The group pointed out that the first two years of future cash flows typically only account for 11 per cent of the value of a business, suggesting equity markets are oversold.
Equities could deliver “jaw-dropping returns” over the coming years, according to CrossBorder Capital, which said that the recent fall in valuations is completely out of proportion to the impact of the coronavirus pandemic on future earnings.
The fund manager said equity market movements are driven partly by emotion and partly by value, based on discounted future cash flows. Yet it pointed out that the first two years of future cash flows only account for 11 per cent of the value of a business, while for a growth stock, this figure is less than 4 per cent.
“In short, most of the ‘value’ lies in more distant future prospects,” it said.
“Clearly, if a business fails it has no future, but for the vast bulk of firms, this will not be true.”
Emotion also plays a huge role in asset valuations, which is typically expressed through risk premia – the amount by which a risky asset is expected to outperform the known return on a risk-free asset.
CrossBorder said the best measure of raw emotion it has found is investors’ risk appetite, which it defines as the degree of skew found in asset-allocation decisions between risk assets (such as equities) and safe assets (such as cash and government bonds).
The group pointed to a graph of asset allocation versus world economic growth, which shows investors tend to become too aggressive in risk-on periods and too cautious in risk-off periods – and said that arbitraging these swings of emotion can be extremely profitable.
Source: CrossBorder Capital
“From past experience, whenever the Risk Appetite Index is below the -40 index threshold, subsequent two-year ahead returns average +33 per cent,” it explained. “Latest readings show a swing into extreme pessimism with an index reading of -79.9. Such a reading has never occurred in the long data period since 1978.”
CrossBorder said it has other “dangerous” views that run contrary to the current consensus. Another one of these that makes it more optimistic relates to the $6trn worth of global stimulus, totalling around 6.5 per cent of world GDP. This is equivalent to around a one-third increase in the $20trn pool of central bank money.
“Many of the currently depressed pundits should start counting,” it added. “Assuming a standard liquidity multiplier of around 7x – it could be even more because regulators have further freed up capital constraints to the tune of around $500bn – then this implies a $45trn boost to global liquidity.
“This could ultimately push global liquidity higher by as much as 40 per cent, taking it to a record-setting 205 per cent of world GDP.”
Another consensus view is that the dollar will continue to strengthen, which is bad for world growth and tends to hit emerging markets particularly hard as many of these economies borrow in the US currency. The dollar is up about 7 per cent against the pound this year, yet rather than move higher from this point, CrossBorder believes it may have already peaked.
Performance of currencies in 2020
Source: FE Analytics
“Clearly the swap markets are technically ‘short’ dollars, given the huge prospective debt roll-overs required and the likely reduced willingness of US dollar holders to remain on the offer,” it said.
“However, we believe much of this is in the price and so we are still less convinced that the US unit will rise from here.
“In fact, economically, the US real exchange rate needs to fall from current levels to help to rebalance the US economy. What’s more, the US dollar fell after the 2008 financial crisis and did so largely because corporate cash flows skidded lower and Fed supply blasted higher. Same could happen again?
“The subsequent strength of the US dollar since then owes something to progressively tighter Fed policies, but much more to the strong pick-up in US dollar demand as the world and US economies then rebounded.”
The group pointed to a chart breaking down capital flows into those created by the Federal Reserve through money-printing and those taken up by the private sector. When the private sector demand exceeds the Fed’s supply, the dollar typically rises in value over the following 12 months, as demonstrated by the Forex Risk Index. When this measure is falling, it indicates that the momentum of the trade-weighted US dollar is rolling over because the Fed’s supply is rising more rapidly than private sector needs.
Source: CrossBorder Capital
“We conclude from this that the US dollar looks close to a peak,” it finished.
With debate increasing over whether “helicopter money” could help tackle the global economic crisis, we asked Schroders’ chief economist Keith Wade about the tactics of governments.
Rob Crayfourd and Keith Watson, portfolio managers of CQS New City’s Golden Prospect Precious Metals trust, consider what role gold can play as the coronavirus continues to impact markets.
The pullback in gold and gold miners post the Covid-19 market shock provides significant opportunities for active managers who can select individual companies that present the most attractive relative value.
One of gold’s primary investment attributes is as a store of value in uncertain times. Gold is supposed to provide an insurance policy within a portfolio, to protect against market crashes. When the market falls, gold should rally and offset the losses elsewhere in the portfolio. This rule generally holds true until we see a liquidity crunch on the scale of early March, due to virus concerns. Precious metal equities have shown little immunity to a synchronised sell-off of this scale. This has exceeded the selloff during the global financial crisis for its pace and extent. Unfortunately, during these moves everything correlates, as institutional investors scramble to sell relative winners to cover losses elsewhere and address their margin rather than consider true value.
Let’s put this into perspective. Gold initially sold off $200 from its February high of $1,673/oz, but has since recovered to $1,653/oz as of 7 April, a 9 per cent gain year-to-date (YTD). Over that period, the New York Gold Bugs index has lost 12.8 per cent. When we look at gold in producer currencies such as Canadian and Australian dollars, or the Mexican peso, gold has seen much great gains. Gold has also gained 17.4 per cent YTD to in sterling. This is important as producer’s costs are dominated by the country in which they produce, thus their margins will benefit as their costs fall more than their revenues.
Gold performance YTD, normalised to 100 (Orange = Gold in USD, Blue = Australian Dollar, Red = Mexican Peso, Pink = GBP)
The initial pace of the market selloff is what was truly remarkable. The risks of herd mentality are elevated in a market that is overly dominated by passive funds and exchange-traded funds (ETFs) and it looks like those fears came to fruition with the most extreme selling pressure coming from positions held in major ETFs. This provides significant opportunities for active managers who can select individual companies that present the most attractive relative value in a sector that has overly sold off.
Looking forward it is important to remember the drivers of gold. Gold is a currency more than a commodity, although it carries zero government credit risk and thus typically performs well in times of low interest rates and stimulus. This was seen in the performance of gold during the global financial crisis. in late 2008, gold fell to $720/oz, before rallying to $1,900/oz in September 2011. The actions we have seen in the last few weeks include unprecedented levels of government support that exceed even those seen during the global financial crisis. Europe has foregone any budget constraints to raise borrowing to fund large stimulus plans, whilst the US has likewise announced significant monetary and fiscal stimulus. The fall in the oil price is a further beneficiary to miners, with open-pit miners benefiting the most due to higher usage. Although in some cases the full benefit won’t pass through fully to a miner’s costs, as prices can be regulated by the countries in which they operate.
An outstanding question is the ability to operate under the backdrop of Covid-19. We have already seen the temporary closure of mining in South Africa, Chile and Peru, amongst others, due to attempts to reduce the movement of people. We are likely to see further projects forced to wind down in the coming weeks. In general, the miners have strong balance sheets that are able to weather a period of production outage, while any fall in production should support commodity pricing.
While there are still many unknowns, the weakness of the stocks appears unjustified by the fundamentals and strong gold pricing. The ability to operate is a risk, but one that looks manageable for now. In the longer-term fundamentals for precious metals look better than ever as we see the largest transfer of corporate risk on to government balance sheets that we will hopefully ever see in our generation.
Rob Crayfourd and Keith Watson are portfolio managers of CQS New City’s Golden Prospect Precious Metals trust. The views expressed above are their own and should not be taken as investment advice.
Scottish Investment Trust’s Alasdair McKinnon explains how investors are making the same mistakes about US tech as they did with airlines a month ago.
Despite a month of turmoil in markets following the spread of Covid-19 around the world, investors are still holding onto the belief that the large-cap US technology stocks that have dominated performance for so long remain untouchable by the crisis, according to trust manager Alasdair McKinnon.
Scottish Investment Trust’s McKinnon (pictured) invests in a ‘cycle of emotion’ following the peaks and troughs of an investment’s returns on the stock market, characterising the high and low points investors will experience at any particular point.
Seven weeks on from when the US market peaked The Scottish Investment Trust manager said that most investors are “in denial” having come off the ‘euphoria’ stage of the cycle in mid-February.
‘Euphoria’ is the primary stage leading up to the peak of the investment return, which in this current cycle was prior to 19 February. The other end of that is the ‘fear’ stage where investors sell out of a company as its returns bottom out.
But on the way down to that is ‘denial’ which McKinnon said many investors are still going through with US technology stocks despite markets crashing all around them.
It’s a mistake we have already seen in the current market downturn when it came to airlines, McKinnon said.
With airline stocks peaking on 20 February McKinnon said that red flags were already cropping up about airline businesses as cases of coronavirus began appearing outside of China.
“All of February flights were being cancelled, left right centre, the world was slowly shutting down. But the market was ignoring it,” he said.
“And what’s the market doing now?” McKinnon asked. “Well, it’s saying US technology is immune to the cycle, whereas we’re saying ‘no they’re not, they’re just late-stage cyclicals’.
“All these companies that everyone’s worried about how they’re going to pay their bills, well they’re right and they're not going to be able to pay for all these software products. It’s just the next stage in a big slowdown that’s occurring.
“So that’s why we still think we’re in ‘denial’ and muddling through.”
“Just as investors were doing a month ago with the obvious cyclicals they’re now not doing it with the second stage [cyclicals] and we’re saying, ‘Well, hang on a minute. If the frontline cyclicals are basically shutting down, what does that do to the second stage? How are they going to pay their bills if they’re not going to [be able to] pay their bills?”
US technology stocks have largely driven the S&P 500 returns in recent years, as investors have sought to partake in the growth brought about by the disruptive impact of new technological innovation.
But McKinnon believes that they’re not so untouchable because they’re vulnerable to businesses closing and workers having their income reduced.
Not even a company such as Microsoft which has been pegged as a major benefactor from people having to work from home, is immune.
“Microsoft is a great company but it’s done too well,” McKinnon said, adding that investing in it now would not produce strong returns.
“The only way – from our perspective – is down because companies are going to struggle to pay their bills, so they’re not going to be able to pay Microsoft. Microsoft moved to a subscription model and people won’t be able to pay that.
“They’re not going to see the growth everyone thinks they might see, they haven’t thought that through yet.”
Although his portfolio doesn’t hold any US large-cap names McKinnon started to make changes to his own portfolio in order to deal with the impact of the coronavirus in early February before markets peaked.
He said when news of coronavirus cases reached the general public he realised that – alongside it being a human health tragedy – it’d be severely disruptive to the Western world’s supply chain.
But at the time “the stock market didn’t care,” because of the ‘euphoric’ stage they were blinkered to, he said.
As such, McKinnon said that he got rid of a lot of the “deep cyclicals” in the Scottish Investment Trust. Selling out of services, retailers and banks McKinnon explained that although they would’ve recovered if the economy picked back up, if we an economic shut down followed it becomes harder to value cyclicals, “cheapness is no measure here since the earnings potentially are going to disappear”.
