Monthly Fund Focus: Gold, Nutshell growth, Biotech opportunities

Gold prices are moving steadily higher, yet most investors shun the shiny precious stuff. This month’s funds article looks at gold as an asset class, why professionals dislike it, and why UK investors have done well out of the precious metal. It also examines an innovative new way to invest in gold AND generate an income. Plus, a unit trust that I think feels like an alternative to Fundsmith and Blue Whale which uses a thoroughly systematic approach to picking quality global equities. And why biotech investment trust RTW deserves a closer look.

Gold is on a roll

The chart below is, I think, remarkable. It shows the Come gold price since a recent low in 2018. I have also shown the trend line (red and light blue straight lines) plus the 20-day (green) and 200-day (dark blue) moving averages. Gold prices are on a roll and seem to be breaking past all their recent barriers, with $2500 being the most recent. Price spikes from a few months ago were driven by intense Chinese buying, but the recent positive momentum is hard to pin down. Market veterans might point to the recent weakening of the US dollar and the likelihood of lower interest rates, while slightly more contrarian types could also suggest that massive government fiscal deficits, especially in the US, are prompting fears of long-term monetary inflation. Take your pick of explanations; I have no unique explanations.

I can say that here in the UK gold has been a cracking investment for sterling investors. Analysts at the broking website eToro recently put out a note that observed that the price of gold has surged at nine times the rate of UK inflation over the past 20 years whilst growing much faster than the price of real estate. In July 2024, the average price of gold was over six times higher (525%) than it was 20 years earlier, jumping from $391 to $2,446 per ounce. The UK’s consumer price index (CPI) rose by 57% over the same period. The precious metal has also proven to be a far more lucrative investment than real estate. While UK property prices rose 93% from July 2004 to June 2024—easily beating inflation—the price of gold increased more than five times faster.

Graph 1 – Percentage increase in gold and real estate prices against inflation since 2004

Inflation since 2004 (based on CPI) Increase in price of gold since 2004 Increase in average house price since 2004

2009 13% 144% 9%

2014 27% 228% 27%

2019 35% 262% 56%

2024 57% 525% 93%

Source: The Office for National Statistics, Trading Economics, and the Land Registry as of 22nd August 2024.

Given these impressive returns, you might think that most UK-based investment professionals, many of which manage your money, would be big fans of the shiny precious metal. Wrong! New data from Asset Risk Consultants shows that most private client discretionary managers have low exposure to gold, using it sparingly and tactically on price momentum. The report by consultants at Arc makes the following observations:

• Since 2004, gold has risen 570% versus the total return of 610% of world equities
• Since the first modern Olympic Games in 1896 (the same year the Dow Jones was founded) gold is up 120 times but over the same period equities are up 1,000 times
• 75% of private client discretionary investment managers have under 2.5% gold exposure^*
• Gold exposure for managers is tactical (based on price momentum), rather than strategic
• Gold has been more volatile than equities since 2003

ARC found that gold has generally not been a material component of the average private client discretionary portfolio, supported anecdotally by the latest quarterly ARC Market Sentiment Survey (‘MSS’), which included a question asking each discretionary fund manager what proportion of their typical steady growth investment solution is directly exposed to the gold price. Circa 75 per cent of the 83 managers who responded had either no gold exposure or less than 2.5 per cent. No manager had an exposure level above 10 per cent.

An income from gold?

I don’t really have any good explanations for investment professionals’ curious lack of interest in gold. Maybe they think gold is just too difficult to invest in, or maybe they find it difficult to charge fees on simple gold physical holdings. One other possible explanation is that gold, unlike equities and bonds, doesn’t produce a reliable, frequent income – until now.

Of course, there are many ways of owning gold, ranging from buying physical gold coins and bars (which are expensive given the premium charged for refining and classification) through physical gold exchange-traded commodities to gold mining equities (some of which do pay a dividend). We can now add another way of accessing gold – by owning exchange-traded funds that use an options strategy to provide an income from owning gold i.e what’s called covered call writing wrapped up within a gold price tracker. In the US, there’s been a massive surge in ETFs that use some form of covered call options writing—I’ve written about these market-wide products many times in these letters.

The appeal is simple – in the risky world of equities, you can generate income by selling upside options regularly. Covered call strategies have long been used by professional equity fund managers here in the UK – Schroders, for instance, has a stable of very successful Income Maximiser products that have been around for at least a decade.

The practicalities of a covered call strategy aren’t overly complex. Let’s assume you own a stock or an index. You sell away day/week/month call options, which means the buyer of the option makes all the upside past a set threshold – say, the first 3 or 5% over that period.

