04 Feb 2021
Capital at risk. This content has been prepared for professional investors only. All financial investments involve taking risk which means investors may not get back the amount initially invested.
We would look at the Brexit agreement from two perspectives. First, over the coming months and years there are bound to be recurrent disruptions, disputes, discussions and compromises as some aspects of the deal – foreseen and unforeseen – are ironed out. In our view, this may give rise to the occasional bout of stock or sector risk, albeit that this is likely to be short-term in nature. In general, it is difficult to see any significant parts of the UK market that would be impacted by this. It is worth saying that Brexit is commonly discussed in the context of downside risk. But there may be some areas where the agreement unlocks greater opportunity.
More important is that the agreement removes the barrier to allocating flows to the UK market. We are now on a more level playing field with other equity markets. This reappraisal of the UK market will take time but, interestingly, with £47bn of UK companies taken over in 2020 some are in more of a hurry!
The portfolio is positioned to benefit from the total return that accrues from long-term cash flows which are attractively valued. In other words, we have not made any radical changes pre and post the agreement.
The UK market will benefit from any reflation trade, given its value tilt. Financials and commodities would be obvious beneficiaries. Financials exhibited resilience in late 2020 as fears of delinquencies faded, along with pressures on net interest margins. We expect this resilience to become an attraction as investors rotate away from other parts of the market – and we envisage the resumption of dividends in 2021.
Commodities are likely to be much more prominent in 2021 than last year. Sustained demand from China will be buttressed by increased activity in the West, post-vaccine. And then there’s the increased focus on green issues within fiscal stimulus packages. Decarbonisation and broad ESG factors are becoming structural drivers on the demand and supply side, and growing climate ambition is set to boost demand.
Away from these two sectors, our main observation is that strong companies who survive this disruption will gain customers as rivals disappear. So while certain industries may have shrunk and so offer a smaller pool of revenues, they may be shared between fewer companies.
We would remind investors that we are looking at sustainable cashflow over at least 3-5 years, with an average holding period of 6+ years through a diversified portfolio, which is currently around 50 stocks. While these are thoughts on sectors that could change in 2021, we are bottom-up investors taking a long-term view on our investments which we prod, poke, hypothesise on and re-test on an ongoing basis.
Overall, we think the UK market has the ingredients for better performance relative to other markets. And that corporate fundamentals are much better than one would have feared just a few months ago. While too much inflation would upset global markets broadly, the UK is better placed than many.
In our view, the primary determinant for further disparate performance is bond yields. Rising yields will put further pressure on the valuation of growth stocks and certainly improve the performance of value – in relative if not absolute terms. A strong recovery in economic growth, with plenty of stimulus in place, could worry bond investors. However, to create enduring outperformance value stocks will need resilience of profits and cash flows.
On the whole, we believe our companies are well positioned as we exit lockdown. Over the past three months, one notable feature was that companies – particularly those businesses that find themselves directly in the path of the coronavirus storm – are coping better than feared. Rates of ‘cash burn’ or losses were more contained than previously thought. This helped to offset the disappointment that the disruption caused by the pandemic might be prolonged. However, any delay to vaccine rollouts or further strains of Covid, could further push out the recovery.
The dividend of the UK market will have fallen by about 35-40% in 2020. We expect there will be some growth in dividend payments in 2021 and more so in 2022. Any pushback in the recovery could lead to disappointment in the scale and speed of dividend recovery.
Adrian Frost, Nick Shenton and Andrew Marsh manage the Artemis Income Fund.
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