How has coronavirus affected your day-to-day work (from a portfolio and workplace perspective)?
My everyday work has gone on as usual. Prior to the terrible Covid-19 outbreak I often worked from home and JOHCM has given me an identical setup at home to the one I have in the office. UK Opportunities is a small team consisting of Michael Ulrich, Roshni Rajan and me, so lines of communication are good and decision-making remains effective.
How are you getting to grips with the epidemiology of coronavirus?
Covid-19 is clearly a very nasty virus. However, we are far from experts, so rather than spend lots of time counting cases or trying to time the impact of lifting lockdowns, we’re focusing on the big picture, mainly political changes and the responses of UK plc. At the company level, the good news is that management behaviour is starting to change for the better. Before the crisis we had three major issues with the companies in our investment universe: over distribution, over leverage and over valuation. Today the tide is turning on many of these issues, with 43% of the FTSE 250 (excluding investment trusts) having cancelled or suspended dividends, as at 9 April 2020. A terrible situation is forcing the hand of management to stop over distributing and prioritise de-leveraging balance sheets.
The months ahead are unlikely to be a straight line recovery, so companies will need to raise more equity, and not more debt, so they can be more resilient and better businesses on the other side. We’ve been careful to ‘update the facts’ on company-specific growth drivers in order to own those which still have growth tailwinds as we come out of the Covid-19 pandemic. We now have good levels of valuation upside in our portfolio on a three to five-year view.
How have you changed the portfolio in recent weeks as the crisis has escalated?
The outbreak has brought about both new opportunities and challenges for the portfolio, but the overall direction has been towards a higher quality fund. Having been conservatively positioned coming into the crisis, with some 20% of the fund in cash because of our concerns about over leverage and over valuation in markets, we’ve been busy deploying capital into well-researched names on our shopping list. A good example of this is Homeserve. We’ve wanted to own this stock for a long time given its good growth tailwinds, geographical diversity and sticky customer base. We got a valuation window to buy a position in March.
For some of the companies we held in the fund, the facts have changed so materially, where long-term growth tailwinds have suddenly become headwinds, that we’ve had to sell to zero. For example, we sold Lancashire, over concerns about government intervention in business interruption insurance claims, and Associated British Foods because its main earnings driver, Primark, is likely to suffer an acceleration away from the High Street, while its business model of manufacturing cheaply in Asia may be challenged in the medium term.
Do you have any behavioural mechanisms in place for navigating the market volatility?
As a fund, we think a lot about the impact of human behaviour on investment returns, hence we have some good ‘nudge’ (credit to Richard Thaler and Cass Sunstein) structures in place to reduce emotional responses. We spend a lot of time researching the best companies in the UK market, understanding their long-term growth drivers, setting out the facts under which we’d own them and our through-the-cycle view of their intrinsic value.
Having clear rules around factors such as leverage and cyclicality of earnings certainly helps to steer us away from some more uncertain pockets of ‘value’ in the market. Also knowing when the facts have changed is vital to deploying our sell-to-zero discipline. When buying new names we try to avoid inertia by setting rules around the level of falls in a share price to determine the speed at which we buy a stock. As these falls accelerate and the valuation upside increases, so does the pace of our buying.
What has surprised you most about markets during the coronavirus sell off?
The degree of government intervention in all aspects of business and personal lives has been incredible. We have gone from a market based on ‘financialisation’, where returns were engineered with increasingly high levels of risk, to one where nationalisation will be commonplace. At the market level, we could end up with extensive government ownership of bonds and stakes in companies. At the company level, those which have had government bailouts will likely have their hands tied in the years to come. Political risk is now the number one risk we face as investors.
What are the most important points you want to hear from your holdings at the moment?
The way companies are responding to the crisis is very important. This goes beyond the important shift in capital allocation, away from over-distribution and over leverage, back to investing in growth again as shareholders are one component of what makes up a business. How companies treat their staff, customers, suppliers and landlords will be vital to how quickly companies can recover from the crisis and the degree to which goodwill which ‘oils the engine’ remains intact.
How do you find working remotely during volatile markets?
As investors, controlling our environment is very important to how we respond to stressful situations. Having a good working from home set up is vital, as are taking time to think, get away from the screens and make good long-term decisions.
How does this compare to other market sell offs that you’ve managed money through?
Two of the biggest differentiating factors in the Covid-19 crisis are the enormous response by governments and the travel and retail sectors which the pandemic most heavily affects. Government control over the pace of recovery is all-encompassing and hard to predict. At the company level, the crisis is particularly centred on consumption stocks in the retail, travel and leisure sectors, where business activity has been reduced to almost zero in most cases. The change in human behaviour around these sectors will also be the most profound as permanent shifts in the way we consume are likely to occur.
What do you do for fun when you take a break from working at home?
I go for a walk or spend time with my three children.
What is your favourite snack when working from home?
Dark chocolate. The timing of Easter has been fortunate.
Do you have a ‘top tip’ to share on working remotely?
Take time away from your screens to help with perspective.
Rachel Reutter is senior fund manager on the JOHCM UK Opportunities fund
