February Performance Update…

The decision to invest in times of crisis is one of the hardest to make. It goes against all your natural instincts and biases, though as so often is the case in life, the hardest decisions are usually the most important.

After a difficult start to the year, our portfolios have performed reasonably well in recent weeks, in particular compared to their respective risk benchmarks. Our equity bucket is skewed towards ‘quality’ businesses, which tend to perform well in volatile markets like this, and our commodity and bond holdings have increased in value, giving the portfolios a strong defensive base. That by no means underestimates the market volatility though, which has been the highest it has been since March 2020, with European and other International Equity markets some 20% below their peak only 10 weeks ago. The fact that our drawdowns year-to-date are not approaching these levels, should create useful opportunities for growth. We would also add that our comments around opportunity should be viewed in context – the situation in Ukraine is dreadful on a number of levels.

Back to the current conflict, from here we broadly see three scenarios. The first and most optimistic, is that Russia and Ukraine find some common ground to negotiate a break-up of Ukraine, recognising parts as Russian territories and making a commitment to become ‘neutral’ on the global stage. Although there would still be significant knock-on effects on the prices and supply of commodities and food, it would also likely lead to sanctions being relaxed over a period of time, minimising the economic damage.

The second scenario is a protracted conflict that despite Ukrainian resistance, over time leads to Russian control. This would likely lead to a demilitarised Ukraine potentially with a puppet government to maintain control. Outside of the greater human impact, Russia would then be sat on NATOs doorstep, so tensions on the geopolitical front would remain elevated for longer, with many of the current sanctions staying in place. Longer sanctions mean further disruption to supply chains and likely more persistently high commodity prices and therefore inflation. This would be much more damaging for the global economy than the first and would likely push some economies into recession.

The final and most pessimistic scenario is an escalation between Russia and NATO, via an invasion of Poland for example. It is important to say we place a very low probability on this outcome, especially given the challenge Russia has faced in Ukraine, and the strength of the sanctions already in place, though clearly it would have huge consequences.

Obviously, the above scenarios do not paint the most positive picture, and the outcome is difficult to predict, though from an investment standpoint at least, we still see reasons to be cautiously optimistic. It is specifically important to note that the markets’ base case is something like scenario two, and given that we see scenario one as much more likely than scenario three, that leaves the reasonable possibility of a positive surprise, which would cause markets to bounce back significantly and within a short space of time.

In addition, providing we avoid scenario three, over the long run, many of the challenges we face around food and commodity prices, will in time be solved. So whilst this conflict is inflationary (and at present we feel it elongates inflation peaks by 3-6 months longer than previously expected), in our view it doesn’t hugely change where inflation will be in 3-5 years’ time. Similarly, economic growth will be pulled south through a combination of falling confidence and the need to spend more on the stuff we ‘need’, and therefore less on the stuff we ‘want’, though that is more of a 2022 story than 2023 or beyond.

In times like these, it is therefore worth reaffirming that we invest money for the long term, and the times of greatest opportunity are also those where volatility is highest. The chart below illustrates this well, displaying a three-year journey that includes the COVID crash in March 2020, to present day, which sees us firmly entrenched in another difficult environment.  In periods such as this, many companies lose value as panic sets in and everyone becomes very short term, though often there is no particular correlation between the success of these businesses and the geopolitical conflict. An example would be Barclays. They have no Russian exposure but are down 30% since the start of January. Consumer stocks like Next have seen similar drawdowns to March 2020. Certainly, consumer confidence has had a negative shock, but the outlook for Next must be better than it was in March 2020 when all shops were shut indefinitely.

These examples are just some of the opportunities that are being created by the current volatility, and so to that end we remain focused on taking advantage of them. Timing is always difficult, understanding where markets might bottom out and create the best buying opportunity is similar to trying to catch a falling knife, though we will do so strategically and in stages so as to minimise risk. The objective will be to come out from the other side of this conflict much as we did after COVID (the chart below again being a prime example), and on a long-term view, we are confident in our strategy.

In the immediate future, it would be nice (both for our investments and for humanity) to see a shift towards scenario one. But either way, rest assured that our investment team have significant experience in navigating difficult markets, and these are the times when we are working hardest on your behalf. We are confident that we will look back over the months and years ahead and see the benefits of some of the tough decisions we have taken in recent weeks.