But he didn’t sell every cyclical stock in the portfolio.
“We are aware that this virus will pass, although we don’t know how long,” he explained. “And a mistake I've noticed over the years, with people – and myself as well, I’ll add – is you can get too wedded to the current environment and take your eye off the prospect of change.
“We know at some point there’ll be a big down-leg, and then they’ll be recovering, just as there’s often a big up-leg, and then there's a big fall.”
As such he is holding onto supermarkets because people need to keep buying food – although McKinnon said he didn’t foresee the food and stockpiling boom people went through before the lockdown. He also added to tobacco, utilities and gold mines and held onto cyclicals which were “relatively resilient” in the current climate.
Although he admitted that making these changes so early in February he wasn’t sure if they would pay off the market went through a further two or three more weeks of rises.
Over the past five years until global markets peaked on 19 February, the trust made a return of 41.81 per cent, underperforming its IT Global peer group (78.52 per cent).
However, taking March’s heavy sell-off into consideration, the trust’s five-year return remains positive and is up by 17.21 per cent although it still underperformed the average IT Global trust (which was up by 45.09 per cent).
Performance of trust vs sector over 5yrs
Source: FE Analytics
The trust is currently trading at an 11.4 per cent discount to net asset value (NAV), is four per cent geared, has a dividend yield of 3.4 per cent and ongoing charges of 0.58 per cent, as at 7 April.
Matthews Asia’s Robert Horrocks explains which country could be most at risk if the impact of coronavirus worsens.
India is likely to suffer the most if there is a further deterioration in global economic conditions as a result of the coronavirus, according to Matthews Asia’s Robert Horrocks.
The global response to the Covid-19 coronavirus has been robust, with stringent measures to tackle the spread balanced with substantial levels of support to prevent economies from collapsing.
Nevertheless, Matthews Asia chief investment officer Robert Horrocks (pictured) – who is co-manager of the $189.4m Matthews Asia Dividend and the $71.1m five FE fundinfo Crown-rated Matthews Asia ex Japan Dividend funds – said there are still several key risks that could emerge to further challenge markets.
And the country that could be affected the most is India.
The first big risk facing markets is that the dollar panic – witnessed as the coronavirus started to spread beyond China – makes a comeback and investors start to worry about the supply of the currency.
The ‘dash to cash’ occurred around the first weekend of March and saw bond yields spike, equity markets sell off and the US dollar strengthen.
“Everything was being sold to hold US dollars,” Horrocks explained. “This was the dollar panic stage and it was the most scary stage of the crisis.”
Countries with large current account deficits and those with much reliance on external financing are most likely to be affected by a shortage of dollars, he said.
The Australian and Indonesian banking systems are both reliant on external financing, which could rise should the US dollar strengthen, although both should be resilient enough to withstand the move in the short-term.
“The most exposed [to this risk] is India, it’s banking system is under greater stress than most other places,” Horrocks said. “It does have a current account deficit and it’s hard for it to deal with in that situation.”
Current account balance (Balance of Payments, current US$) – India
Source: World Bank
Yet Horrocks said a shortage of US dollars is not something that he is overly worried about.
“This is the one I’m least concerned about because it is the easiest to fix,” he explained. “The Federal Reserve has shown a willingness to do whatever it takes to fix it. If it does come back it will be short-lived and dealt with.”
The second risk to markets that could emerge, said the Matthews Asia manager, is the economic effect of the lockdown.
“You have to look at who went into lockdown later and less aggressively,” he explained. “If you were first in there as soon as you got cases of the virus, you locked it down and you did so aggressively, [then] you'll have less need for draconian nationwide lockdowns and the economic impact will be less.
“Within Asia, it's not really about north Asia, they’ve dealt with it so far. China, Korea, Japan, Hong Kong, Singapore all seem to have emerged from this and for all the talk of a second wave, it hasn't really happened.
“India went into lockdown late and did it aggressively, so it didn’t have the impact and probably went into lockdown too late to control the spread of the virus and the aggressiveness of the lockdown is going to have a fairly significant impact on domestic demand.
“In addition, they were going into this having had weaker and nominal GDP growth, so they were just in a more vulnerable position.”
The final risk, said Horrocks, will be the impact of coronavirus on aggregate demand and the ability of governments to provide a fiscal boost to help stimulate their economies because of weaker demand.
“The best response has probably been the US. We had the usual political horse-trading before any stimulus package gets through, but we’ve now had big fiscal stimulus packages put in place,” he added.
“The one country that’s going to struggle is India because the government is not in a strong position. It’s already had a big stimulus with the corporate tax cuts, it kind of fired its bullets before this happened.
Performance of Indian rupee rebased in US dollar YTD
Source: FE Analytics
“One of the stress points here is the financial system, ultimately they need a round of capitalisation and probably the currency comes under pressure. Asian currencies look OK to me, but the [Indian] rupee is the one where you have vulnerability.”
One country that Horrocks is least concerned about with any of the risks is China, which was the first to be affected as the coronavirus emerged in Hubei province’s city of Wuhan.
“China really looks pretty good through the lens of these risk factors,” he said. “Monetary risk? Well, we never had the dash-for-dollars panic as a closed capital account. So, it seemed relatively insulated from that.
“Lockdown risk? It locked down early and hard and seems to have emerged from that and the impact on domestic demand will be much less severe than you see in Europe and the US, is my guess. You’ll have secondary effects from global weakening, but China should post positive GDP growth for the year, which is unlikely to happen in Europe and the US.
“And the fiscal response to emerge from this? The amount of stimulus required from China is much less because of the lesser domestic impact. But does anybody doubt that they are in a position to stimulate through fiscal or monetary means or do they have a lack of willingness to do so?”
Yet Chinese companies are trading at lower valuations than their counterparts in the US, said Horrocks. And this is despite a much worse situation for the US in terms of rising numbers of coronavirus cases and deaths and better prospects for the Chinese economy.
Performance of funds YTD
Source: FE Analytics
Year-to-date (to 7 April), Matthews Asia Dividend is down 10.10 per cent, outperforming the average IA Asia Pacific Including Japan peer, which is down by 10.28 per cent, and the MSCI AC Asia Pacific benchmark, which has lost 11.4 per cent.
Meanwhile, the Matthews Asia ex Japan Dividend fund is down by 3.44 per cent compared with a 9.26 per cent fall for the MSCI AC Asia ex Japan benchmark and a 12.66 per cent loss for the average IA Asia Pacific Excluding Japan peer.
Ninety One Asset Management’s Simon Brazier explains how the coronavirus has provided a good opportunity for quality investors worried about valuations.
Concerns about the health of markets heading into the coronavirus pandemic helped protect Simon Brazier’s Investec UK Alpha fund and has now prompted the manager to make several changes to the portfolio.
Brazier (pictured), who is co-head of quality at Ninety One Asset Management – formerly known as Investec Asset Management – said that he had been warning investors in the £1.9bn Investec UK Alpha fund about the possibility of an external shock to markets.
He explained: “We certainly didn’t predict the coronavirus, but we have been saying to our clients for over three years now that we were worried about slowing top-line growth, the fact that margin growth was very limited – if not margin pressure – and that valuations were very full.
“You would find it quite difficult to find opportunities to buy companies at attractive valuations over the long term.”
As such, the construction of the portfolio has reflected this with the number of stocks in the portfolio falling from around 90 in 2013 to just under 50 as opportunities have dried up.
In addition, over the past three years the amount held in FTSE 100 stocks has risen from 60-65 per cent of the portfolio to 83-85 per cent. This, said the manager, has come as cyclicality in the portfolio has been removed by moving out of sectors such as industrials, leisure, retail and housebuilders into more globally diversified, cash-generative and defensive businesses.
“What we have been warning our clients for the past three years is that we felt there was a significant potential for liquidity, currency and economic risk going forward,” he explained. “There were exogenous risks that could have been the catalyst – obviously coronavirus wasn’t one of them – but we felt that any shock to the system would be difficult.”
And when the coronavirus hit, the fund’s focus on less economically sensitive areas helped it weather some of the worst of the market sell-off.
Performance of fund vs sector & benchmark YTD
Source: FE Analytics
Year-to-date (to 6 April), the Investec UK Alpha has made a loss of 21.69 per cent faring better than the FTSE All Share index (which is down by 26.47 per cent) and the average IA UK All Companies peer (which has lost 29.34 per cent).
“The fund was fully invested so you can’t escape the direction of the markets,” said Brazier. “Having said that we performed relatively well in this environment.”
Since the spread of coronavirus, Brazier has been making a number of changes to the portfolio to adapt to the new market paradigm.
The first change to the portfolio and one that marks a departure from his previous stance was to move to a neutral position in the oil & gas sector.
While the oil price war helped to kick-start the March market sell-offs, a resolution between its Russian and Saudi Arabian protagonists now seems in the offing and that positioning seems prudent, particularly for companies that have already endured a lot of belt-tightening as a result of low prices in recent years.
“I’ve always been underweight oil & gas, but it’s an area of the market which is obviously a significant part of the UK market,” he said. “And we felt that at the current valuations [that] we’ve got from the oil price, but also from companies that have ample liquidity on their balance sheets and the ability to generate cash through either disposals or reductions in capex [capital expenditure], mean that they are well-placed at least and they’re coming off a base of very low oil prices which are quite politically based.”
Performance of FTSE UK Oil & Gas vs FTSE All Share over 1mth
Source: FE Analytics
Another change to the portfolio is the addition of quality companies that have been dumped in the coronavirus sell-off, such as InterContinental Hotels Group and Ryanair.
“We’ve added to these levels because we’re now pricing in quite a negative outcome scenario that if it were to see any resolution in the next six-to-12 months and travel were to pick up again, we would be well-placed,” he said.
As well as coronavirus-struck stocks, Brazier has been adding to quality names that have now become more affordable from a valuation perspective such as investment platform Hargreaves Lansdown and media company Ascential.
Finally, the manager has been making some ‘relative value’ trades within the fund taking companies such as Unilever, Imperial Brands, British American Tobacco and Tesco that have performed well in the sell-off to their original positions in the portfolio.
“We had to take – effectively – the relative profits off the table and then reinvest into some of the names that we own that have underperformed or that we feel are long-term players,” he explained. “For example, Experian is one of those very good long-term businesses and where there’s been an opportunity to recycle capital into.”
Ultimately, Brazier said he remains focused on companies that can grow their profits in a consistent way throughout the cycle, that are diversified, and are cash generative.
Nevertheless, the manager will continue to take opportunities where he finds them – particularly as markets have been pricing-in particularly negative scenarios – because he has been unable to for so long.
