It was a difficult month for performance. With the debt at fair value the NAV fell 4.8% versus a 3.6% fall in the broader market. Keeping the debt at par the NAV fell 4.3%. There are a few key reasons for the underperformance:

• Concerns around a slowdown in global economic growth meant that at the sector level, the difference in performance this month between ‘defensive’ and ‘cyclical’ sectors was stark. Sectors including consumer staples, utilities and healthcare outperformed while cyclical sectors such as energy, materials, financials and industrials underperformed. This detracted from performance, with the largest detractor at the sector level within the portfolio being financials, where stocks such as Hiscox, Prudential and Direct Line all performed poorly (none had any company-specific news). In a lower bond yield environment all will see lower investment income and this will mean earnings forecasts need to come down.

• There were a few company specific one-offs, the largest being Shoe Zone which had a profit warning. They have ~460 stores on the UK high street and it is a (modestly) difficult period at the moment. The operational gearing inherent in this type of business meant that ~2% disappointment at the sales level led to ~14% downgrade at the profit level. While this is clearly disappointing the long term positives of the business remain – a management team (who own almost half the shares) very focussed on cash generation and keeping costs down, a largely non-discretionary purchase (eg children’s school shoes, work shoes) and a strong balance sheet.

• Fair valuing the debt continues to detract from performance. It is now reducing the NAV by 20p, up from 7p at the beginning of the calendar year.

The portfolio valuation is now looking low – as a blend the portfolio is on under 11x forward earnings and within this there are 36 stocks on under 10x earnings. These companies are a diverse list but can be broadly be classified into two areas – global growth (companies such as Morgan Advanced Materials, DS Smith, Prudential) and domestic growth (RBS, house builders, Royal Mail). For these companies to re-rate there needs to be more confidence around the global economy and the domestic economy respectively. The latter (ie confidence in the domestic economy) would be more important to us in a relative sense as we would be more exposed to the domestic economy than the broader benchmark.  For there to be confidence in the domestic economy there needs to be a resolution to Brexit. We do not have an angle as to what the outcome of the debate will be but we must surely be nearing a resolution.

Glossary
Cyclical stocks/sectors: Companies that sell discretionary consumer items, such as cars, or industries highly sensitive to changes in the economy, such as miners. The prices of equities and bonds issued by cyclical companies tend to be strongly affected by ups and downs in the overall economy, when compared to non-cyclicalcompanies.
Gearing: A measure of a company’s leverage that shows how far its operations are funded by lenders versus shareholders. It is a measure of the debt level of a company. Within investment trusts it refers to how much money the trust borrows for investment purposes.
NAV (Net asset value): The total value of a fund’s assets less its liabilities.