are probably seeing our last increase of rates from the Bank of England as you said. And thank you for providing great insight on the legal and law services, and we have some information also about the health of the related real estate. Thanks for listening also to our audience and more to come on IBKR.com. Thank you very much.
Thank you very much for having me Guillaume. Cheers, bye.
Guillaume Roux Chabert
Thank you Keith. Cheers bye bye.
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