So, let’s say a security is worth £100. As the owner of said security, I write a call option that says that everything above £103 goes to the call option owner over the next month. If the value falls, the option expires worthless. But if the underlying security hits, say, £110, then the option buyer gets £110-£103=£7 less the costs of the option (say £1, for instance, for a month-long option, purely hypothetically).

Most call-writing strategies implemented by ETF issuers in the UK have been at an aggregate level, i.e. a whole index full of stocks. For example, Global X offers call write options for the NASDAQ or the S&P 500.

In the last few weeks, though, Leverage Shares here in Europe has extended the call writing strategy to individual stocks with the launch of IncomeShares for Tesla, Nvidia and Gold. See more HERE.

The idea is exactly as I explained. You harvest income from owning the underlying securities, which in the case of Tesla gives you an income of 103% pa and 113% pa with Nvidia.

The risk with these equity-backed products is obvious – the underlying value of the shares is very volatile, and the income generated is huge, but you could lose out in two ways. The first is that the underlying shares may collapse in value – Nvidia shares are down sharply in the last few weeks – and then the call options could keep you out of a sudden rebound in the underlying share price. In my honest opinion, call writing for volatile tech stocks is a dangerous game which I would avoid.

However, the third product, the gold income shares, is much more attractive. Why?

1. Gold, as an asset class, offers very low volatility. In fact, gold is one of the least volatile assets available to investors. That means your income upside is vastly lower (no 100% call writing income), but the downside risk in a crisis is vastly diminished.
2. When gold moves up in value, it tends to trend higher over a sustained period with very few day-on-day huge increases (unlike whipsaw rebounds for Tesla and Nvidia). To repeat the same point – gold isn’t that volatile.
3. The covered call structure on offer here is a weekly (every Friday) out-of-the-market call on gold prices. Historical data looking back about 5 years shows that it increased by more than 3% on a weekly rolling basis just ~8% of the time.
4. If gold trends are much higher, you won’t get all the upside (see my discussion of an equivalent US product below) but you will get some/much of that upside trend.
5. In the meantime, the distributing upside, according to Leverage Shares, is about 9.7%

So, in sum, you get some – but not all exposure – to gold on the upside with an income. On the downside, you’ll still be exposed if gold falls in price, but that income yield might provide some cushion. Along the way, you are invested in a classic hedge product, which traditionally never pays an income but, in this structure, receives an above-average (certainly above cash) yield for owning said hedge.

Product details

·         Product Name IncomeShares Gold+ Yield ETP or exchange-traded product

·         Issuer Leverage Shares PLC Base Currency

·         USD ISIN XS2852999775

·         Inception Date 22 July 2024

·         Management Fee 0.35%

·         Strategy: Covered call written on the underlying which is the SPDR Gold Trust ETF (GLD)

·         Countries available: United Kingdom, Italy, Germany, France, Spain, Netherlands, Ireland, Poland and Belgium

·         SIPP/ISA Eligible and UCITS Eligible

·         first payment on 31^st July, paid out to holders on August 12^th

·         website details – incomeshares.com/etps/income-shares-gold-yield-etp/

·          The lead market maker for these options ETPs is Virtu

·         The coverage ratio is 100% – Leverage Shares aims to write calls on the full underlying holdings of GLD, not just a partial amount.

This isn’t a completely new idea. In the US, there is an equivalent product called Credit Suisse X-Links Gold Shares Covered Call ETN (GLDI), which has been around, I think, for at least the last year, and I believe is generating a yield of around 11% pa (on monthly call options from what I can read).

The chart below shows the share price over the last year for the ETN from Credit Suisse (now UBS) in black against the gold price in green. As should be obvious, the gold price has outpaced the income ETN, precisely because the ETN is writing away much of the upside on a regular basis. Nevertheless, the ETN has trended higher with the gold price, and I sense that a weekly call structure should capture more of the upside if the gold price does head higher.

Bottom line?

I would avoid single stock, covered call ETN/ETP/ETFs as they are, in my view, just too risky even for an adventurous type. But I quite like the defensive profile of this Gold Income Share. It provides some hedge protection against macro and geopolitical risk while also generating some income. In a pure physical gold tracker ETC, you will be better off in a bullish environment (for gold), but you won’t get any income. These Income shares do remedy that situation. For the right defensive investor, these could be a great hedge against risk.

Nutshell Growth Fund

Many moons ago—the late 1990s, to be exact—I got a tad obsessed with stock screening. I’d spend hours assembling a vast list of screens and then unleashing them on the market. These screens varied in nature; some were value-driven, others momentum and growth. Each had myriad metrics embedded within them, and I’d spend many happy hours (!?!) updating these via systems such as Sharepad (or Sharescope, as it was then known).