“The whole aim has been to buy low and sell high and the whole problem for the last two or three years is they’ve only been given the opportunity to buy high,” he explained.
However, the ‘great unknown’ is the coronavirus and markets will likely remain volatile until either testing takes place on a greater scale than at present or a vaccine is developed.
“There will be a day – and this is the first time in my career of 22 years – where I’m not relying on central banks and actually relying on scientists to provide a floor to the market and, therefore, a recovery,” said Brazier.
“That to me is going to be when the market recovers – as the science comes through – and provides comfort rather than the Fed pumping another $1trn of QE because that helps Wall Street, I’m not sure it’s helping Main Street yet.”
Since Brazier began managing Investec UK Alpha in January 2015 to the peak of markets on 19 February, it had returned 43.98 per cent against a 44.23 per cent gain for the FTSE All Share benchmark and a 43.71 per cent return for the average IA UK All Companies peer.
Since 19 February, however, the fund has outperformed both its peers and benchmark making a loss of 21.89 per cent, compared with losses of 26 per cent and 29.03 per cent for the benchmark and IA UK All Companies average.
Performance of fund vs sector & benchmark under Brazier
Source: FE Analytics
Investec UK Alpha has an ongoing charges figure (OCF) of 0.82 per cent.
While plenty of uncertainty remains, market commentators say it's not too soon to start thinking out how the eventual recovery will play out.
JPMorgan Chinese has changed its name to JPMorgan China Growth & Income and has altered its dividend policy to match.
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Mark Walker, managing partner at Tollymore Investment Partners, explains how and why you should be creating a long term investment strategy in the current environment.
As long-term investors our efforts are focused on finding companies capable of increasing their intrinsic values through their own efforts. Ideally, we are trying to identify high quality businesses facing short term, but surmountable, problems, but whose attractive long term prospects are intact. In the short term there can often be little correlation between price and value, or stock success and business success but over the long term this correlation is high; this disparity is the key to making money, but it can persist for long periods of time. Discipline and patience are required to exploit these price/value discrepancies. As long-term investors we can take advantage of the time arbitrage afforded to patient investors with patient capital. While the informational source of edge for professional investors has decreased over time, the ongoing shortening of security holding periods has increased the advantage of time arbitrage for long term investors. By focusing on quality companies we can benefit from those companies’ intrinsic value appreciation.
In my experience alternative approaches that necessitate the prediction of sharp asset re-ratings, and the identification of catalysts that will cause these, are meaningfully more difficult to execute. By owning a portfolio of businesses steadily compounding the value of their economic earnings, we are tipping the odds of earning a satisfactory return on our equity ownership in our favour. Meanwhile we can exploit stock market volatility to manage the portfolio in a way that may augment this underlying business value compounding. The average difference between the 52-week high and the 52-week low stock price for US large caps is 50 per cent. This vastly overstates the likely difference in private business valuation from one year to the next. I expect the change in underlying per share value of portfolio holding companies to do most of the work for me in delivering acceptable annual investment results, but sensible and occasional portfolio management decisions should enhance these returns over the long term.
Process: Competitive advantage
So we are looking for businesses that can sustainably create value through their own efforts. This means finding companies that can earn economic profits in excess of the cost of the capital employed to generate those profits. We want companies that can do this sustainably. In the absence of lasting unfair advantages, the entry of new capital and intelligent effort will drive returns towards to the cost of capital. This capital cycle economic theory is academically and empirically broadly accepted.
There are two ways to potentially profit from this capital cycle. The first is to invest in the mean reversion of returns to cost of capital levels. This requires the ability to time the entry and exit of capital within an industry, and the catalysts that might give rise to a change in returns on capital e.g. the closure of factories, industry consolidation or bankruptcies. In addition, this requires ‘renting’ the stock for a period of the capital cycle when the market is extrapolating forward financial performance that is likely to mean revert. For these two reasons, this approach is inconsistent with an investment programme which has long term business ownership as the cornerstone of its investment philosophy.
The second approach is to identify companies whose supernormal profit potential is larger and more sustainable than the market believes. This is consistent with the recognition that patient temperament and capital are important sources of edge in executing a long-term investment strategy.
Assessment of business quality involves gathering evidence that supports or refutes the existence of an economic moat, developing an understanding of the factors that have created this moat and whether the moat is likely to narrow or widen in the future. This involves a close examination of management’s incentives and capital allocation ability. Management must be able to sensibly compare the value of various capital allocation choices. A rigid cash use ranking will not do. Dividends are value destructive if they are made in lieu of available positive net present value investments. Share repurchases are value destructive if shares are acquired at market quotations materially above intrinsic value. Asset growth shrinks per share business value if incremental cash returns are below the opportunity cost of capital.
While an appreciation of frameworks such as Porter’s Five Forces is useful in understanding competitive dynamics within various industries, it is important to safeguard against an overly prescriptive employment of these frameworks. Sometimes investors seem very keen to apply a ready-made label to the source of a company’s moat e.g. switching costs, network effects, intangible assets, cost advantages and so forth.
Execution: Making better decisions
We, fund managers, should be in the business of creating, not transferring, value. In the pursuit of this goal investors’ capacity to make good decisions is taken for granted. Making good decisions is not commonly considered a source of edge.
As investors we are frequently encouraged to consider the edge that will allow us to outperform markets. The debate surrounds the trio of informational vs analytical vs behavioural source of competitive advantage. In our experience most investment firms are focused on the first two. This is partly due to a mandate to gather assets vs delivering superior investment returns. Undue weight is given to what looks good in a pitch book vs what works. In a world in which data has been rapidly democratised, a focus on informational edge can encourage excessive spend on travel/corporate access/over the top or misdirected primary research.
Analytical edge may be possible, but a belief that we can more intelligently analyse information than our very smart and experienced peers can open the door to overconfidence and hubris. When we become overconfident, we become unreceptive to evidence that contradicts our opinions. It is important to develop strategies and systems to ensure we remain sceptical of our own views and attentive to the facts and evidence that may support or refute them.
One such strategy is the recognition that behavioural edge is the most obvious opportunity to make better decisions and earn better returns over the long term. Behavioural edge is about creating a culture and environment that gives us the best chance of making optimal decisions. Optimal decisions are those that allow us to satisfy our goals of creating rather than transferring value, and of solving our partners’ problems. It is predicated on a belief that we can tip the odds in our favour over time by repeatedly making good choices day in, day out. These decisions can relate to how we organise our day, where we focus our efforts, when to start and stop research, whether to invest, how much to invest, when and how much to sell, forming views of management, staffing, office location, investment partners, and designing fee structures.
The organisation of roles and responsibilities within large asset managers can lead to overconfidence. Sector focused analysts (focused on analytical rather than behavioural edge) have a small investment universe but are forced to pick winners and losers. This narrow focus can encourage excessive data collection and detailed financial forecasting, leading to overconfidence. The segregation of roles can impede rational decision making too. Diligent and thoughtful fundamental research on the handful of factors that matter is a pre-requisite rather than a source of edge. But one should acknowledge the diminishing or even negative returns of more information. Industry incentives are inconsistent with epistemological humility; pressure to sound smart is highlighted by the widespread practice of detailed financial forecasting.
The design and implementation of thoughtful incentive structures is crucial to being able to faithfully execute a genuine long-term investment strategy. Fee structures should avoid the undesirable outcome that investment managers can become rich by delivering below cost of capital returns to investment partners. Hurdles or investment rebates can help to achieve this aim. Investment managers without skin in the game face a major impediment to good decision making, because it makes it harder to fight the asset gathering imperative in pursuit of a returns-focused investment objective.
Entrepreneurs often say that execution is more important than ideas. The same is true of investment strategies. The ability to execute a strategy is more important than the uniqueness or marketability of that strategy (for performance, not necessarily for gathering assets). So it’s important to think about how we can best execute our strategy. There are no points for difficulty or originality in this business; there are points for making decisions that lead to satisfactory long term returns for our partners and clients.
Mark Walker is managing partner at Tollymore Investment Partners. The views expressed above are his own and should not be taken as investment advice.
Barings Investment Institute’s Christopher Smart outlines the events that have to happen before a durable economic recovery from coronavirus looks sure.
A wave of earnings revisions, credit ratings downgrades and corporate bankruptcies will have to be ridden before investors can even think about a meaningful recovery from the coronavirus crisis, according to Barings’ Christopher Smart.
With large parts of the globe under lockdown to prevent the spread of coronavirus, it is now just a matter of time until economic data confirms that the world has entered into a deep recession.
Since their peak on 19 February, markets have tanked in recognition of this fact with many parts of the global equity space dipping into a bear market – including the UK, which is among those worst hit by the sell-off.
Performance of stock markets since 19 Feb 2020
Source: FE Analytics
Christopher Smart, chief global strategist and head of the Barings Investment Institute, said: “Market conversations these days wrestle with 100 versions of a single question: ‘How bad will it get?’ Most end with a vague consensus that things will get worse before they get better, but there is still little agreement about how much worse and when markets will start to see through to the other side.
“Obviously, the depth and breadth of the crisis depends primarily on how quickly the virus is contained and how soon we will comfortably board a plane once again. Even as we all struggle to catch the first glimpse of sunrise, much will depend on how quickly markets navigate the darkness before the dawn.”
However, Smart warned that there are five “darker developments” that have to come about before the coronavirus recovery can start in earnest.
With such a deep hit to the economy expected, a meaningful recovery in financial markets cannot get underway until its impact on companies’ earnings has been realistically priced into their stock valuations. But this will cause further volatility on the way.
“If there is little in nature more fearsome than a herd of thundering wildebeest, there is nothing in financial markets more harmful than a herd of sell-side analysts downgrading earnings estimates,” Smart added.
Although the number of analyst downgrades of S&P 500 stocks now exceeds the levels of 2008’s financial crisis, the size of their second quarter downgrades stands at around 10 per cent, which the strategist said seems “relatively modest”.
“This time, it's not just because analysts are almost always behind the curve, it’s mainly due to the level of uncertainty remains exceptionally high,” he added. “Companies themselves have stopped issuing guidance, which makes stocks still look much cheaper than they actually are.”
Amid the widespread deterioration in the economic outlook, credit analysts have been busy reassessing debt sustainability of corporate borrowers.
Smart noted that investment-grade firms raised $260.7bn in fresh debt in March – a monthly record – as they anticipated tougher times ahead, although some of these will inevitably be downgraded to a high yield rating in time and some investors will be forced to sell.
“There have always been ample pools of high yield capital to pick up these ‘fallen angels’, but they themselves will be under some stress,” he added.
“Downgrades also trigger covenants that force early repayment of some debts or redirect cash flows to more senior creditors. It will be a bumpy ride as these cascade through markets.”
