20 Mar 2020
The view from our fund managers…
20 March 2020
Having initially taken a sanguine and measured view of the impact of coronavirus, equity markets have latterly been forced to adopt a much more negative prognosis. Initially, the suffering was concentrated in the most obviously affected sectors. Yet while that suffering has continued, the weakness has now spread to less directly affected areas as investors have sought sources of liquidity.
We value the constituents of our portfolio not for their short-term prospects – but for the next five years and beyond. It has been our judgement that current events, although seemingly seismic, have not materially altered that longer-term outlook.
It would, however, be wrong to assert that there are not factors that might start to alter that view. Some companies, for instance, may have insufficient finance to weather the coming storm and there is a risk that some may need to raise fresh capital. In our portfolio those that may be in the front line of this – SSP, Tui, Informa – have already seen steep falls in their share prices.
The issue of more shares – or of debt – to provide this additional finance means less profit will be distributed among a greater number of shareholders. Indeed, in some cases share prices are probably already discounting that eventuality.
The importance of good management…
The first line of defence will be the actions managements take to protect their companies. We try to invest in businesses that have strong managements who think like business owners and who should therefore prioritise actions that will be in the interests of long-term investors. To do this, it might be necessary – indeed preferable – for some companies to reduce or suspend their dividends for the time being.
This may seem to run counter to your interests as unitholders – but we would rather see management preserving the fabric and long-term earnings potential of a company rather than taking measures to support dividends in the short term.
On potential dividend cuts…
The possibility of a period of lower dividends for some companies must now be contemplated. Set against that, however, the yield on the UK market at the time of writing is hovering around 6%, which would imply that the market has gone some way towards recognising the risks to dividends.
The measures taken by governments and central banks to cushion the impact of the virus has led to even lower interest rates and this is likely to persist for some time. This has the effect of making equity cashflows and dividends, notwithstanding inevitable reductions, more attractive.
Although the prospect of lower dividends is a concern, we would point out that our portfolio gains its income from a broad spread of companies. Those dividends are significantly less concentrated by sector than the dividend from the All-Share.
Much of our time has been spent – and will continue to be spent – on the most affected parts of the portfolio and in understanding those companies’ ability to weather the crisis. The fund’s positioning and composition has changed little through this period other than through the impact of share-price moves. Our only move of note (prior to the sell-off) was to reduce further our already low weighting to the oil & gas sector.
No false bravado…
It would be wrong to populate any thoughts on the outlook with any false certainty or bravado: the implications of the coronavirus outbreak will be correlated with its duration. In the meantime, governments and policymakers will continue to do ‘whatever it takes’. One might hope that, given the universal nature of the crisis, it will elicit more forbearance and cooperation between counterparties than would otherwise be the case.
While the news will likely remain daunting for some time, we take comfort from an observation made by Jeremy Grantham in March 2009: “Be aware that the market does not turn when it sees light at the end of the tunnel. It turns when all looks black, but just a subtle shade less black than the day before”.
Adrian Frost, Nick Shenton and Andy Marsh, Artemis Income
20 March 2020
A particular challenge at present is creating a portfolio that can weather the current volatility whilst positioning for a recovery that should take place once the spread of the virus slows and economies bounce back. The issue here is to ensure we don’t end up at the market’s bottom with the portfolio we wish we had had as the Covid-19 crisis took hold.
In the interim, dealing with market dislocations between similar stocks, accentuated by liquidity is both adding complexity and creating opportunities. For example, VINCI, a construction and concessions business, has underperformed its peers significantly during the sell-off as investors decide to switch from infrastructure (more geared) plays into utilities (less geared). In a market where liquidity remains thin, sellers of VINCI accentuate the price drop and, on the other side, hold up the purchase on the other side, like National Grid for example. As a result, we are looking at relative value, where our conviction on a stock remains resolute but where selling has mispriced the opportunity.
At the same time, we need to consider how the world has changed and will look as we move through the (virus) contagion and as global economies recover. When added to the themes (whilst little discussed currently) that remain wholly relevant and prevalent such as the importance of ESG, this will influence our thinking and the shape of the portfolio.
Over the past six months we have steadily been closing our underweight in healthcare. With the likelihood of Joe Biden as Democrat nominee in the Unites States (the best outcome for healthcare’s status quo should the Democrats win the election,) a world in lockdown and an emerging world where vaccines and drugs will remain ever more paramount, we are now overweight healthcare versus the benchmark. Our holding in Sanofi has performed well. Given their fast growing vaccines and consumer businesses, they offer a solution for today and tomorrow. At the same time, the new management team continue to exit old pharma lines of business, push further on costs and pay out a 4.5% dividend yield whilst remaining (but over time closing) at a discount to their global pharmaceutical peers.