This unhealthy obsession even found its way into print via the Investors Chronicle, where we launched a dedicated Stock Screening Newsletter for slightly nerdy types like myself. God, it even ended up in a book for the Financial Times which, at one point, allegedly cost hundreds of pounds to buy second-hand (Smarter Stock screening was the name of this magnum opus).

Now, reflecting on my earlier obsessions, I’ve begun to see a link all the way through to my more recent interest in exchange-traded funds or ETFs. What interested me all those decades ago was the idea that one could be

1. Systematic in-stock selection
2. There were some screens that worked better in different markets than others i.e. there is no magic, one-size-fits-all all route to investing success
3. You were removing the emotion from investing and
4. You weren’t over-reliant on analysts’ reports and forecasts

Scratch away the veneer of quantitative reasoning, and I think I was already articulating an inherent suspicion of what one can call idiosyncratic stock selection risk. In simple language, I was deeply worried by the way that active fund managers took all sorts of weird risks based on hunches, projections, and guesses. This drew me to stock screening and its ruthlessly numerical or quantitative way of looking at markets.

If one used the language of economics, what interested me was quantitative investing and factor-based investing, i.e., picking out factor metrics to screen through a market. Over time, this idea of factor investing emerged into the mainstream of investing via exchange-traded funds or ETFs. The first iteration was smart beta – ETFs that screened a market using either single factors (value, momentum) or multiple factors. Whole fund management firms such as Research Affiliates/RAFI and Ossiam emerged to champion these fundamental factor ETFs.

But smart beta never really took off with mainstream private investors – they remain popular with big institutions – because there was something missing in the mix: the human sitting at the centre of the quantitative machine. Yes, it’s great to remove emotion and subjective forecasts from the process of selecting stocks, but you still need humans to do three vitally important things:

1. To manage top-down risk
2. To make sure that the models and systems still have relevance and don’t need tweaking and, finally
3. To trade the positions efficiently and cheaply

Most smart beta ETFs have faded away or have very little money invested in them because many mainstream investors worry about this lack of humans in the machine. But factor-based investing is still a great idea—it removes emotion, lets the numbers speak, and helps reduce costs by not overpaying for an active fund manager and their company sports car.

What’s emerged is a middle ground, usually run by hedge fund managers. They employ systematic factor models but build in human-controlled risk management systems and then overlay human-based trading capability (knowing how to size trades) to implement the strategy. These strategies come in all shapes and sizes, with the most common being relative value investing. It works and makes many hedge funds a great deal of money, but it’s mostly not available to private investors.

Back in the less rarified world of funds aimed at private investors, a version of this systematic investing has emerged in what I call the School of Quality. Well-known fund managers such as Terry Smith or Nick Train run big funds that are fairly systematic in their approach to finding what they perceive to be quality stocks with real growth potential at reasonable prices. Some call this the quality factor, though others think that quality is too undefined to qualify as a factor (there are quality ETFs, by the way). Jamie Ward over at Sharepad has a great article critiquing many quality approaches – you can read it HERE.

Quality as a factor is much debated, but in reality, you’re probably looking at a combination of the following metrics:

–          High operating margins and highly profitable

–          Decent balance sheet

–          Positive share price momentum

–          Reasonable valuation metrics given the growth potential

–          Some moat of competitive advantage

–          Probably, the need for a liquid stock and decent visibility of finances pushes you towards more mid to large-cap stocks

Cynics will mutter that this sounds a bit like cakeism for investors: a bit of value here, a bit of growth there, add a bit of momentum, and they’d probably be right. Some economists, as I have already noted, doubt that quality investing is a factor, while plenty of commentators have noted that quality investing is so elastic that it can include huge swathes of the market.

Nevertheless, the intrinsic underlying appeal of quality doesn’t need explaining. Who doesn’t like great world-class businesses whose shares aren’t overvalued? At this point, my old concerns about idiosyncratic bias and emotion creep back in. I worry about the lack of rigour and the degree to which emotion and attachment to stocks come into play, and I hanker after the cold, unsentimentality of the hedge fund versions that aim to be rigorously systematic.

Cue an interesting, relatively new boutique manager called Mark Ellis and his Nutshell Growth fund. Mark’s background is a classic mix of banking prop desk trading – 25yr+ NatWest Markets and Citibank – plus long stints at fund managers such as Symmetry Investments. But Mark has also fallen hook, line and sinker for the school of quantitative systematic investing and drunk deeply from the fountain of factor investing, even penning his academic paper on the subject while doing a post-grad degree in quant finance.