The third “darker development” will be a growing number of companies going out of businesses, as a sustainable recovery cannot come about until this has been worked through the system.
“The lucky firms will merely suffer downgrades, but others face bankruptcy or even liquidation. Savvy investors manage to avoid most of these, but there will surely be land mines that explode unexpectedly,” Smart said.
“It's hard to imagine a crisis of this magnitude not claiming some large and beloved retailing victims that were already on the ropes. There will also be sovereign debts tore structure across the emerging world as capital retreats at an unprecedented pace. Argentina and Lebanon were basket cases before we had heard of the coronavirus, but others will now join the list.”
Likewise, Smart argued that it is difficult to imagine how a durable recovery came come about without Russia and Saudi Arabia concluding their oil price war.
Performance of oil in 2020
Source: FE Analytics
Oil’s price has hit the floor in 2020 after Saudi Arabia said it would ramp up production at the same time as the coronavirus crisis sparked a slump in demand. Crude is currently trading at just $26 a barrel.
“There seems to be a deal in the works that would limit supply and provide a floor on global prices to save large sections of the industry from collapse,” the Barings strategist said.
“Still, financial markets will not fully embrace the recovery until there is confidence that oil has returned to a predictable range. Commodities prices more generally may need to stabilise to signal that global demand has bottomed out.”
Governments and central banks have unveiled massive stimulus packages to combat the economic effects of the coronavirus pandemic, but Smart said “there is much more to do” before a genuine recovery arrives.
“The $2trn package the US Congress approved is more emergency assistance than recovery stimulus,” he said.
“Even so, much will depend on how quickly it can be distributed to small businesses and households. The Fed has been fast and creative in unblocking credit markets, but banks will face further stress as their loan books turn bad.”
However, up to now, there has been little thought about the economic blow that will soon hit developing countries and their additional needs for aid and debt forgiveness.
“Durable recovery will also require much more international cooperation,” Smart finished.
“If the G-20 does little more than issue bland statements, investors will have to see more concrete bilateral cooperation on expanding trade, stabilising markets and boosting investment.”
Trustnet asks several managers for their thoughts on one of the most challenging periods ever for UK small-cap stockpickers.
It had promised to be a slightly better year for UK stocks focused, following the Conservative party’s comprehensive victory and greater certainty it provided over Brexit.
But all of this has been undone due to the impact of the coronavirus outbreak which has caused global markets to sell-off as governments have ordered people indoors and economies have ground to a halt.
However, it’s been companies toward the lower end of the market cap scale that have suffered as the coronavirus has taken hold and started to impact markets.
As the below chart shows, the blue-chip FTSE 100 index fell by just 23.84 per cent during the opening quarter of the month.
However, the mid-cap FTSE 250 index was down by 30.72 per cent and the Numis Smaller Companies plus AIM (excluding investment companies) benchmark lost 32.60 per cent, both recording their worst quarterly showing in recent memory.
Performance of indices in Q1 2020
Source: FE Analytics
Whilst UK authorities have announced extraordinary measures to combat the economic impact of the coronavirus on smaller companies, Trustnet asked several fund managers if these go far enough during one of the most challenging times in recent memory.
“While there remains significant scepticism, at some point, investors will return to equity markets,” he explained. “When this occurs, the UK could be set for particular attention, as UK stocks still trade at a relative discount to other developed markets.”
Indeed, in the micro-cap space that Wotton focuses on companies are trading at a 20 per cent discount, he said, evidence of just how unloved they are currently.
But this could end up benefiting UK stockpickers once the coronavirus crisis has abated Wotton said as they could provide cheap, attractive entry points to valuable companies.
“With double and triple discounts, small and micro caps will undoubtedly pique the interest of corporate buyers and private equity investors,” the LF Gresham House UK Micro Cap fund manager explained. “Companies with sound fundamentals are available for purchase at attractive prices – and, for foreign investors, at a favourable exchange rate.”
One of his micro-cap peers, Richard Power – head of Quoted Smaller Companies at Octopus Investments and manager of the £33.2m FP Octopus UK Microcap Growth fund – agreed, adding that coronavirus will only have a short-term negative impact on UK smaller companies.
“We remain of the belief that this will only have a short-term impact on the smaller companies sector,” he said. “Investors may well be feeling risk-averse right now, but quoted smaller companies will resume the growth path they were on in due course.”
Investing in companies with a market cap below £100m, Power invests 75 per cent of the portfolio in ‘established leaders’ – companies with strong track records and management that should continue performing well in a downturn.
“Smaller companies are arguably more adaptable to these situations,” Power said, “and as long as they went into this with an appropriate capital structure and supportive shareholders then they should emerge with long term prospects unscathed.”
Regarding his own his FP Octopus UK Microcap Growth fund Power said that he was not making “any specific sector changes”.
“We came into the crisis with a relatively high cash balance, and have been committing more funds to companies we have known well for a long time, and whose share prices have hit very attractive levels on a 12-month view and companies we believe to be particularly well placed to continue to grow in the current conditions,” he said.
But are measures designed to shore up the UK’s smaller businesses enough to help them in the long term?
“Unprecedented times call for extreme action,” Philip Harris (pictured), manager of the five FE fundinfo Crown rated EdenTree UK Equity Growth fund, said. “And the Chancellor’s recent announcements have laid out the foundations for substantial measures to stabilise the economy, the likes of which have never been seen in peacetime.”
Harris said that further measures will probably have to be put in place as the lockdown is extended and the true impact of the virus is revealed.
For any company the coming months are “all about survival,” Harris said, and could lead to some cancelling their dividends to cope.
Dan Harlow, portfolio manager of both the AXA Framlington UK Mid Cap and £155.4m AXA Framlington UK Smaller Cos funds, added that companies now need to be making sure that their business will be able to reopen once the lockdown has lifted.
“With zero visibility on earnings outlook for the year, businesses are in cash conservation mode,” he explained. “The primary motivation and rationale behind management behaviour is ensuring that they have a business to return to once the pandemic passes.
“To ensure this is possible, all market participants are working hard providing policy support and financial flexibility to counter the dramatic impact this black swan event is having.”
But whilst the measures have been well-received by companies themselves Gresham House’s Wotton adds that markets appear somewhat indifferent to the news.
“Almost zero [per cent] interest rates and measures to inject liquidity into the system are welcome support but have been greeted with a shrug from financial markets,” Wotton said.
“There are limited monetary levers remaining,” he added, noting that whilst giving direct support to business is “potentially hugely significant” the key to its success will be how quickly it is enacted.
Many of the most popular funds are topping their sectors amid the ongoing market volatility, although there are some big names that have fallen to the bottom.
Many of the funds that have captured large inflows over the past 12 months – a big proportion of which are index trackers – have performed relatively well during the coronavirus sell-off, FE fundinfo data suggests.
However, our data also shows a handful of popular strategies have fallen to the bottom of their respective sector as markets have sold off. These include the likes of JOHCM UK Dynamic and Man GLG UK Income.
Since their peak on 19 February 2020, markets have plummeted as coronavirus spread around the globe and forced many countries to put their populations under lockdown. This will have pushed the global economy into recession – and markets have reflected this.
As the chart above shows, every major equity market was down in the opening quarter of 2020 as investors dropped risk assets as the pandemic worsen. A recent Trustnet article looked at the virus’ impact through a range of viewpoints, including investment style, industry and fund sector.
Here, we examine the impact of the sell-off on the 50 funds that have proven most popular with investors over the 12 months to the end of February – so the products they had been buying just before the sell-off took hold.
The below table shows these funds ranked by their approximate 12-month net inflows as well as their performance and quartile ranking since the 19 February market peak. We have excluded sectors like IA Unclassified, where quartile rankings are not appropriate.
Source: FE Analytics
One immediate thing that jumps out from the table is just how popular passive strategies have been – and how they have tended to outperform some of their active peers during the sell-off.
The Vanguard LifeStrategy range has been a persistent favourite with investors over recent years, thanks to its diversified portfolios, cheap ongoing charges and easy to understand approach.
Vanguard LifeStrategy 60% Equity, Vanguard LifeStrategy 40% Equity and Vanguard LifeStrategy 20% Equity all sit in the top quartiles of their respective peer groups for the coronavirus sell-off so far.
Other best-selling index trackers have put in first- or second-quartile performances since 19 February, including State Street UK Equity Tracker, HSBC American Index and iShares Emerging Markets Equity Index (UK).
However, that’s not to say that all passive strategies are at the top of their peer groups and Vanguard LifeStrategy 100% Equity is an example of one that isn’t. Its 23.62 per cent loss puts in the bottom quartile of the IA Global sector.
But there are plenty of best-selling active funds that are topping their sectors are well.
Anthony Cross and Julian Fosh’s Liontrust Special Situations fund has been a consistently strong member of the IA UK All Companies sector and has attracted high inflows as a result. It also managed to outperform during the sell-off.
CFP SDL UK Buffettology, which is managed by Keith Ashworth-Lord, is another that has taken in plenty of money over the past year on the back of strong performance. It’s in the IA UK All Companies sector’s second quartile since 19 February.
Other funds that have a reputation for being good defensive holdings and have been taking in money for the past 12 months include TB Evenlode Income and Trojan Income. Both of these funds are in their sector’s first quartile.
Mike Riddell and Kacper Brzezniak’s Allianz Strategic Bond fund is another notable entrant on the above list. A recent Trustnet article showed this was one of the most heavily-researched funds among professional investors, thanks to its aim of maintaining a low correlation to global equities.
This fund has been gaining net inflows over the past year and has made a 13.08 per cent total return since the sell-off started, putting it in the first quartile of the IA Sterling Strategic Bond sector.
But not every popular fund has prospered during the coronavirus crisis. Four funds on the above list are in the respective sector’s bottom quartile between 19 February and 3 April, including the aforementioned Vanguard LifeStrategy 100% Equity.
Henry Dixon’s Man GLG UK Income and Alex Savvides’ JOHCM UK Dynamic funds are the two most noteworthy of the other three. Both have a strong following from professional and retail fund buyers and have performed strongly in the past.
However, both managers follow the value style of investing. This has struggled for much of the past decade (although the funds have navigated this quite well) but has significantly underperformed over the coronavirus sell-off as investors moved more towards the relative safety of quality stocks.
Another 10 of the 50 most bought funds are in their peer group’s third quartile over the sell-off, while 19 are in the second quartile. That leaves 17 which are in the top quartile.
The FTSE 100 has risen 2.45 per cent in early trading, despite last night’s news that the prime minister is in intensive care for coronavirus.
The FTSE 100 has risen 2.45 per cent in early trading, despite last night’s news that the prime minister is in intensive care for coronavirus.
