Without wishing to be too dramatic, the first quarter of 2020 is by far the most extraordinary I have seen during my 23 year investing “career”. Literally, everything has changed. Large sections of the world are on lockdown due to the COVID-19 pandemic. Many businesses have been mothballed. Aside from key workers (who are all doing an amazing job), half the remainder of the UK population are working from home while the other half have either been furloughed and/or forced to rely on state aid such as universal credit. Many quality businesses are drawing down credit lines. There has been widespread cancellation of dividends. An increasing number of public companies are having to raise funds via equity placings (diluting shareholders in the process) while private companies are having to take on “government guaranteed” debt.
The details vary country by country but essentially, it is a similar picture the world over and of course, many citizens around the world do not have the safety net that can provided here in the UK.
To compound matters, Russia and Saudi Arabia decided that now would be a good time to start an oil price war leading to massive over supply globally and potentially taking down large portions of the heavily indebted US shale industry.
I could go on but it all feels highly apocalyptic and the stock market continues to be incredibly volatile – in both directions. FTSE 100 shares are behaving like illiquid AIM shares at times, such is the volatility. The rotation in UK shares after the Brexit vote in 2016 saw some wild swings as funds rotated but this is on an all together different scale.
Before I leave this preamble behind, it is also worth noting the incredible levels of (and pace of) monetary and fiscal stimulus amidst the backdrop of already highly indebted economies. The key difference between this stimulus and the GFC of 2008/9 is that this time round the stimulus is being aimed at businesses and individuals rather than helping banks to shore up their balance sheets. We have just experienced a decade of asset inflation. I am no economist but simple logic suggests we probably have a decade or more of price inflation to contend with. You just can’t increase the money supply and expect nothing to happen.
Only three months ago when writing my 2019 annual review, I wrote “I would never rule out a period of hyper-inflation but hope not to see it in my lifetime”. Things have moved so quickly in the last quarter and in ways that I had not imagined possible that I am now of the view that there is a distinct possibility that I will indeed experience hyper-inflation during my lifetime – assuming that the virus doesn’t get me first. I hope that we will just end up with regular inflation but the odds that it will be something worse than that have increased significantly. I hope I am wrong.
Despite underperforming all of my benchmarks during the first quarter (the FTSE All Share TR by a few basis points but Vanguard (VWRL) by 12% and Fundsmith by a whopping 18%), I believe that my portfolio is reasonably well positioned for the new world that we are faced with.
I went into Q1 with a buy-hold-verify mindset and expecting a market sell-off at some unknown future point. My plan in a market sell-off was largely to do nothing, using dividend income for my living expenses while waiting for my quality holdings to recover their capital value over time. Time in the market rather than timing the market.
That would perhaps explain why I was slow to act. On 31 January I wrote, “As things stand, the portfolio is around 4% in cash and I am in no rush to deploy it. I don’t think the markets have fully priced in the effects of the coronavirus yet”. And as recently as 13 March my strategy remained in place, when I wrote “My portfolio currently has 23 constituents. Every holding pays a dividend and my intention is to hold each for the longer-term as long as the investment thesis remains valid. I assess this based on business performance rather than share price (mostly). My living expenses are covered by dividend income, so I can take a slightly more relaxed view on capital fluctuations.”
And then, everything changed. The 13th March was a Friday (superstition anybody?) and on Monday the 16th the country began going into lockdown (full lockdown was just one week later). The days that followed were complete chaos with companies being mothballed, guidance being withdrawn, dividends being cut, credit facilities being maxed out and a massive fiscal stimulus package announced by the Chancellor (and an even bigger one was announced in the US). In a very short space of time, the investment thesis behind many of my portfolio constituents had been destroyed – at least in the short-term. Living off dividends is a great place to be until those dividends stop being paid while simultaneously seeing a significant reduction in capital values amidst an environment of extreme business uncertainty.
The main risk that I saw in relation to my own strategy was one of pound cost ravaging – having to supplement income from share sales while share prices are depressed.
In the first half of March, I definitely felt some (a lot) of YTD pain but remained confident that my buy-hold-verify strategy would prevail – indeed, I even “capitalised” on the market falls by deploying the cash I had built up (around 10% going into March 2020). Well, a whole bunch of my holdings then failed the verification test – all at once.
I am very pleased with my response under pressure. I followed my process – when the investment thesis fails, sell – and have been able to pivot into recovery mode while maintaining the integrity of my portfolio and investment strategy.
For the record, I exited Persimmon (PSN), Games Workshop (GAW), Vianet (VNET), Belvoir (BLV), Personal Group (PGH), Paypoint (PAY), Rightmove (RMV), ULS Technology (ULS), Amino Technologies (AMO), Legal & General (LGEN). In the midst of the initial sell off in early March I also exited M&G (MNG) and several investment trusts; Henderson High Income (HHI), JP Morgan Growth & Income (JCGI), Honeycombe (HONY), Smithson (SSON) and Real Estate Credit Investments (RECI).