On the flip side, we wonder how banks will emerge from this. Society is still angry at the bailouts over a decade ago and will demand more. We have seen promises of robust stimulus around the globe and the banks will play a part in this. Indeed, earlier in the week we witnessed eight of the largest US significant banks halt buybacks until at least June. This is an effort to restore confidence to consumers, show that they are open for business and available to provide liquidity. We are not sure how this plays out, but in a world of zero rates and a world with a rightly so, greater conscience, we have been reducing our overweight since the end of 2019.
When we put all this together, we have concentrated the portfolio today in larger cap names which has improved the overall liquidity of the portfolio while adapting its shape to the current environment. We continue to monitor the liquidity situation in our portfolio and the markets on a day to day basis. We continuously re-adjust our portfolio accordingly while maintaining or adjusting the shape of the portfolio depending on prevailing conditions
Jacob de Tusch-Lec, Artemis Global Income
20 March 2020
We have been reducing US equities and increasing Asian stocks. The US is only now going into measures which will slow activity, while some of Asia is emerging from those measures. Also, US citizens are not used to government directives on how they should live, so it may be hard to slow the virus. In the most recent data, there are 6,520 cases in the US with over 1,700 in New York alone. This compares with 1,950 in the UK – a country of 66 million people (New York state population 19 million) and Japan has 709 active cases in a population of 126 million.
We believe social measures will last well into the summer and that this will produce a recession in the US and a worse recession in Europe. However, many equities are now looking very attractive for longer term investors, including a range of companies with very defensive business models. We have been buying telecommunications companies and consumer staples businesses to add to our technology and healthcare investments, leaving a very resilient portfolio which we believe will be well placed to cope with a prolonged recession. Our cash levels are starting to come down from a peak of around 8% last week.
Simon Edelsten, Alex Illingworth and Rosanna Burcheri, Artemis Global Select
20 March 2020
Many are comparing this with the global financial crisis in 2008. This is worse. Then, it was one segment of the economy failing, the banks. This time it is the whole economy failing. Analogies with war seem appropriate and it is inevitable that the scale of the intervention from the authorities will be beyond anything seen in history. It is likely to involve helicopter money - handing every citizen a cheque to help them survive short term hardship. Add to that very substantial quantitative easing, on top of the measures we have already seen. On top of this, there will be short term tax cuts, many already announced. Expect further substantial intervention in every aspect of markets and even day-to-day life.
The implications for markets are profound. Government bonds initially traded up sharply as rates were cut - but then reversed as investors sought liquidity and were unable to access credit markets. US Treasury yields started this month at 1.2%, fell to 0.6% and have now reversed that entire gain. In normal circumstances, you would expect yields to stay remarkably low. However, the scale of future funding gives investors concerns that yields will need to rise to compensate for all the issuance. We have over 40% of the fund in government bonds – a position held since the end of last year, predominantly in US Treasuries split between five- and 10-year maturities. This has generally been helpful, particularly as all other bond asset classes have fallen in price so much.
Currency markets have also been frantic, with sterling weak but, as much, the US dollar very strong. Holding US dollars in a crisis has never been a bad policy. We had unhedged 5% of our US dollar position (at around US$1.30) some time ago (now $1.16 as I type) and this helped performance somewhat.
Investment grade markets have become completely dysfunctional. They are just starting to show some signs of settling at substantially lower levels, after the intervention of the ECB. It is inevitable that nationalisations of industries will happen, as effectively happened in the financial crisis. Airlines, for instance, cannot cope with this sort of shock. The only uncertainty is which companies will get nationalised; and whether the government will honour their debt. We have been buying “A” corporates and senior bank bonds. There is no doubt in our mind that we will come out from the other side of this with most of these companies intact, though many with pretty battered balance sheets.
Banks are not the eye of the storm this time round. They have lots of capital but we are not inclined to add to our junior bank positions yet. Personal defaults will increase which will involve them having to make more provisions, but failures amongst the major banks are extremely unlikely.