As at 08:32, the blue-chip index stood at 5,719 points as investors were heartened by signs that the coronavirus pandemic is slowing. This follows gains in strong US and Asian markets overnight as well as a decent session for the FTSE on Monday when it rose more than 3 per cent.
Performance of FTSE 100 members at Tue opening
Source: London Stock Exchange
The number of new coronavirus cases appears to have steadied in several countries in the past few days, offering hope that the lockdown measures put in place in many parts of the world are starting to have an effect.
Meanwhile, prime minister Boris Johnson was admitted to intensive care yesterday after failing to recovery from coronavirus. He had been self-isolating because of the virus, while working remotely to head the UK’s response to the pandemic.
On the news that prime minister Boris Johnson is in intensive care for coronavirus, a Number 10 spokesperson said last night: “Since Sunday evening, the prime minister has been under the care of doctors at St Thomas’ Hospital, in London, after being admitted with persistent symptoms of coronavirus.
“Over the course of this afternoon, the condition of the prime minister has worsened and, on the advice of his medical team, he has been moved to the Intensive Care Unit at the hospital.
“The PM has asked foreign secretary Dominic Raab, who is the first secretary of state, to deputise for him where necessary.
“The PM is receiving excellent care, and thanks all NHS staff for their hard work and dedication.”
The Danish investment bank has issued its second-quarter outlook as the world struggles with the coronavirus crisis.
Worldwide central bank policy responses to the coronavirus crisis will combat recession and deflation but will have significant repercussions after “the lost economic year” of 2020, according to strategists at Saxo Bank.
Recent weeks have seen central banks around the world announce dramatic loosening of monetary policy in an attempt to ease the economic impact of the coronavirus pandemic, with interest rates taken to historic lows and massive quantitative easing programmes rebooted.
In Saxo Bank’s second-quarter outlook, chief economist and chief investment officer Steen Jakobsen said the virus outbreak set three major macro impulses in motion: a global demand shock, a supply shock, and an oil war forcing prices to multi-year lows.
“The triple hit to the global economy almost guarantees 2020 will be a lost economic year, with policymakers needing to pull out all the stops to address a real, global recession” Jakobsen warned.
The economic effects are already starting to be revealed in the data. In the UK, claims for the universal credit benefit welfare jumped by 1 million in the past two weeks, up from 100,000 usually expected in the same period.
In the US close to 10 million Americans filed for unemployment and non-farm payrolls fell by 701,000, according to figures that capture just a fraction of the layoffs that occurred in March.
The fact that coronavirus has caused large parts of the economy to shut down makes a global recession inevitable but central banks stepped in with looser policy.
“Central banks try to move in quickly with ‘support’ in the form of rate cuts and liquidity provision,” Jakobsen said.
“We have full confidence that when we leave 2020 the policy measures taken will prompt strong inflationary forces that even point to the risk of stagflation.”
But the CIO noted that whilst the central bank support will be good for the cost of financing liabilities, it does not help equity or credit prices on the asset side.
“Here, the ‘crowded theatre with a small exit’ metaphor applies, with everyone selling to deleverage across the board,” Jakobsen added.
As markets continue to sell off, Steen anticipates more volatility and a cleaning out of valuation models for private equity and other high-risk assets that are “predicated on low interest rates, central bank intervention and the somewhat naïve assumption of multiples that can go up forever”.
He drew an analogy to the global economy as a “financialized super tanker” fueled by credit and low interest rates, previously heading towards the “port of deflation”, but now changing course, heading to the “port of high inflation”.
With the central bank policy tool box empty, Jakobsen believes the world is on the verge of full Modern Monetary Theory (MMT), where “politicians take the reins from obsolete central banks and expand spending without constraint from debt issuance (true money printing)”.
“The UK budget was an early indication of this and was drawn up even before the coronavirus impacts began to crystallise” he claimed.
Jakobsen highlighted that after World War 2, the Marshall Plan saw the US issue “infinite credit” to a war-torn Europe in order to create demand and help the destroyed continent rebuild. “Governments will create money far beyond any on- or off-balance sheet constraint,” he argued.
As a result, the chief investment officer at the said the Danish investment bank’s portfolio allocation will focus on being long inflation and long volatility.
Saxo Bank head of FX strategy John Hardy said: “The trigger of this credit crunch is of course the coronavirus outbreak, but the severity of the fallout is a product of a financialised global system made so incredibly fragile by leverage and the QE medicine used to alleviate the last crisis.”
“This time around, due to the severity of the issue, policymakers have no qualms about throwing orthodoxy out the window and printing infinite amounts of cash to drop on the economy.
“The most interesting theme in progress will be the scramble to find alternatives to the US dollar,” he added, referring to the fact that most emerging markets economies owe debt in US dollars.
“This crisis is proving even more clearly than the last one that the fiat-USD-as-global-reserve currency system is dysfunctional beyond all attempts to salvage it” he said.
“Complicating the search for an alternative is the fact that in a deglobalising world, Bretton Woods-style arrangements will prove very hard to come by”.
Hardy said Saxo Bank is convinced that the policy medicine of MMT will eventually be engaged on sufficient scale to avoid deflationary outcomes and, that if correct and if inflation stages a sharp recovery, even if it starts to “run hot”, a key metric of relative currency strength would be the real interest rate — how much the CPI exceeds the policy rate at various points on the sovereign bond curve.
“Those countries overheating the printing press and running ugly, negative real rates will eventually find their currencies weakening rather than benefitting from the initial push of fiscal stimulus,” he added.
Christopher Dembik, head of macro analysis at Saxo Bank, said the economy has been in this state before, referring to the secular bull market of the 1950s and early 1960s.
During most of that period, the Federal Reserve followed a ‘lean against the wind’ monetary policy that ultimately lead to the Great Inflation, where too-loose monetary policy had a dramatic effect on the economy and inflation.
“In 2020, the global economy is facing a much more difficult challenge that may lead to similar consequences if not controlled: stagflation,” he said.
“The huge fiscal stimulus that is coming is likely to increase inflationary pressures in months to come. We are moving from ‘bailout the banks’ in 2008 to ‘bailout SMEs and anything else’ in 2020.”
Dembik said that contrary to common thinking, Saxo believes the coronavirus is not a temporary market shock, claiming that Covid-19, along with demographics, will precipitate the end of the secular bull market.
He believes the baby boomer generation, a population of about 76 million people in the US, could structurally depress equity valuations in the coming years, as they transition out of the workforce and draw down on retirement funds.
“Demographics will disrupt not only the stock market — they’ll disrupt the financial sector as a whole” he argued.
“Retirement of the baby boomers happens at the worst time ever for the stock market, especially when other structural factors are already affecting the macroeconomic outlook,” he concluded.
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Nick Payne, head of global emerging market equities at Merian Global Investors, explains how long-standing “investing rules” can bring comfort and help with decision-making during tough market conditions.
I will not add to the litany of words, written and spoken, predicting when the virus will come under control, as the truth is we have no more idea than you. Instead, we can focus on the facts and how our long-standing “investing rules” can bring us comfort, as well as help with decision making, during tough markets.
The dramatic fall in share prices across the globe does present the long-term investor with an opportunity. We’ve already bought one company on our watch list – Mercado Libre, Latin America’s leading online e-commerce portal. We also have five or six excellent companies under very close observation with a view to starting to build positions at the appropriate time. We don’t have a crystal ball and are not naive enough to think we can “catch the bottom” but valuation upside has opened up to an extent to which we think will be very well rewarded if one can have the patience to look forward a year or two.
In these unprecedented circumstances, we must stick to what we know: the mantra of investing for the long-term and focusing on the fundamentals is more important than ever. All of the companies we consider fit our quality and sustainable growth criteria of:
1. High return on capital,
2. A moat, or barrier to entry, to protect and sustain 'number one' position,
3. Growth via the opportunity to reinvest in the business.
For us, the ideal combination is a business whose end market is growing and where it is also able to take market share. If the business is good and growing, the chances are over time that its intrinsic worth will increase and the share price will follow.
One thing that comes to the forefront of any investors mind during a bear market is risk, how much do you already have in your portfolio and can you take any more on?
We continue to define real risk as a large permanent loss of capital NOT share price volatility (which in markets like this is almost inevitable). We aim to mitigate this by buying high-quality business franchises, run by honest and competent management and with low balance sheet risk. Over the years, we have seen good companies wrecked by over-expansion of the balance sheet. For that reason, most of the non-financial companies in our portfolio have very low leverage or even net cash balance sheets. For those companies with debt, we have re-examined liquidity, duration and maturity schedule. Ultimately, if you invest in well-run businesses, with strong balance sheets, you have more confidence of their ability to survive through some hard times.
How do you value a retailer who has just closed their shops or an airline that’s not flying? Such is the near impossibility of trying to guesstimate 2020’s earnings. However, it’s worth remembering Benjamin Graham’s assertion that “in the short term the market is a voting machine, in the long run it’s a weighing machine”. We are interested in the “weight” of a business, or its long-term earnings and cash flows, and it is paramount to keep in perspective that a dramatic cut to quarterly/half-year or full-year earnings should not reduce the long-term value of a business by the 40 per cent, 50 per cent, 60 per cent or 70 per cent declines attributed by the stock market.
We are seeing the weighted average upside on our portfolio (the upside if all holdings reached our target prices) hitting levels not seen since 2008/09. Several stocks in our portfolio now have triple-digit upside in percentage terms. By way of example we highlight Bank of Georgia, a bank that together with its principal competitor has 70 per cent market share of the banking market in Georgia, is well capitalised and has a large portion of its loan book in liquid assets. It’s very profitable, generating circa 24 per cent return on equity, yet it’s trading in the market on 3x trailing price to earnings (P/E) ratio, 2.5x forward P/E and 0.5x book value. Even if we assume a 50 per cent cut in profits, its multiple looks reasonable for a dominant company in a market with structural growth.
As “social distancing” enters our lexicon we observe that the social and economic effects of the pandemic are only expediting growth in nascent trends. Chinese citizens in lockdown have become accustomed to using grocery delivery services and Alibaba has seen rapid growth in its service. Similarly, enforced remote working will expedite the adoption of cloud-based solutions by corporates, a trend that plays to the strength of companies such as Alibaba and Tencent.
One of the enduring attributes of the companies in which we seek to invest is their ability to thrive and get stronger during a crisis at the expense of their competitors – they come out the other side with an even stronger moat. HDFC bank in India and BCA in Indonesia will still be among the best banking franchises in Asia when this crisis passes, but they will have likely gained further market share from their competitors by going into the crisis with surplus capital, ready to lend when others grapple with problems and benefit from a flight to quality on the deposit side of their balance sheets.