In a rather unusual move, Mark abandoned hedge fund land and is now offering his systematic process to retail investors with some help from a City grandee – his new Growth fund was seeded & supported by the Family Office of Lord Michael Spencer, the founder of ICAP. The strategy was incepted in January 2019 & over three years, has consistently outperformed global Quality/Growth peers – it is classic quality factor investing with a bias towards growth stocks but with a rigorous top-down risk control process overlayed.

Nutshell Growth: Process

Mark’s approach is to avoid the behavioural biases of traditional fund managers. Inside his black box, he has built a proprietary model that includes 30 different factors based on his original research published back in 2004. These measures include classic quality growth metrics such as high return on equity (RoE), high Profit Margin and strong share price Momentum, and valuation measures such as P/E, Free Cash Flow Yield, and Expected IRR. In the technical language of factor investing, Nutshell Growth is biased towards size, credit strength, quality and profitability and slightly biased to momentum.

To manage risk, Ellis has a series of metrics based on capital preservation, including something called minus beta, which measures how companies perform relative to the index on down days. There’s also an in-house, proprietary Recession Indicator.

As for implanting these metrics, the Nutshell approach starts with over 10,000 stocks, uses classic metrics to win them down to 600 stocks and then uses the factor model to end up with a shortlist of 200 stocks, which are closely monitored over many years. This shortlist is also subject to various exclusions such as China risk (see next idea) and, more obviously, a detailed ESG screen. Mark is a big fan of ESG screens, me less so – so the less said on this score, the better!

The last element is what’s called agile rebalancing i.e the portfolio is actively traded (turnover on an annual basis is well over 100%). This sizing of bought-in positions and managing selling stocks marks this fund out from investors such as Nick Train, who historically sit tight in their positions for long periods of time. This could sound an alarm bell for many investors in terms of extra trading costs but Ellis says his trading background means that only a few basis percentage points are added to costs. He also points out that the historical beta of the fund has “been considerably lower than indices and most peers – we have run with less risk”.

So, in simple language, you’re buying into a systematic, quality, and growth global equities fund that is very active in-stock selection and managing downside risk, with an additional ESG overlay if that’s your thing.

It’s more expensive in terms of fees than a quality ETF, but you have much more active manager involvement than an ETF, and the newish fund has built up a more than decent track record in comparison to its actively managed peers such as Fundsmith and Lindsell Train.  The high turnover also distinguishes this fund from many of its quality peers, such as Fundsmith and Lindsell Train (who manage vastly bigger sums of capital). But I would argue that the Nutshell strategy is vastly less idiosyncratic and personalised!

Fund details: Nutshell Growth Fund

·         Description: A concentrated portfolio of exceptional companies at reasonable valuations

·         Top ten holdings (end July) at 60% of portfolio: Alpha Group International, Arista Networks, Alphabet, AutoZone, Fortinet, Fortnox, Hermes, Meta Platforms, MSCI, and Nvidia

·         Launched 18/5/2020

·         Current portfolio: 60% US, 10% UK, Consumer discretionary 29.7%, IT 29.4%, Financials 21.9%

·         Portfolio characteristics: PE 21.6, free cashflow yield 3.7%, Return on Equity 42%, average beta 1.08

·         Fees: Institutional Founder (0.85%), Institutional (1.00%), Retail (1.15%)

The graphic below lists companies that found their way into the Nutshell screens over time

The table below shows returns on a historical basis for the Nutshell Growth fund

The next table shows returns against the peers Nutshell likes to identify: these include well-known names such as Fundsmith and Blue Whale.

Looking at the portfolio at the moment, Ellis is highly confident—he reports that “the last recalibration has led to the highest tech exposure since the fund started. The growth and valuation factors coupled with momentum are very compelling and suggest this sector and the AI story have further to run, especially versus the alternative investment set on offer.”

As for seasonality, Ellis suggests watching the US election cycle:

“historically, US Midterm years have struggled in Q2, after which point returns have been strong, especially in Q4 and Q1/Q2… Investing now gives exposure to historically the most lucrative seasonal period in the US Election Cycle”.

And how did the fund react to the recent market turbulence? On LinkedIn Ellis reports that:

“Last week’s market volatility offered a significant tail-risk event, revealing how funds perform under exogenous shocks. Our proactive relative value strategy allowed us to navigate these challenges with minimal drawdown. As a result, we ended the week roughly flat and are currently only about 1.4% below our all-time high as of Friday, August 9th – IF GBP class.”

My bottom line? If you’re looking for an emotionless, hedge fund-style, systematic way of gaining exposure to a quality basket of global stocks, then I think Nutshell Growth has real merit. Its very active trading approach may scare some investors off, but I would suggest that you be ruthlessly pragmatic about both the buying and selling process and be on top of market liquidity and trading risks.