Meanwhile, high yield bond markets. We went into this crisis with as low a percentage as we have ever had at 28%. However, they have sold off sharply in anticipation of much higher defaults. We reduced some of the more exposed areas. Namely, cinemas and by good fortune Stonegate the pub chain have bought their bonds back at a good premium too. Some companies will default. That is inevitable, but prices now fully discount that. A brutal move in such a short time. We are looking at specific opportunities to increase but favour better quality investment grade and high yield markets for now. Later in the crisis, high yield bonds will become attractive.
Overall, this is worse than 2008 but many parallels can be drawn. The authorities are compelled to step in. Intervention will be more widespread, comprehensive and intrusive in every way, but the other side of the financial crisis was enormous profits. The same will be true here. So we are adding to small selective positions most days – financed by reducing our government bond position. Unfortunately timing the recovery will be difficult but the factors we will watch for will be the peak in death rates – certainly in Italy, but also the US. We are not there yet, but with China seeing the other side, after two months, it is possible to see light at the end of this rather dark tunnel.
James Foster and Alex Ralph, Artemis Strategic Bond
20 March 2020
After such dramatic moves in markets the big question has to be what is now being priced in. Liquidity squeezes both ways are creating large swings; but currently we are looking at recession now being 100% priced into investment grade spreads. Default rates are currently pricing in around 8% levels, and you’d expect high yield to possibly reach 1000bps on the wide end. With them currently trading around 800/825bps as I type (having widened from 350bps,) there is still a little to go. The current issue is that we have never had such a big potential liquidity problem as we see today - which means we will almost certainly overshoot the now certain recession.
There are some big mitigating factors, however. Government yields at near zero means that corporate bonds yields have never been more attractive at this stage of the cycle. Central banks could step up at any time to purchase further corporate bonds. Due to the financing of most companies, thanks to historically low yields, balance sheets are resilient with refinancing pushed out further down the line. Default rates in the end may not reach the same level as previous recessions – except for some sectors like oil and retail who will bear the brunt of this pandemic.
Our portfolio has suffered due to its exposure to equities and high yielding credit. We did however cut equity positions down to 11% (from 17%) and have maintained a relatively defensive bias in our credit holdings to a high yield index. We maintain a 10% holding in Treasuries. We manage the fund with its main aim in mind – to generate higher levels of income. Naturally we are biased towards high yield but with valuations being so stretched we had dialled down the risk. Consequently, the credit portion of the fund has – so far – fallen 4.8% relative to a global high yield index down -7.8%.
We have yet to invest back into high yield. Indeed our last moves have been sales. Before the recent large sell-off we sold most of Loewen, a German arcade player which has had to shut down temporarily; Telepizza (home delivery pizza); and Oriflame (Swedish beauty retailer) which has since fallen 20%. We cut AMC – cinema owners of Odeon - and Edreams, a holiday booking agent. All have fallen substantially since. We did use some of the money to invest back into investment grade bonds- such as senior bank bonds - where we think these will rally first within credit.
Furthermore, we have recently added a couple of percent back into equities after the dramatic falls. Equities have fallen some 35% in Europe so far this year and in very rapid fashion. This has erased all of the valuation-driven gains of 2019 and also now accounts for a substantial earnings decline for 2020. Having reduced our equity exposure earlier in the year, we are now taking advantage of the weakness to build it back up again. We believe this market will recover first.
We need a few things to be in place to see a meaningful recovery in asset prices. Valuations are rapidly pricing in the risks. Monetary policy has done what it can. With no more fire power left on rates, it can only now really extend bond-buying. We believe there will also be a co-ordinated fiscal response.
These responses are all bringing forward the idea of helicopter money and eventual steepening of yield curves - but that is for another day. The current blended dividend yield on the equity portion of the fund is 6.3%, a level we expect to look back on with the benefit of hindsight as being a tremendous opportunity. We will also look to add to high yield as the market overshoots.
We have prioritised liquidity as the markets deteriorated. We have just under 11% in Treasuries and 11% in equities / cash and a balanced portfolio such that liquidity in the portfolio is not an issue. We continue to monitor the liquidity situation in our portfolio and the markets on a day to day basis. We continuously re-adjust our portfolio accordingly while maintaining or adjusting the shape of the portfolio depending on prevailing conditions. But given the extraordinary circumstances we did feel it prudent to sell a couple more names within credit this week. We have mainly resisted selling high yield - with the exception of Altice - as we believe over a 12 month view that would be the wrong decision. Consequently, we have reduced positions in Naturgy, Credit Suisse and Aviva.
We are comfortable with the liquidity buffer we have generated and believe that selling risk further down would not be in the interests of our investors over the long term.