Nick Payne is head of global emerging market equities at Merian Global Investors. The views expressed above are his own and should not be taken as investment advice.
*All data sourced from Merian Global Investors and Bloomberg, as at 25 March 2020.
Faced with what is likely to become one of the deepest but shortest recessions of modern times, PIMCO’s Joachim Fels and Andrew Balls explain what might unfold in the coming months.
The coronavirus recession will be the first ever ordered by government decree, according to PIMCO’s Joachim Fels and Andrew Balls, but the extraordinary levels of fiscal and monetary support should help the global economy bounce back once the spread of the virus is brought under control.
Global economic adviser Fels and Balls – PIMCO’s chief investment officer for global fixed income – said the recovery is likely to be U-shaped, in their opinion, although there remain a number of unknowns about the virus.
“There is no precedent and thus no good playbook for the global recession that is currently unfolding,” said Fels and Balls.
“Recessions are usually caused by the interplay between severe economic and/or financial imbalances building up during the expansion and a typical late-cycle tightening of monetary policy, sometimes aggravated by a sharp increase in the price of oil.
“This time is very different because the underlying cause of the downturn is a truly exogenous shock that originated from outside the economic and financial sphere: a highly contagious new coronavirus that has been spreading fast in a globalised world since the start of the year.”
As the pandemic threatened to overwhelm health systems, governments around the world responded by “aggressively curtailing economic and social activity” to stop its spread.
This, they said, has already led to a sharp drop in aggregate output and demand in many Western economies in the latter part of March – as represented below by composite purchasing managers’ indices (PMI) data – which should continue as measures remain in place.
“Over the past 10 years, all these PMIs were largely range-bound between about 45 and 60, except for a brief dip in Japan’s PMI in 2011,” the pair noted. “Then, in March 2020, all four composite PMIs dropped significantly: the euro area to 31.4, Japan to 35.8, UK to 37.1, and US to 40.5.
“Thus, we are seeing the first-ever recession by government decree – a necessary, temporary, partial shutdown of the economy aimed at preventing an even larger humanitarian crisis.”
While the slowdown has been unexpected and sharp, there have been no major economic imbalances - limiting the number of legacy issues once the virus is brought under control.
“Consumers were less exuberant than in the previous cycle, firms hadn’t overinvested in capacity, housing markets – with a few exceptions – didn’t overheat, and inflation was generally low and stable,” said Fels and Balls.
While the speed and severity of the downturn has surprised many investors, so too has the reaction of policymakers and authorities to the coronavirus.
“Policymakers have been pulling out virtually all the stops in an attempt to keep the recession from turning into a lasting depression with mass bankruptcies and mass long-term unemployment,” said the pair.
Unprecedented monetary and fiscal support has been unveiled by governments and central banks, which in many cases exceeds that announced during the global financial crisis of 2008.
Nevertheless, while a deep recession is "inevitable" given the shutdown of major parts of the global economy, the robust response is likely to prevent a global depression and should help support economic recovery once restrictions are lifted.
As such, Fels and Balls expect that the global economy will transition from “intense near-term pain during the virus-suppression phase to gradual healing over the next six-to-12 months” once the spread of the virus has been brought under control.
PIMCO’s base case scenario remains for a U-shaped rather than a V-shaped recovery because the lifting of restrictions will be gradual and at different speeds for different sectors and regions. In addition, it will take some time to repair the supply chain and clear logistical and transport bottlenecks.
“As a consequence, following the nosedive in economic activity that is currently underway (the downward I in the U), we expect the bottoming process to last a few months after the virus is under control (the L in the U), before output and demand ramp up back closer to more normal levels eventually, helped by fiscal and monetary support (the upward I in the U),” they said.
There are two main downside risks to a U-shaped recovery, the pair warned: first, a prolonged L-shaped trajectory and, second, a recovery interrupted by relapse ("call it a W").
These two risks could emerge should either pandemic curve or should the default curve of highly leveraged cyclical corporates deteriorate.
“A prolonged stagnation would likely result if governments’ current suppression strategy turns out to be insufficient to significantly slow the spread of the virus, so that suppression measures have to be kept in place for longer than the six to eight weeks currently anticipated,” they said.
“With activity depressed for longer in this scenario, many of the more highly leveraged firms in the cyclical parts of the economy would likely default, feeding back negatively into jobs and demand.
“Conversely, even if the virus suppression is successful in the near term and a lifting of containment measures leads to a revival of economic activity, we may experience a second wave of contagion later this year that leads to renewed economic stoppages. A relapse following the recovery would likely be exacerbated by defaults of cyclical companies that survived the first wave.”
Jupiter Asset Management’s head of fixed income strategy believes that forced selling from the crisis has created an opportunity in the bond market.
There has been an indiscriminate sell-off of ‘safe haven’ sovereign, investment grade and high yield debt, according to Jupiter bond manager Ariel Bezalel.
In a recent update, Bezalel said that a key feature of the coronavirus crash was “forced selling” from investors who had to sell their most liquid assets to raise cash, which hit US Treasuries hard.
However, Ariel Bezalel, head of fixed income strategy at Jupiter, explained that it was “not an entirely shocking development” and that similar price action was seen during the global financial crisis, which proved to be only temporary.
“Once chaotic flows slowed down, fundamentals reasserted themselves and Treasury yields dropped,” he said. “We’re seeing this dynamic play out again now, with Treasuries now showing signs of stabilising following the liquidation phase.
“We anticipate that safe haven assets like government bonds will continue to stabilise in due course and continue their trend of relative outperformance, but in general investors should be braced for more volatility.”
Performance of bond sectors over 2020
Source: FE Analytics
Bezalel praised the combination of the fiscal and monetary policy response to the coronavirus pandemic by governments around the world and said the cumulative effect has been better sentiment in credit markets.
He highlighted the US government’s approval of a $2trn fiscal stimulus package and the US Federal Reserve announcing it would buy an ‘unlimited’ amount of US Treasuries and commit to $300bn of investment-grade corporate bonds and asset-backed securities purchases.
The Fed’s actions supported the credit market and that the purchases of corporate debt were largely unexpected, subsequently creating a positive impact on markets, the manager added.
Elsewhere around the world, the Bank of England cut the base rate to 0.1 per cent and restarted its quantitative easing, the Reserve Bank of Australia cut rates to 0.25 per cent and announced quantitative easing and yield curve control, and the ECB unveiled a €750bn new bond-buying programme.
Bezalel – who runs the £4bn Jupiter Strategic Bond fund – said all these actions were ultimately positive for both government bonds and corporate credit markets, although cautioned they are likely to remain volatile.
“As volatility continues, it is not unlikely that we could see the Fed stepping in to purchase equities, as indeed the Bank of Japan has been doing for some time,” he continued.
Performance of Jupiter Strategic Bond vs sector since launch
Source: FE Analytics
Jupiter Strategic Bond benefited from taking a defensive stance at the beginning of the year, with hedges in credit default swaps and a short on the Omani rial cushioning the blow. But its position in high yield, particularly in energy, was the largest detractor, the manager revealed.
At present, he is bullish on US, Australian and New Zealand government bonds, expecting rates to remain low.
Bezalel also explained the fund is “cautiously” increasing exposure to credit, particularly “high quality, defensive opportunities that have been driven by forced selling of short-dated paper”.
Longer duration senior-secured notes in defensive sectors like telecoms have also been added to, as has bank exposure on “attractive double-digit yields”. High yield exposure is around 33 per cent.
The manager is also steering clear of sectors such as airlines, autos and the leisure industry, but holds debt from protein producers “which benefit from pork supply and demand disruption in China”.
“Despite the supportive measures announced by governments and central banks, many companies are vulnerable to default risk and may not be able to survive the wait for fiscal support,” he warned.
With emerging market sovereign debt, the fund is minimising exposure whilst maintaining short-duration emerging market US dollar sovereign bond exposure from the likes of Egypt and Ukraine.
These countries are liked because of their high cash reserves, low reliance on oil and commodity exports, and multilateral financing support, with yields of almost 10 per cent in US dollars for one-year bonds.
Performance of major currencies vs US dollar in 2020
Source: FE Analytics
The strategy is also long the US dollar, which has so far outperformed all other major currencies.
“As the world’s reserve currency, we believe that we are now entering a period in which the US dollar will be king, driven in part by the shortage of dollars in offshore markets” Bezalel explained.
This will likely cause “considerable pain” to the global economy, especially in emerging markets where US dollar-denominated debt is estimated stand at around $12trn in aggregate.
He also highlighted potential struggles in the Middle East, as the impact of the drop in oil prices will likely be exacerbated by dollar strength.
“There are simply not enough dollars going to the outside world at this critical juncture” he argued.
Giving an overall outlook, Bezalel said he is closely looking for signs that the market has priced in the worst impact of the coronavirus.
This isn’t likely to happen until infection levels peak in Europe and the US, and that the day “still seems a way off”.
When economic recovery does come, the manager expects a slow-burn recovery, not a V-shaped rebound.
“Despite our continued caution, we ultimately see this crisis as an opportunity to generate returns for our clients into the future, taking advantage of mispriced credit in financially strong issuers,” he finished.
Bezalel’s Jupiter Sterling Strategic Bond fund has generated a total return of 15.70 per cent over the past five years, compared with 9.99 per cent from its average IA Sterling Strategic Bond peer. The fund is also down 1.73 per cent year-to-date versus 6.19 per cent from the sector.
The fund currently yields 3 per cent and has an ongoing charges figure (OCF) of 0.73 per cent.
With stock markets plummeting over recent weeks because of coronavirus, Trustnet looks at how the first quarter played out by asset class, investment style and fund sector.
This quarterly series is usually called ‘The charts showing what you should have bought’ but following the heavy losses in many parts of the market, this edition has been retitled ‘The charts that show what you should have avoided’.
No-one will have been able to avoid the fact that the coronavirus outbreak has led to widespread turmoil, with more than a million cases detected worldwide and tens of thousands dying from the illness.
As well as the terrible human cost, the coronavirus pandemic has shaken financial markets to their very core. Below, we look how 2020’s first quarter played out from a range of viewpoints.
The chart below shows just how bad a quarter was had by global equities, represented here by the MSCI AC World index. The coronavirus pandemic and resultant lockdowns in many countries mean that the world is facing a recession and stock markets tanked on the back of this realisation.
But the 16 per cent fall in global equities looks minor when compared with near 60 per cent drop in the oil price. Oil is trading at around $20 a barrel, thanks to a price war between Saudi Arabia and Russia combined with the demand-smothering effects of the coronavirus crisis.
It shouldn’t be too surprising, therefore, that the only parts of the market to make positive returns over 2020’s first quarter were safe havens.
