We are currently in unprecedented times. A global pandemic has led to a bear market in equities and likely global economic recession as governments introduce extreme measures to contain the spread of Covid-19, effectively putting much of life as we know it ‘on hold’.  The strong returns of 2019 are a distant memory as the FTSE All-Share has now fallen by almost 30% so far this year (to 24^th March).  It has been truly an astonishing period for equity markets and life in general.

Although the Trust had started to move more defensively over the last 18 months, increasing its bond exposure and adding to pharmaceuticals and consumer staples, it has not been immune from some of the significant share price falls across the market, exacerbated by the gearing within the Trust.

While some of the Trust’s holdings have fared better than others in this environment, such as Tesco, Unilever, AstraZeneca, Hilton Food Group and Cranswick, others in the retail and travel & leisure sectors, which are most impacted from government lockdowns, have suffered. On a brighter note, one area that has been particularly strong has been the Trust’s holdings in US investment grade bonds.  We purchased the majority of the holdings in November 2018 when yields were particularly attractive.  The Trust has benefitted significantly by the strong performance of these assets, with yields moving to extremely low levels which now don’t offer compelling value, especially against the Trust’s cost of borrowing.  We therefore took the decision to sell £12m of those bonds earlier in March, and to lower the Trust’s gearing once more.

Within the equity portfolio we have also been lowering the exposure to cyclical companies, selling IAG (the holding company of British Airways) and brick manufacturer Ibstock back in January, and housebuilder Vistry and asset manager Jupiter more recently. The sale proceeds have been used to increase holdings in more stable businesses that should have dependable cash flows and dividends, such as British American Tobacco, Reckitt Benckiser and the French pharmaceutical company Sanofi.  I have also taken advantage of the significant market falls to initiate new positions in other businesses with strong global franchises and robust balance sheets, such as Coca-Cola and Burberry.

The short term impact from the virus and the measures to contain it will no doubt bring worries about dividend sustainability.  Many companies in the last few days have announced their intentions to suspend or postpone dividend payments given the uncertainty.  While we have a focus on companies with strong balance sheets, we will not be immune from dividend cuts or postponements as government actions will put pressure on companies’ short term cash flows. No doubt there will be more to come and while painful for the revenue account, we support companies that take this prudent approach if it means shoring up their financial strength.  The Trust’s well-diversified portfolio and a bias towards quality companies will help limit the impact while the Trust’s revenue reserves, which have been built up over the last few years, has the potential to provide further support to our own dividend.

Although the outlook is particularly uncertain, there is some early evidence from China that factories in most parts of the country are now returning to production, suggesting that the spread of COVID-19 can be managed. Indeed, once it can been established who has already recovered from the virus and is now immune, governments will want to start easing restrictions gently. In the meantime, governments and central banks globally have announced significant stimulus packages to help support economies while valuations have now fallen to very attractive levels.  Although it is still a time to remain cautious, the recent market sell-off has created good opportunities for long term investors.  These are unprecedented times but we have confidence in our disciplined investment process, which has produced good performance over the longer term.

 

Glossary

Bear market – A financial market in which the prices of securities are falling. A generally accepted definition is a fall of 20% or more in an index over at least a two-month period. The opposite of a bull market.  

Bond – A debt security issued by a company or a government, used as a way of raising money. The investor buying the bond is effectively lending money to the issuer of the bond. Bonds offer a return to investors in the form of fixed periodic payments, and the eventual return at maturity of the original money invested – the par value. Because of their fixed periodic interest payments, they are also often called fixed income instruments. 

Dividend – A payment made by a company to its shareholders. The amount is variable, and is paid as a portion of the company’s profits. 

Equity – A security representing ownership, typically listed on a stock exchange. ‘Equities’ as an asset class means investments in shares, as opposed to, for instance, bonds. To have ‘equity’ in a company means to hold shares in that company and therefore have part ownership.

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. 

Yield – The level of income on a security, typically expressed as a percentage rate. For equities, a common measure is the dividend yield, which divides recent dividend payments for each share by the share price. For a bond, this is calculated as the coupon payment divided by the current bond price.