Neil Hermon, Fund Manager of Henderson Smaller Companies Investment Trust, comments:
“The Covid-19 outbreak has dramatically changed expectations for global economic growth. The lockdown measures we have seen across the globe are having a profound effect on economic growth and have caused an unprecedented demand shock. Government actions to protect consumers and businesses from the worst impact of this shock will soften the blow but ultimately can only be short-term in nature given the scale of the bail-out required.
“Our approach is to consider our investments as long-term in nature and to avoid unnecessary turnover. The focus has been on adding stocks to the portfolio that have good growth prospects, sound financial characteristics and strong management, at a valuation level that does not reflect these strengths. Likewise, we have been employing strong sell disciplines to dispose of stocks that fail to meet these criteria.
“During the six months to 30 November 2020 we added to a number of positions in our portfolio and increased exposure to those stocks which we feel have further catalysts to drive strong performance. New additions to the portfolio include: De La Rue, a supplier of banknotes and security products; Empiric Student Property, a provider of student accommodation; Gresham House: an alternative asset manager; Headlam, a floorcoverings distributor; Volex, a provider of integrated manufacturing services and power products; and Youngs Brewery, an owner and operator of pubs.
“In terms of market outlook, the virus will pass and the global economy should recover. However, the shape and magnitude of the recovery are, at this point, uncertain. In the UK social distancing measures and national lockdown had an initial positive impact on infection and death rates but a ‘Second Wave’ has seen restrictions tighten again. The positive vaccine news announced in November has raised the very real possibility that life may return to some sort of ‘normal’ during 2021 with a consequent sharp rebound in economic activity.
“Outside of Covid-19 there has been positive progress on other key matters. The EU and the UK have finally agreed on a trade deal removing the threat of the damaging implications of a hard deal Brexit. The US election outcome was closer than expected but a definitive resolution has now been reached. Hopefully a Biden presidency should see a more conciliatory and pragmatic approach to US foreign and trade policy.
“In the corporate sector, conditions are intrinsically stronger than they were during the financial crisis of 2008/2009. Balance sheets are, in particular, more robust. However, the scale of economic shock means that this ‘strength’ will be severely tested and key questions for investors today revolve around a company’s available liquidity, leverage, bank covenants and ability to see the economic downturn through. On the whole, so far, the UK corporate sector has performed well during the crisis and most companies are beating their initial, post Covid-19, earnings and cash expectations.
“In terms of valuations, the equity market is now trading below long-term averages if we apply historic earnings. However, corporate earnings will be sharply down in 2020 and the extent of recovery in 2021 and beyond is uncertain. Additionally a significant proportion of corporates have suspended or cancelled dividends, preserving cash to shore up their balance sheets.
“Although much uncertainty remains around short-term economic conditions, the virus will pass and we should see a recovery. The movements in equity markets have thrown up some fantastic buying opportunities and we expect many listed companies to emerge stronger from the downturn. However, it is important to be selective as any recovery will be uneven and strength of franchise, market positioning and balance sheet will determine the winners from the losers in a post Covid-19 world.”