If one were an overtly cynical, dismal economist type, one could worry that quality investing might go out of fashion or stop working as a factor. One might also worry that the model might be tinkered with and quietly modified over time, detracting from future returns, but the chief attraction, I think, will probably remain – this fund is about finding decently valued growth stocks with positive momentum. That’ll clearly be a dismal place in weak, risk-off markets, but in the long term, I would argue these kinds of stocks have consistently outperformed.

RTW Biotech Opportunities

RTW has undergone a profound transformation in the last few years. I’ve been writing about this fund for at least the last two years, and I continue to own stock and add to that holding regularly – more so in the last few days. When I first started writing about the fund, it was seen by many in the market as more focused on life sciences venture capital, with more of an emphasis on private investments. That puts it in the same category as another UK-listed fund, Syncona, which has been deeply unpopular in the UK and currently trades at a discount of over 40%.

But RTW has been transformed over the last few years into a vehicle that is primarily invested in listed biotech firms, admittedly on the smaller cap end of the spectrum. Most of its portfolio investments are now public companies and private companies are probably no more than 12 to 18 months away from an IPO. The takeover of Arix – another UK-listed life sciences investor – was also instrumental in that transformation, delivering a healthy pile of cash, which it has now broadly deployed.

From a low point in NAV terms in late spring 2022, we’ve seen the NAV climb steadily until last week —the NAV increased by 7.7% in June alone, with the fund boasting a NAV of $655m. By comparison, the Russell 2000 Biotech Index and the Nasdaq Biotech Index returned -6.51% and +2.6%, respectively. The RTW share price discount has also tightened from a peak of around 40% to its current level of just under 20% at the end of July.

The current increase in the NAV is in part driven by gains in a firm called Avidity, which has driven returns for the second quarter in a row. According to RTW, “The company shared Phase 1 data for its second program, FSHD, another muscular dystrophy with no approved drugs that ends with patients in wheelchairs. Treatment improved muscle damage markers and increased muscle strength. After some struggles the past couple years, second generation RNA medicines are now delivering exciting breakthroughs.”

The Arix deal has also allowed the fund to ramp up its programme of new investments. RTW completed investments in six new private companies in the first half of the year, including two in obesity – this included a firm called Hercules which according to RTW is “one of the largest biotech company creations this year. Its clinical-stage pipeline includes an injectable GLP-GIP and an oral GLP in-licensed from Hengrui, one of China’s leading biopharma companies.”

RTW has also benefitted from M&A activity and new IPOs. One such deal was J&J’s takeover of Numab, a bispecific immunology company, which was bought for $1.25bn. To reflect the deal, the company’s holding value of Numab was increased by 2.86x. In terms of IPOs, Artiva Biotherapeutics has just completed its listing, valuing it at $116 million. As of 30 June 2024, Artiva represented 0.13% of the Company’s NAV.

I’d also note that broker sentiment is improving regarding RTW. Investment bank Jefferies and their highly regarded analysts Matt Hose only last week brought out a note suggesting the fund was a buy.,

“We see RTW as uniquely positioned among life science funds, as its approach of full lifecycle investment across the capital structure widens the opportunity set and allows for various points at which to crystallise value. Its private marks seem fair given frequent revaluations and a strong track record of uplifts to IPOs/exits, something that will become increasingly pertinent as the fund once again makes greater use of private investing following a shift away from public market opportunities. Risks include a key man (Roderick Wong) and a lack of formal discount control/continuation votes. The latter provides limited share price catalysts, although in NAV terms the portfolio will likely benefit from the IPO window opening, in addition to industry trends underpinning biotech M&A. RTW trades on a 25.4% discount to our estimated NAV, and we initiate coverage with a Buy recommendation.”

I would point to a possible tightening of the discount as a crucial short-term driver of the share price. The great majority – over two-thirds – of the portfolio is now in publicly listed businesses, which puts the fund in the same peer group as Biotech Growth Trust and BB Biotech – both of which I also rate highly. These long-established funds have a significant small-cap bias – as does RTW – and Biotech Growth Trust trades at a roughly 9% discount, while BB Biotech trades at an 8% discount. RTW does have greater private investment exposure but many of these businesses are very late stage (no more than 18 months), and thus a more significant discount compared to Biotech Growth and BB) is justified but not one that is as I write this well over 20%.

I sense that a 10% to 12% discount would be more appropriate, implying at least a 9% to 7% tightening of the discount over the remainder of the year.

At the current, more depressed price of $1.55, I would be a strong buyer of the shares.

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