An update from our investment managers, Ben Ritchie and Louise Kernohan
As we write this, UK Equity markets have fallen 30% over the past month (since 20th Feb) as a result of the COVID-19 pandemic, in what has been one of the fastest market declines in history. This is as investors try to rationalise a collapse in global demand, rolling supply chain shocks, an increasingly strained financial system and on top of that a significant health threat amplifying uncertainty and stress. The economic consequences are as yet unclear but as it stands a global recession looks likely. It is also worth noting that alongside the COVID-19 spread we have seen the effective collapse of OPEC+ as a price setting cartel which has led the oil price to fall back towards $20 a barrel, a level last achieved in 2001.
What does this mean for the companies we invest in? The outlook for corporate earnings growth in 2020 has significantly deteriorated in the last 4 weeks. It is difficult to quantify the magnitude of the impact at this stage, but there is certainly the capacity for many companies to become loss making in the short term. This will inevitably have an impact on company dividends, particularly in the most vulnerable industries such as travel, leisure and retail. However, more positively, corporate balance sheets remain relatively strong, central banks and governments are taking major action and with pandemics being finite in length there is scope for a rebound which has the potential to be a lot quicker than in 2008/09 if productive capacity of both labour and capital is effectively insulated.
What does this mean for DIGIT? Our strategy to invest in high quality businesses aligned to structurally growing industries and with strong balance sheets leaves us in relatively good stead and to date the investment portfolio is outperforming the FTSE All Share. We are benefited by our overweight position to sectors that are relatively less affected such as healthcare and non-discretionary consumer products, plus our underweight position to the Oil & Gas sector and only very modest exposure to the heavily impacted industries of travel, leisure and retail. The modest gearing position that we run with however is a headwind in the declining market. The outlook for company dividends for the year ahead is uncertain, but we believe that as it stands today the income we anticipate to be at risk remains a manageable portion of our total expected income. We will continue to closely monitor the situation.
We have adopted a cautious stance for some time and see little reason to shift from this conservative focus on high quality businesses. We cannot fully mitigate the impact of falling markets but we will continue to ensure that the companies we hold are in a position to minimise the long term impact on franchise value and their ability to pay and maintain their dividends.