An update from our investment managers, Ben Ritchie and Louise Kernohan - 15 April 2020
The FTSE All Share fell very sharply over the first three weeks of March, dropping 25%, before staging a rally in the last few days of the month which has continued into April. The fall from the 20th February to the market trough on 23rd March was over 35% and marked one of the quickest declines into a bear market in financial history. The subsequent bounce back has also been one of the sharpest rallies in modern times. The negative impact on markets was primarily driven by the rapid global spread of Covid 19 and the increasingly stringent social measures being taken to arrest the pandemic with consequently significant effects on the economy. At the same time the Opec+ cartel were unable to agree on production restrictions, leading Saudi Arabia to increase oil output at a point when demand was collapsing. This had the effect of driving down the price by more than 50% with a very large knock on effect for oil related stocks. In terms of performance over this time, banks and companies exposed to discretionary consumption and aviation have been hit very hard as were those perceived to have weak balance sheets. In contrast gold miners, supermarkets, consumer staples and pharmaceutical stocks all proved relatively resilient.
Amidst the sharp decline in the equity market we took the opportunity to draw down some borrowings from our variable bank facilities which raised our gearing by about one percentage point. We reinvested this capital, along with some of our existing cash, into a number of companies that we believed would be relatively resilient in tough markets but where the share prices had declined sharply. This included additions to recent purchases SSE and Coca-Cola HBC as well as Direct Line Insurance and Rio Tinto. Towards the end of the month we made further additions to SSE, Coca-Cola HB, emerging market fund manager Ashmore and insurer and asset manager M&G, attracted by a combination of business resilience, yield and valuation. To help fund some of these purchases we made a number of small trims to companies where the share price had proven more resilient and where yields were relatively low such as Abcam, Dechra Pharmaceuticals, Diageo, Experian and London Stock Exchange. We also exited Italian listed hearing aid retailer Amplifon given an increasingly tough outlook for the business, a relatively high degree of leverage and an expectation that the dividend would be cancelled.
Economies continue to face a triple threat of collapsing demand, supply chain disruption and tightening financial conditions. Significant policy response has been deployed by central banks and governments with interest rate cuts, further quantitative easing, fiscal stimulus and regulatory forbearance being actioned. The signs are that the most worrying indications of systemic distress in the financial system have brought under control. That notwithstanding the depth of the ensuing recession is likely to be the greatest since the depression in the 1930's and the long-term impact on economies is highly uncertain. The duration of social restrictions remains the key determinant of the ultimate financial impact and markets increasingly seem to be pricing in a relatively rapid recovery. Yet while isolating people at home is almost certain to stop the spread of the virus, the ability to safely relax the restrictions and restart the economy is as yet untested and we would be wary of using the Chinese experience as a comparable template for the western democracies.
In such conditions we are remaining focussed on closely monitoring the financial strength of our holdings with an emphasis on operational and financial leverage and cash generation. We have adopted a cautious stance for some time and see little reason to shift from this conservative focus on higher quality businesses. We cannot fully mitigate the impact of falling markets, nor offset entirely the income impact of the number of dividend cuts we have seen so far. But we want to make sure that the companies we hold are in a position to minimise the impact on franchise value and their ability to pay and grow their dividends over the long term. In particular experience has taught us to be particularly wary of chasing yield at the expense of total return. As a result we remain watchful for opportunities but for the moment are quite happy to retain a relatively defensive tilt to our overall positioning.