My main purchases over this period have been new positions in Moneysupermarket.com (MONY), IG Group (IGG), 3i Group (III) and Supermarket Income REIT (SUPR) along with topping up various existing holdings, the most significant being Anglo Asian Mining (AAZ) and Spectra Systems (SPSY).
In restructuring the portfolio, my guiding light has been owning companies where the investment thesis remains valid and intact in relation to the portfolio objectives. In short, that means investing in quality businesses (or assets) with reliable cashflows and the ability to grow those cashflows over the long-term. This does mean that I have jettisoned some companies that I would like to own again at some point, most notably Games Workshop (GAW) and Rightmove (RMV) but at this juncture, I have sufficient doubt about the impact and duration of the lockdown vis-à-vis the current valuation.
I thought it might be useful to end this Q1 summary with a line or two on each of the 15 current portfolio constituents. In particular, I am focused on the business performance and 2020/21 outlook.
Anglo Asian Mining (AAZ) – The company have provided an update and seem well organised to manage the COVID-19 situation. Their main mines remain open and active, although there is always the possibility they will need to close as part of extended lockdown measures. Their main refiner is also temporarily closed due to the lockdown in Switzerland, although other refining options are available if these do not come back online in a timely fashion. Meanwhile, their main commodity (gold) is currently trading well above the $1480/oz upon which the 2020 guidance was issued (just 6 weeks ago).
Spectra Systems (SPSY) – During March the company issued a cracking set of 2019 figures, raised the dividend by 30% and increased guidance for 2020. Perhaps it helps that they are a lean technology company whose main business is part of the central bank supply chain.
Bioventix (BVXP) – A great set of interim figures were published during March, an increased interim dividend declared and confident guidance provided for 2020/21.
Moneysupermarket.com (MONY) – Trading continues during the lockdown and Money Saving Expert has seen a massive increase in activity during March. The final dividend is maintained but understandably, 2020 guidance is withdrawn.
Strix Group (KETL) – Ironically, I exited this holding earlier in the quarter based on their manufacturing dependence on China, only to rebuy once reassurance was provided. Subsequently, the company have confirmed a return to 90% capacity and have maintained the final dividend. It remains to be seen if the schedule of new product launches in the second half of 2020 goes ahead as planned.
GlaxoSmithKline (GSK) – There have been a couple of positive announcements around how the company are contributing to the search for a coronavirus treatment/vaccine but thus far, no revised business update. I am hoping that means no material change to guidance and that the dividend will be maintained.
IG Group (IGG) – I am looking forward to seeing the Q4 numbers from IGG. They should be benefiting from both the market volatility and the lockdown. Hopefully, they will be stellar numbers and the dividend will be maintained.
3i Group (III) – I exited this holding in October 2019 at £10.82 per share and I was happy to rebuy last week at £6.95-£7.20 per share. The dividend (over 5% at my entry prices) looks secure and the two largest investments are Action and 3i Infrastructure both of which should have a solid outlook.
Impax Asset Management (IPX) – Asset managers are bound to come under pressure from both market performance and fund outflows. In the case of IPX, I am happy to hold through this period because I think they will survive comfortably in the short-term (2020) and thrive in the medium term (3-5 years). They are developing a strong position in an important and growing niche and are competing for sizeable mandates. I have taken profits on this holding previously and will add again in future if the market offers me a compelling price.
Income Shares – HICL Infrastructure (HICL), Henderson Far East Income (HFEL), Renewables Infrastructure (TRIG) and Supermarket Income REIT (SUPR) are all offering reliable and hopefully sustainable quarterly income.
Vanguard Emerging Markets (VFEM) – A tactical allocation
iShares Physical Gold (SGLN) – A tactical allocation
Cash – At the time of writing, I am carrying around 10% cash which should also be regarded as a tactical allocation, especially as that makes it my second largest position.
The portfolio weightings as at 31 March can be seen here.
The market has a habit of making fools of us. I have taken my pain this quarter and restructured the portfolio to resume the pursuit of my objectives – course correction if you like. Hopefully the capital value will recover over time, driven by the underlying business performance. By my calculations, I am currently looking at around 20% fall in dividend income for the year. This could be improved if I deploy my cash sooner rather than later. It is also possible that there will be further dividend cuts.
I try not to make too many macro type predictions but it seems to me that market sentiment at the moment is primarily driven by the coronavirus news and the likely duration of various lockdowns around the world. Perhaps that is all this is and we’ll see a Q2/Q3 hit to the economy, a technical recession and everything comes bouncing back.
My own view is that things are likely to be much worse than that. As I said earlier in this piece, the prospect of rising inflation is a real concern and the prospect of hyper-inflation is no longer as remote as I would like it to be. Globally, there is a debt bubble (governments, businesses and individuals) that could easily burst and send the world into a recession and who knows what other consequences? That debt burden will have become significantly worse by the time we all come out of lockdown.
With the above in mind, I am happy to be invested in cash generating businesses with strong balance sheets, an intact business model and reasonable forward visibility. I am happy to have gold exposure through both SGLN and AAZ. And I am happy to have some cash on the side.
Keep safe and stay strong everyone.