We are living in extraordinary times and investment performance of the Company has been among the casualties. The Net Asset Value of the portfolio is down markedly year-to-date (35% as of 29th March) which is around 8% lower than the benchmark. Clearly this is very disappointing.
The bull market that had characterised recent years did little for the fortunes of value stocks, but in the last year and a half, the environment has deteriorated further still. Approaching the end of February, the portfolio was approximately 4% behind the benchmark, not the result of any stock-picking disasters, but simply because growth rather than value stocks have been so firmly in vogue.
As COVID-19 struck, I recognised the risks to the most impacted sectors such as airlines, and quickly sold my small Dart position (at a significant profit) and my small Wizz Air position. Unfortunately, I underestimated the degree to which Western governments would need to curtail economic activity and thus the huge knock-on effects.
Over the last few weeks I have been conducting dozens of company meetings - and our analysts literally hundreds of meetings - to hear what’s happening on the ground. Our fixed income colleagues have also been feeding in what’s been happening in debt markets, while our healthcare team very ably lead by Dr Judith Finegold, has been making sure that we have the best possible view of what this virus means medically.
A series of global investment team meetings have been put in place and we are communicating regularly on a global basis, with teams almost universally working from home. While these are deeply unsettling times, Fidelity has the best possible resources to deal with this situation.
What is now clear, is that beyond just the initial lockdowns, there will also now be a global recession at least as bad as seen in the 2008/2009 period and quite possibly worse. Indeed, investment banks and our own internal economists are predicting a Q2 economic contraction in the -10 to -25% range, much larger than the worst quarter in the global financial crisis of -8%. Additionally, the government support measures will result in significantly higher government debt-to-GDP levels for Western countries which have had to lock down. This is at a time when debt-to-GDP levels are already high.
I think it is consensus that we will have a deep recession, although it is not clear to me whether market participants are yet correctly assessing how long this may go on for. It seems inevitable that there will be significant and wide-ranging dividend cuts in this environment.
Going into this crisis, the portfolio had what I believed was its highest ever defensive weighting. Unfortunately, it emerged that we had a number of large positions in what I considered, and still consider, economically unsensitive names which are, however, activity sensitive. For instance, C&C (a drinks distributor (70% on trade) and brewer) and Photo-Me (ID photos and laundry machines) are normally defensive but have proved not to be in this environment.
Additionally, some of the names I had expected to outperform given their defensive nature have not done so. Mylan, Imperial Brands, ContourGlobal, Babcock and Serco are all largely unaffected by COVID-19 but are all down by 20% or more on year-to-date basis. These are big positions in the portfolio and I have been topping up, as I see these irrational share price moves as a potential future creator of performance.
In a downturn, mid- and small-caps tend to get hit harder, and thus the portfolio’s structural overweight here has been punished, with mid-caps down 5% more than the index and small caps 8% worse at the time of writing.
What am I doing?
In the first instance I have been working through the portfolio to assess where a deep recession and/or the lockdown process will likely cause balance sheet problems. I have then looked to sell names where I think there is a real bankruptcy risk. This is something of a moving feast, as in some sectors revenue falls are so severe that even companies with net cash balance sheets may go bankrupt as they cannot cover costs and burn through cash. Levels of government support and bank forbearance will also be important and these are changing daily.
While the leverage of the fund has gone up meaningfully since January (from 2% to 12%), many of the stocks I have added to have been defensive names.
The largest addition to the fund is a telecom operator, an unloved stock but a clear winner of the current crisis where revenues are going up and costs are falling, but where the stock has fallen 20% year-to-date, only slightly outperforming the market.
I have also increased the position in communication equipment firm Ericsson, which I bought initially in the early part of Q1 to take advantage of a significant expected increase in telecom-related capex spending. I have added two small-cap gold miners, both of which had fallen 50%, despite the price of gold rising. Including existing holdings Semafo (recently bid for) and pawnbroker H&T Group, the fund now has circa 3% in gold linked equities.
I have trimmed back the portfolio’s oil exposure selling around 2% across BP and Shell. I have also added to support services firm DCC, to utilities, as well as to health-care company Mylan. I have added selectively in some cyclical areas where balance sheets are strong, but these are small additions with circa 1.5% total increases in support services and industrials. Given the large recession we are about to go through, I think it is right not to be too aggressive at this point.
Life insurance is another area I have added to and has latterly started displaying the defensive characteristics I was hoping for by meaningfully outperforming last week.
There can be no two ways about it - tragically many lives and businesses will be lost as a result of this crisis. From a purely investment perspective however, there are also lot of opportunities to buy companies at exceptional prices, without having to take big cyclical risks. The portfolio remains fairly balanced with a defensive tilt, but geared to the market given the attractiveness of value stocks.
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The value of investments can go down as well as up and you may not get back the amount you invested. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments are subject to currency fluctuations. The shares in the investment trust are listed on the London Stock Exchange and their price is affected by supply and demand. The investment trust can gain additional exposure to the market, known as gearing, potentially increasing volatility. This trust invests more heavily than others in smaller companies, which can carry a higher risk because their share prices may be more volatile than those of larger companies and the securities are often less liquid. This fund uses financial derivative instruments for investment purposes, which may expose the fund to a higher degree of risk and can cause investments to experience larger than average price fluctuations. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.