Alex Ralph, Artemis High Income
20 March 2020
Markets continue to be weak and to experience significant daily price moves, similar (even worse) to periods in the global financial crisis of 2008. As the coronavirus has spread around the globe, fears of a slowdown have now shifted to concerns around how deep the recession is likely to be.
At the country level, we continue to see high dispersion. China and Taiwan, where the response to the virus was quick, and focused on containment, have outperformed. Those that are yet to face up to the challenges of dealing with it have lagged the market. Latin America (Brazil in particular) features heavily here.
It is clear that investors are in ‘flight to safety’ mode. Cyclicals have lagged defensives, energy/commodities worst, healthcare/telcos/tech best. Value lags growth and small caps lag mega caps. These continue to be style headwinds for the fund.
Looking ahead, lower energy prices should be helpful to China and India and others that are net importers of oil. We’ve seen significant stimulus in China and expect others to follow. This will support growth, but will take some time to feed through into markets. For now, the shorter term headwinds need to be navigated.
In terms of actions, on the shorter term risks, we cut our holdings in Latam airline Copa Holdings and Mexican airport OMAB. These face immediate threats with negative shocks to demand. Within energy, our largest holding Lukoil has seen some sharp price falls. Whilst many markets that produce energy will struggle with such a low oil price, Russia is one that can tolerate it more than others. Lukoil offers a yield of almost 15% now and, with sufficient cash, is one we’re sticking with.
Elsewhere, we’ve been more patient and watchful. Opportunities will continue to arise and we’re not rushing in to catch falling knives, nor are we loading up on defensives. The portfolio remains spread across a range of sectors. The portfolio now trades on a p/e of 5.9, with a dividend yield of 6.5%.
I suspect investors will find this a compelling proposition for yield and growth once we get through the demand shock. Markets will remain volatile, but can also turn quite rapidly. Asian economies have been much better at dealing with the virus than those in Europe/US so far. As a result, they have the potential to recover quickly too and we should expect investors to start to allocate more capital towards them as a result.
Raheel Altaf and Peter Saacke, Artemis Global Emerging Markets
20 March 2020
Some aspects of our portfolio have been helpful recently. For instance we went into the price war between Saudi Arabia and the US with zero direct exposure to oil. Also we quickly reduced our exposure to banks which we have benefited from.
The biggest areas of concern in the portfolio are those companies which depend on social interaction especially Churchill Downs (casinos, horseracing) and Planet Fitness (gyms). The uncertainty is obviously not knowing how long social isolation will be followed in the US (both required and how long followed.) While we reduced our holdings in both companies, the degree of underperformance was still painful. We have been in touch with both companies making sure we understand any issues concerning their indebtedness. At this point we are happy to continue to hold both companies as we believe their inherent strength, in terms of unique assets and advantaged business models, will be as valuable in the future as we thought they were in the past.
We also reduced our exposure to Burlington Stores and Lowes. On the other hand we do believe that the current environment will benefit online businesses; and we increased our holdings in Amazon and Activision.
Within healthcare we added Johnson and Johnson and Pfizer, two defensive mega caps with no balance sheet issues and healthy dividends.
We are mindful that a very significant amount of global stimulus has been added to the global financial system. But at the same time some industries such as airlines, cruise and hospitality will suffer a significant amount of dislocation, especially when those companies are indebted. We think there are much better opportunities to ‘bottom fish’ in much better businesses such as technology software and consumer franchises. At this point we are not doing so in energy or banks. Nor are we hunting in distressed balance-sheet situations for opportunity.
We are concerned that the steps taken within the US to combat the coronavirus have been late and haphazard. At the moment we do not believe the market can have a sustained rally in the face of significant bad news.
Cormac Weldon, Artemis US Smaller Companies and US Select
20 March 2020
The fund is down ~42% year-to-date
It is hard to maintain a long-term view when markets are as volatile as is currently the case. However, it is perhaps useful to remember that since 1955 the return from the Numis UK Smaller Companies Index has never been negative on a seven-year view. If it just recovers the ground it has lost this year, that is a 79% return. We see the impact of the virus as severe but temporary. It is interesting to note a significant uptick in director (who can afford to be long term and don’t have redemptions to worry about) buying. RPS, Pressure Technologies, Vitec, Money Supermarket and Redde Northgate are all companies held in the portfolio where there have been material (over £100k) recent purchases.
UK directors have been actively buying with the recent turbulence
Mark Niznik and William Tamworth, Artemis UK Smaller Companies
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