Aviva Investors: There is too much fear about the short-term outlook for UK equities

Further information: View the Aviva Investors UK Listed Equity Income factsheet and fund profile here. 

By Chris Murphy 27 May 2020 

So far, equity markets have borne the brunt of investors’ coronavirus-related concerns. In this Q&A, Chris Murphy explains why he thinks the reaction is over-blown in the UK and where he sees the opportunities and risks emanating.

Just as nature abhors a vacuum, investors abhor uncertainty. The global coronavirus pandemic has certainly delivered on this front and so we asked Chris Murphy, senior portfolio manager for UK Equities, for his thoughts on the current market environment and where he sees risks and opportunities emerging.

What are your current thoughts on the COVID-19 crisis?

The world is going through an unprecedented shock; it is quite different to anything we have ever experienced in that a forced lockdown has resulted in many companies closing their doors overnight.

When markets dip in a ‘normal’ economic cycle, businesses have the opportunity to cut costs and adjust their underlying models. But there was no real warning of what would happen to the economy as a result of this virus spreading and the current situation means companies have not been able to adjust their costs quickly enough as revenues collapsed. It really is, here is that word again: unprecedented.

How concerned are you about company profits and dividends?

For me it is not just about profits, but about how the pandemic impacts cash flow. Companies need cash flow to pay their day-to-day expenses. This doesn’t exist currently and unsurprisingly it has had a knock-on effect on dividends. Many have made the decision to defer dividends. Now even as an income manager I am fully supportive of that in the short term. It is much, much more important that businesses survive this crisis and look after their employees and supply chains. This is particularly important for bigger companies that help provide funding through working capital for smaller suppliers.

How have you adjusted the portfolio in the short term as the crisis has unfolded?

We focus on the long term, and the key for us is to make sure the portfolio is in the best position once the market recovers. If we look after the capital captured in periods like this, there will be a bigger pool of assets in the future for the unit holder to generate income from. I am not buying companies that are ‘cheap’ or because they are the only dividend payer in town. We have instead focused on ignoring the market noise (as much as possible) and tried to work out where companies are going to be in two or three years’ time.

Well-known names we have added to in the portfolio include Intermediate Capital Group, Schroders and Prudential. Other more stable businesses that have held up well, such as Tesco and Unilever, we have reduced positions in.

Will you take advantage of opportunities over the medium to long term?

We have intentionally not made wholesale changes to the portfolio: we feel it is far better to ‘drip feed’ money in a period like this as opposed to trying to second guess a market recovery or the exact bottom. A history of investor returns proves that retail investors in particular are quite bad at that, and currently we are a fair way from finding out the full extent of the pandemic’s effect.

Ultimately, the way we structure the portfolio, the way we analyse stocks and think about companies and cash flows over the long term has not changed. When clients ask if we are trading more as a result of prices falls my answer is always no: in a volatile market I am not going to try to be clever and guess where prices may or may not move to.

During the global financial crisis, we didn't change the way we ran the portfolio either and that comes back to having confidence in our belief structure and philosophy of what we are trying to achieve, as well as knowing the types of [quality] businesses we want in our portfolio.

Is there a concern some companies may not survive this crisis?

To an extent, there is too much fear driving movement in the short term. Take the financial services sector where some company share prices dropped overnight. Intermediate Capital Group is around £11 [as of mid-April]; I trimmed some of the existing position on valuation and for portfolio construction purposes at £19 at the start of the year. It went as low as £6 at the end of March, yet its business model is unchanged – so we added to the position. The price movement is an example of fear and greed at work in the market, which we like to avoid. 

It is also easy to lose sight of what is going on: this isn’t a black hole. There is a finite period of time for which this can go on and there is light at the end of the tunnel at which point we believe dividends will return. And we do expect the majority of companies, once this has crisis has ended, to return as dividend payers.

Is it possible to offset the volatility portfolios are experiencing? 

When the market moves as much as it has and as quickly as it has, it is very difficult to make changes to large positions. In a ‘normal’ downturn, whatever that may look like, there is better line of sight of volatility occurring and there is usually time to move the portfolio around to protect capital. Today, we can do this at the margin but I suspect most investors have either been on the right or the wrong side in terms of names held.

For example, we hold a number of ‘self-help’ story stocks which, in a normal slowdown would have continued to do very well. But take a stock like Melrose who bought GKN, an engineering and manufacturing company supplying the aerospace and auto sectors. Car sales have effectively stopped overnight globally, and therefore the short term is going to be very difficult for them. Most companies will simply write this year off, and so there is a need to keep an element of flexibility in portfolios.

There often has to be a big judgement call in the portfolio, too. I see myself as an investor rather than a spectator and I would rather support a business through a difficult time and buy more when the share price drops in anticipation of a recovery later when it comes through.