Gold rallied 11.66 per cent but at points was falling at the same time as equities. In mid-March, when gold was down before rising again, AJ Bell investment director Russ Mould said: “One common theory to explain gold’s slump is that investors are looking to meet redemptions or margin calls and the precious metal is a logical port of call, especially as many investors will have a profit to take and the gold market is relatively liquid. This makes sense, especially as the same happened to gold when all hell broke loose in 2008.”
Government bonds also rose over the quarter as investors sought out areas to protect portfolios and central banks around the world embarked on emergency interest rate cuts and massive quantitative easing programmes to protect economies against the fallout of coronavirus.
The following chart shows how losses in global stock markets were seen in pretty much every geographical location, but some felt the pain more than others.
The UK bore the brunt of the sell-off, putting to bed hope that the country would enjoy a Brexit bounce after years of being avoided by investors. The heavy presence of oil & gas companies in the UK market added to coronavirus woes as the oil price plummeted over the quarter.
Even though the coronavirus originated in China, emerging markets performed better than both the UK and Europe. This was largely down to the resilience of Chinese equities, which make up more than one-third of the MSCI Emerging Markets index but were down just 4 per cent over the quarter.
Not all emerging markets fared as well, however, with the MSCI Brazil index tanking some 46 per cent over the three-month period.
The next chart shows just how badly the value investment style performed in the first quarter. The style has lagged for much of the past decade and the coronavirus sell-off has failed to act as a catalyst for its revival.
The MSCI ACWI Value index dropped more than 20 per cent over the first three months of 2020, compared with losses of less than 10 per cent for its growth, quality and momentum counterparts.
Fundsmith Equity manager Terry Smith, known for his quality-growth approach, recently said: “I was immensely sceptical of the view that so-called value stocks could protect you in a downturn. I have never been a believer in the philosophy that so-called ‘value’ investments would perform well or protect your investment in an economic and market downturn.
“Shares in companies that are lowly rated are so mostly for good reasons. Because their businesses are heavily cyclical, highly leveraged, they have poor returns on capital and/or they face other structural or management issues. It doesn’t sound like a combination likely to protect the business and your investment in difficult times, and so it has proven thus far.”
Turning to the various industries in the global stock market, energy companies have been the hardest hit by the first quarter’s turbulent conditions with the MSCI ACWI/Energy down 40 per cent as the oil price plummeted.
Other sectors highly geared into the health of the economy, such as financials, industrials and materials, also fell hard.
The ‘winners’ – in a relative sense, given losses were seen across the board – were more defensive areas of the market. The healthcare index, for example, kept its losses over the quarter to just above 5 per cent.
Marija Veitmane, multi asset class research senior strategist at State Street Global Markets, said: “We find that the safest stocks right now are those with the strongest underlying fundamentals – stocks that are in a stronger position to defend their earnings. Earnings forecasts have fallen, as analysts try to factor in the impact of the virus on the economy. But have they adjusted enough?
“Whilst no one can answer this question yet, media sentiment remains negative on upcoming earnings leading to a possible earnings disappointment. However, with strong cash flow generation at a premium, healthcare, consumer staples and IT identify as the safest options right now, whilst financials and utilities remain at risk.”
We’ve already seen how UK equities were the worst performers on a regional basis, but the chart below illustrates the fortunes of UK companies of different sizes.
The FTSE 100 is the most closely followed index in the UK and its falls have been making almost daily headlines, with some very heavy losses being incurred followed by the very occasional ‘mega-rally’. But the FTSE 100 has been the part of the market that has held up best.
The mid- and small-cap parts of the market suffered much higher losses as the extreme risk-off sentiment that dominated the first quarter – and especially in March – prompted them to pull back from these areas.
Looking at how all of the above affected the various Investment Association sectors, we see that IA UK Smaller Companies was the worst performer of the quarter, followed closely by IA UK All Companies and IA UK Equity Income.
Ryan Hughes, head of active portfolios at AJ Bell, said: “UK deep value along with mid- and small-cap funds took a real hammering.
“The value space was an area that really struggled over the quarter as those companies that were already perceived by the market to have some degree of problems were punished even further with the likes of Alastair Mundy at Investec (Ninety One) and Andy Brough at Schroders both making an appearance in the biggest losers of the first quarter.”
When it comes to bonds, IA UK Gilts and IA UK Index Linked Gilts were the only sectors in the Investment Association universe to make positive returns during the quarter.
“At an overall level, long duration bonds have been the place to be as government bonds rallied hard amid the collapse in interest rates,” Hughes added. “The Allianz Strategic Bond fund showed that active management can prosper during times of turmoil as the highly regarded Mike Riddell managed to deliver good returns in the strategic bond space.”
In the multi-asset and ‘other’ part of the Investment Association universe, IA Property Other and IA Specialist handed investors the heaviest losses.
Among specialist funds, it was energy and Latin American or Brazilian equity strategies that fared the worst. The worst performer overall was Schroder ISF Global Energy, with a fall of 60 per cent.
And on the fact that the average IA UK Direct Property was down just 1.19 per cent, Willis Owen head of personal investing Adrian Lowcock said: “Given that many funds have been suspended in March because the independent valuers could no longer accurately value the properties, the performance figures are unlikely to be accurate and should effectively be ignored.
“Indeed, when they reopen the sector will likely face a double blow from investors who were locked in redeeming and from tumbling property values.”
Data from Calastone suggests money was pulled out of UK-based funds at their fastest pace on record during March.
British manufacturer Rolls-Royce will be suspending its dividend payouts and abandoning its profit, cash and deliveries targets due to the drop in its civil aerospace business caused by the coronavirus pandemic.
One of the biggest engineers of aircraft engines in the world, Rolls-Royce has been harshly hit by the global measures prohibiting travel. Its civil aerospace arm generates almost half of the company’s revenues and makes its profit from the number of hours its engines fly.
However, this has been hit by the fact that many widebody aircraft are now grounded as flights have been cancelled to contain the spread of the coronavirus.
Adam Vettese, an analyst at investment platform eToro, said: “In any normal market, Rolls-Royce would have been punished heavily for scrapping its dividend and warning of a slide in revenues. However, this is anything but a normal market.
“The aerospace giant’s shares have risen so sharply this morning because of its relatively strong liquidity position as well as the steps it has taken to shield itself financially from the current harsh economic environment.
“How long that last though, with airlines across the world grounding their fleets, remains to be seen. If the coronavirus continues its stranglehold on the global economy by the summer, Rolls-Royce could be posting a much less optimistic update next time round.”
Craig Erlam, senior market analyst at OANDA Europe, said: “There's no shortage of volatility at the start of the week, or overconfidence for that matter, as stock markets jump on some apparently promising numbers in recent days.
“Europe appears to have turned a corner, with Italy and Spain - the worst hit in the region - seeing a sustained period of declining new cases and deaths. Other countries are starting to see similar results as well which is certainly cause for optimism after a quite horrific month. The quarantine measures are clearly having the desired effect; let's just hope people continue to respect them or we could be back to square one.
“Optimism is misplaced as far as the UK and US is concerned though. The next week or two is going to be grim and one day of better data from the US doesn't change that. Investors are keen for the market to have bottomed but I'm not sure they'll easily weather the storm to come and their nerves will likely be heavily tested.”
After Mark Barnett and Invesco lost management responsibilities on the Invesco Perpetual Income and Growth Trust, AJ Bell head of active portfolios Ryan Hughes said: “News that Mark Barnett and Invesco have been served notice on their management of the Perpetual Income & Growth Investment Trust does not come as too much of a surprise given the scale of the underperformance of the trust against the FTSE All Share over the past few years, however it will be a blow to Invesco having also lost the Edinburgh Investment Trust.
“It clearly was of little comfort to the board that other value focused investment trusts have suffered even more in the recent sell-off, while they also have clearly lost confidence in the manager’s ability to capitalise on any post-coronavirus bounce-back which will hopefully come once we emerge from the other side of this current crisis. The £400m trust will now be a highly prized opportunity for a range of UK equity managers, particularly when the assets of so many will have been hit hard by recent market falls.”
Investors pulled cash out of UK-based funds at their fastest pace on record during March as markets sold off because of the continued spread of the coronavirus pandemic, Calastone data suggests.
The Calastone Fund Flow Index shows March witnessed the largest outflows on record for any month “by a long shot”, the most week-to-week volatility and the biggest divergence between the appetite for different asset types since the firm started collecting the data.
In all, investors took a record £3.1bn out of their fund holdings last month, which is almost exactly three times more than in the previous worst month on Calastone’s record: June 2016, when the UK voted to leave the EU.
However, the firm added that “the big story was in fixed income”. Although it might be expected for equity funds to bear the brunt of the selling, by the end of March an “unprecedented” £3.7bn had been yanked out of bond funds.
Edward Glyn, head of global markets at Calastone, said; “Market crises are superficially all the same as volatility soars and asset prices collapse, but they differ enormously in the detail. The temporary loss of fixed income as a safe-haven asset class to counterbalance some of the huge losses in equity markets left investors with little option but to ride it out or park their money in cash or cash-equivalents like money market funds.”
For equity funds overall, just £244m flowed out in March. However, this headline figure disguises the fact that £1.7bn was redeemed from active funds last month while passive strategies took in a record£1.4bn.
Glyn added: “The massive divergence between passive and active funds can be partially explained by long-term trends driving the growth of index investing and by the hard anchor of monthly direct debits, but these factors aren’t enough on their own to account for the huge disparity in March.
“It seems investors attempting to catch market troughs may simply be focusing on timing and just relying on the index to do the rest. But in fact, active managers tend to do rather well in difficult times for stock markets so the big outflows from that segment at a time of such big inflows to passive funds are a little surprising.”
Providing an update on some of the changes he’s made in reaction to the coronavirus, the Fidelity manager explains his thoughts on what the epidemic means for Chinese stocks.
With global markets having been heavily sold off following the impact of the coronavirus pandemic, Fidelity China Special Situations manager Dale Nicholls explains why he thinks the impact will be short-term in nature and how it affects his long-term outlook.
As the epicentre of the outbreak, the Chinese economy was the first to go into lockdown towards the start of the year.
China had already been undergoing an economic slowdown prior to the coronavirus outbreak as annual growth rate decreased from 6.4 per cent to 6.2 per cent, said Nicholls (pictured).
However, the coronavirus outbreak and the virtual halting of all retail sales and production is likely to bear some further weight on short-term GDP growth.
“I also expect general forecasts will need to be revised down in the near-term as we see further pressure being put on balance sheets,” he said.
Yet, Nicholls said he is more concerned about the spread outside of China and its potential impact on the global economy.
“Currently, I am most concerned about the global macroeconomic impact of the coronavirus as it continues to spread beyond China,” said Nicholls, as the number of cases in Europe and the US continue to reach new highs and those in whilst China appear to be tapering.
