The simultaneous decline in prices in equities, government bonds and corporate credit on a scale not seen for many years hit global charitable foundation £34.8 billion Wellcome Trust’s portfolio last year. But in its latest annual report, the charity established in 1936 with legacies from pharmaceutical magnate Sir Henry Wellcome, states that its allocations to property, some hedge funds and holding most of its assets in currencies other than sterling, also stood it in good stead, helping the portfolio return 1.7 per cent in the year to 30 September 2022.
Black spots
One of the worst hit portfolios was public equity, although Wellcome had prepared for a more difficult environment by holding fewer equities (its lowest allocation this century) and more cash. The £13.7 billion public equity portfolio returned -12.7 per cent in absolute terms and was the principal cause of weakness in the broader portfolio, although the internally managed equity portfolio (the Global Compounders Basket) did better than mandates with external managers.
Indeed, Wellcome’s £4.0 billion portfolio of outsourced equity had a “very poor” year. No manager outperformed their underlying benchmarks with the worst performance in absolute terms coming from global growth where the portfolio was down -37.4 per cent. Still, the report states, “We can tolerate this kind of volatility given our long-term perspective – this manager has been in our portfolio since 2003, during which time they have delivered annualised returns of +11.6 per cent.”
Now Wellcome Trust is watching for an opportunity to deploy capital back into public equities, which, it says, (at the right price) should be the default liquid asset class for long-term, unconstrained investors.
(Some) hedge funds do their job
Wellcome’s £4.9 billion hedge fund portfolio (12.4 per cent of total AUM) protected value and delivered a positive return of +5.7 per cent. However, there was wide dispersion within the portfolio. The absolute return funds, which are hedged with sophisticated risk systems and can seek profits in any asset class, delivered +33.7 per cent. In contrast, the £2.3 billion allocation to equity long short hedge funds failed to protect on the downside and delivered a worse return than global equities at -13.3 per cent. Cue possible changes ahead.
“There will be some changes to composites from next year,” the report states. “As a group [long short hedge funds] have underperformed the long bull market in equities and failed to protect our capital as the market has turned. This has led us to consider carefully our exposure to these vehicles.”
However, the report also notes a wide dispersion among long short managers, indicating that some have adapted more rapidly to a very different environment than others. The best performing manager was up +16.2 per cent, while the worst was down -50.0 per cent.
Going forward, Wellcome plans to aggregate reporting on the equity long short funds with its public equity exposure, given the high correlation with equity market returns. This reflects the objective for these managers to deliver a superior return to equities through the cycle by adding value on both the long and the short side. “It is, as we have seen, a tough task,” states the report. The absolute return funds will continue to be reported separately.
Stalled private equity
Despite a one-year return of +7.7 per cent, Wellcome’s £14.8 billion private equity portfolio has not escaped unscathed from drawdowns in major liquid asset classes. Sizeable mark downs are linked to underlying companies requiring fresh capital, something Wellcome expects will be repeated more widely across private assets over time. Moreover, cash flows from the private portfolio have turned negative as IPO markets have slowed down and distributions dried up. However, Wellcome will not pare back investment. “With capital now scarcer, our PE partners are more likely to seek willing co-investors and we are open for business.”
The investor is also keeping more cash on hand in anticipation of distributions remaining thin. “We are keenly aware that cash holdings are rapidly eroded by inflation but for now, we remain content to retain the optionality of a higher than-normal cash balance, especially as it seems likely that distributions from PE will remain subdued for the foreseeable future,” states the report. The largest portion of the private equity portfolio lies in VC funds (£8 billion) bringing exposure to “some of the most exciting, innovative companies in the world.”
Strategies relying on access to abundant cheap leverage will face a particularly difficult future, adds the report. Inflation is a key challenge for all investors but our portfolio strategy of holding real assets (equity and property) and issuing fixed rate nominal debt should provide some protection over the long-term, states the report.
ESG
Emissions in Wellcome’s public equity portfolio have fallen 35 per cent over the last year. A year-on-year decline Wellcome links to its exits from holdings in BP and Shell, sold as part of a strategy of reducing exposure to cyclical stocks. “Of course, our exit from these holdings has not reduced overall carbon emissions, simply those that are linked to our own portfolio.”
Outside of public markets, Wellcome notices increasing recognition that buyouts managers’ longer investment horizons and advantageous governance structures mean they can play a significant role in catalysing the transition. “But there is much work to be done here.”
Wellcome has written to its buyout partners to share examples of best practice and set out its view of gold standard net zero target setting in private equity. “Positively, some of our buyouts managers already have net zero targets, which include commitments to require this from portfolio companies,” it states.
China
Wellcome’s annual report also alludes to the impact of decoupling trends. There remains every prospect that the economies of many Asian countries, including China, will grow faster than those in Europe and North America, it states. However, as the last two years have demonstrated, it is not always easy to translate economic growth into portfolio returns. “The assumption that we can access investment opportunities across the world in a relatively unimpeded way may no longer be valid if we see increasing fragmentation in the global economy and a retreat from integration.”