The Fidelity China Special Situations manager said Chinese authorities will likely follow in the same steps as other countries that have made use of fiscal and monetary stimulus to help their economies through the outbreak.
“I expect further stimulus – both monetary and fiscal – and with lower global interest rates being put in place to support economic growth, China has the capacity to ease further,” he said. “It will be interesting to see if president Xi Jinping will keep China’s 2020 growth target in place.”
But the manager maintains that whilst the short-term impact will be intensely felt “it does not derail the structural shifts underway in the region”.
“I remain cautious as it is difficult to predict the extent and time this will last for,” he explained. “However, if we see continued signs of the virus being contained then this impact could be short-lived as sentiment and demand would improve quickly.”
All of this he believes will result in interesting investment opportunities for the £1.6bn trust to buy into “long-term winners”, especially in sectors such as technology which he believes is home to several global leaders.
Nicholls said he had been reviewing beneficiaries of potential stimulus and paying attention to companies that he expects to be able navigate and emerge stronger through this period.
In addition, the manager said he was shoring his exposure to names which had brought about “more attractive liquidity opportunities have appeared as a result of the markets’ moves”.
Especially, he said, in select consumer staples, discretionary and insurance sectors.
One change the manager has made to the trust’s portfolio as a response to the spread of Covid-19, is to reduce his financials exposure, “given that credit cycle dynamics are deteriorating and also taking down some industrials exposure, especially where it is more global”.
Nevertheless, Nicholls said the measures put in place to protect the strategy during times of greater market stress are starting to come into play.
“The protection strategies – via index puts – are coming into play, which in turn has seen the portfolio’s net exposure fall over recent times,” he said.
This appears to have worked well for the fund as the sell-off has not massively ‘derailed’ his long-term returns.
“The portfolio remains focused on companies with good long-term growth prospects that are cash-generative and have strong management teams,” Nicholls added.
“These include companies that have carved a niche for themselves in the segments they operate in, and often offer an intersection of technological leadership and strong consumption outlook.
“I also maintain that premiumisation or ‘trading up’ within individual consumption categories will continue and this will create some interesting investment opportunities across a range of areas, including sportswear, toothpaste and coffee chains.”
Over the past five years, Fidelity China Special Situations has made a total return of 55.12 per cent compared with a 40.31 per cent return for the MSCI China benchmark.
Performance of fund vs sector & index over 5yrs
Source: FE Analytics
The trust is currently was trading at a 9 per cent discount to net asset value (NAV), is 25 per cent geared, and ongoing charges at 0.93 per cent (as at 31 March).
Adrian Lowcock, head of personal investing at Willis Owen, highlights the three funds he'll be adding before the ISA deadline closes on 5 April.
It is important to make investment choices based on your goals and not on the short-term noise that often permeates stock markets. So, when choosing the investments for my 2020 I have to think about my situation I am 44 years old and my ISAs form part of my long-term goals, which is a combination of retirement and possibly providing some money for my two young children when they grow up. Therefore, any ISA investment decision I make is done so on the basis that I am unlikely to need the money for at least 10 years, and probably longer as I plan to stay invested through my retirement.
This longer-term time horizon gives me a different perspective on markets. The coronavirus crash is a perfect example of this. Falling markets provide excellent investment opportunities as, in the past when markets have fallen, they have always recovered, even if it has taken a while.
Investing for 20 years means I can look at the long-term performance and returns. For this reason, equity income plays a significant role in my portfolio. The power of compounding is huge but you only really see the benefits after doing it for several years.
I can also afford to be patient; I often top up my holdings in Asia and emerging markets even though the regions have been out of favour and lagged some developed markets. I recognise they can remain unpopular for some time however, valuations are not expensive and there are some attractive dividends which when reinvested will contribute to the long-term performance of my portfolio.
Smaller companies also feature significantly in my ISA portfolio. This is an area of the market where, in the UK, we have some exceptional stock pickers who can consistently and considerably outperform the market. Smaller companies can be very volatile and in a downturn, you could see some big falls in values, but this doesn’t mean you should turn away from them.
My ISA Picks
This is a top-up of an existing holding in my ISA. Asia has struggled recently as trade wars impacted sentiment towards the region, however, valuations are attractive compared to developed markets with some excellent long-term opportunities. Investing in this region requires patience and a cautious approach. I consider this a holding not just for 2020, but for a longer timeframe and as such am adding small amounts regularly.
Richard Sennitt is a very experienced manager and has been investing in Asia for over 23 years. He has a strong value discipline and won’t buy at any price. He is a stockpicker and runs a concentrated portfolio of 60-80 stocks. The fund invests in companies which are financially sound, profitable, with proven management focused on shareholder returns.
The UK was beginning to come out from under a cloud for the past three years because of Brexit. That uncertainty had weighed on the country’s economy and its stock market. The recent crash in markets has hit the UK hard but means there are some attractive opportunities. Most importantly there are companies which take greater control of their destiny and are better placed to grow their business in any market.
Richard Watts has managed the fund since January 2009 and is supported by one of the largest and most respected teams in the mid and small-cap space. The core philosophy is to capture under-appreciated growth. Watts combines a broad economic outlook with detailed company analysis. He has a flexible approach and adapts the portfolio for the stage of the economic cycle. Companies selected must demonstrate either: above-average earnings growth; the scope for a positive surprise; or the potential to be re-rated relative to the market. Watts monitors the benchmark construction but will take high conviction positions in individual stocks. This is a top-up to an existing holding.
The landscape for UK dividends is a mess, companies are quickly cutting their payouts. Given the magnitude of the crisis, few companies dividends are safe, in the short term at least. However, some payouts will survive and for those willing to do the work and sift through the businesses as some yields are eye-watering.
This is where the likes of Richard Colwell comes in. He is an experienced equity income manager and has been responsible for this fund since 2010. His focus is on stock selection, and he holds a blend of quality companies and out-of-favour businesses with recovery potential. The high-quality investments have strong cash generation, which can fund both dividends and long-term growth. The recovery selections may not currently pay a dividend but he believes they have the potential to provide income and grow the value of the business in the future. The fund is unconstrained but is mainly invested in large blue-chip companies.
Adrian Lowcock is head of personal investing at Willis Owen. The views expressed above are his own and should not be taken as investment advice.
The chairman of Ruffer says people should pay more attention to the state of the market before the coronavirus crisis struck, adding we could be set to return to the 1970s.
This year’s market crash was entirely predictable, according to Ruffer chairman Jonathan Ruffer, who says anyone pinning the blame solely on the coronavirus pandemic is ignoring the risks that have been building in the market for the past decade.
As a group, Ruffer has long been positioned defensively in anticipation of a market collapse and its portfolios have held up well so far this year – for example, LF Ruffer Total Return is down just 2.03 per cent compared with losses of 13.11 per cent from the IA Mixed Investment 20-60% Shares sector and 25.13 per cent from the FTSE All Share.
Performance of fund vs sector and index in 2020
Source: FE Analytics
And the chairman accepted that while the coronavirus and its associated fallout were “utterly unforeseeable”, he said ignoring the condition of the market before the crash would be like investigating a maritime disaster without examining the ship.
“The Titanic was sunk by an iceberg; the Ark Royal by a torpedo – both were great surprises, as coronavirus has been,” he explained.
“Another way of looking at the fate of the Titanic and Ark Royal is that the former sank because of inadequate bulkheads, the latter because of a flaw in the siting of the engine exhausts.
“In the long run-up to market dislocation, we were preoccupied with the ship, not the icebergs or torpedoes. The instruments of destruction are always out there. If markets are resilient, they cope with them. The danger comes when they are not, and this has been the centre of our earnest enquiry: where were things going wrong? Where were they headed?”
Ruffer said this will be a far harder bear market to navigate than the dotcom bubble or financial crisis, when the market dropped by about 50 per cent each time.
Performance of index in dotcom bubble
Source: FE Analytics
In the first, he said all you had to do was ignore the tech and media stocks that were on obscene valuations, while in the second, you simply had to remember one rule: massive amounts of borrowing would eventually give way to massive amounts of de-gearing. As a result, he bought options on Swiss francs and Japanese yen on the expectation that investors who had borrowed in these currencies would compete to buy them back in the event of a crisis.
“As that bloody meerkat says, ‘simples’,” he added. “This time round, it is neither ‘simples’ nor ‘easies’.
“The problem can be condensed into a single idea – where there is borrowing, there is danger – but this does not come with an obvious solution.
“Leverage has flooded into every asset class. In the world’s portfolios, the most exposed positions have been the first to tumble. But as investors have struggled to re-establish an even keel, they have had to sell the things which are not obviously wrong, simply because these things are capable of being sold.
“This is not a surprise, of course, but it does mean that there has been, ahead of this rough water, a good reason for not owning any type of asset at all.
“In many ways, the battle has been less frightening than the eve of battle, when there seemed no certainties of safety.”
In a previous article published on Trustnet, Ruffer’s investment director Bertie Dannatt revealed how the group has managed to protect against this year’s crash, through long-volatility options, which Ruffer said have now run their course, and positions in credit spreads, which he believes still have plenty of mileage.
Less successful positions included a bet that the Japanese yen would outperform the dollar, and a tilt to value stocks in the equity side of the portfolio.
“Ironically, we believed that 2020 itself was going to be a year when world economies coordinated into a pattern of significant growth,” Ruffer explained.
Looking forward, he warned anyone who is tempted to buy the dips on cheaper valuations that this may not be the one-way bet they are banking on. While this has always been the right call since Alan Greenspan became chair of the Federal Reserve in 1987, the tactic produced mixed results before then.
“Not many of us old-timers who acquired our hard-wiring before 1987 are left,” Ruffer continued.
“I started as a stockbroker in 1972, when a falling stock market was friendless, and bad news was pretty much just that – bad.
“Buying the dips is predicated on the assumption that bad news is in fact good news since it opens up Uncle Sam’s pocketbook. Now debt is so great, and the promises needed so egregious, that there has to be a question mark over the efficacy of the pocketbook.”
Ruffer said that any loss of confidence in the value of the collateral will manifest itself in a fear of inflation. As a result, he has increased his position in inflation-linked bonds (notably in the US), which he said will protect against “a grinding bear market in money, in savings, in prosperity”.
“The time is moving on from a world where we had to protect against sudden shocks – catastrophe insurance is behind us, job done,” he continued.
“The investment landscape is going to become much more familiar, but it will only be a homecoming to the greybeards who have lived it before. Thirty-three years is a long detour – and for many it will have proved a cul-de-sac. It is difficult to master old tricks, second-hand, but my prediction is that it will prove a valuable quality over the next longish while.”