The Investment Committee
8th January, 2021
Quarter 4 2020 Investment Update
We approached Q4 with cautious optimism. First the caution; political noise was bound to increase around Brexit and the US election, with neither seeming likely to pass quietly. We were also due to receive some of the most important clinical trial results in history. That said, our base case always was that we would get past Brexit one way or the other, the US election result would be supportive for markets, and the vaccine news was more than likely to be positive, hence the optimism.
Pleasingly our central case played out, and the reduction in uncertainty was just as positive for investment markets in the short term as the outcomes themselves. Those gains came despite some quite concerning Covid-19 trends across the globe. To some extent they were expected heading into the winter months, though the emergence of the new, more transmissive strain has fast-tracked the need to tighten restrictions and therefore hamper economies. Investment markets have so far looked through these trends, preferring to place weight on what the world may look like in 6-12 months’ time once vaccines have been rolled out.
The vaccine success should not be underplayed either though. It has always been our main hope for a return to normality and 90-95% efficiency was considerably above even the most optimistic targets. We now face a race against time to try to get it deployed as quickly as possible, but for the time being investors are just happy we have them and are moving in the right direction.
Nonetheless, stepping back to the big picture it is becoming increasingly clear that the ‘V-shaped’ economic journey many were touting in March is not going to materialise. We continue to expect it to look more like a reverse ‘J’, with a slower recovery than the fall coming in. Again, using the UK as an example, unemployment has now risen from 3.9% to 4.9% (and will continue to rise) and although there has been some recovery in services and manufacturing, many businesses continue to face tough choices even after a full vaccination programme. Having said all that, the fact we have some form of a Brexit deal may soften the blow, and the UK now looks a more certain place for investment over the longer term than it did six months ago, simply as Brexit is out the way.
To summarise then, we often talk about differences between the short and long term. Certain time horizons matter more depending on your perspective. In Q4 markets traded off short-term concerns in the form of rising cases and further restrictions, causing a sell off in markets in late October. However, the vaccine success in November created positivity, which in conjunction with a reduction in political uncertainty saw a strong end to the calendar year. The question is… did we take advantage of that?
Reviewing a quarter’s performance is always important, though it is the culmination of multiple quarters (and even years) of strong outcomes that is our ultimate aim. We came into Q4 in a good position, with all portfolios in positive territory after achieving some substantial upside since the March lows.
Our story all year had been to focus on quality businesses that are in sectors that are less effected (or even benefit) from the pandemic. When seeing the valuations fall so substantially across all markets in the Spring, we reinvested some cash in ideas we felt would recover well, which played out nicely. We had also taken the view that the UK looked a challenging place to allocate, which again worked as the UK lagged other markets until very recently.
Despite our cautious optimism around vaccine and political news, we were reluctant to rotate too much of our quality equity exposure into sectors that would continue to suffer without a vaccine, namely leisure and travel. We could have added early to these ravaged sectors however instead we chose to take profits to build cash, waiting and hoping for a confirmed vaccine. As vaccine news was announced, we reinvested this cash in the areas that had been hardest hit, effectively rotating some of our portfolios from those staple, defensive sectors, into those more sensitive to an expected economic reopening. In addition, we moved money back to the UK, as the reduced uncertainty provides longer term opportunity at excellent valuations. The UK is not without it’s challenges, though it also offers access to some great businesses that are undervalued versus their overseas peers.
The portfolios again benefited from this activity, adding between 2.91% (Very Low Risk) and 9.21% (High Risk) over the last three months of the year, despite a negative month in October. Those new ideas rallied the hardest, some adding more than 25% in just three months.
As suggested earlier, this quarter was more about building on what had already been achieved in 2020. Overall, the portfolio range returned between 3.27% (Very Low Risk) and 11.92% (High Risk) gross of fees, across the year, with the UK equity market returning a dismal -11.55%. On average we were 3.3% above our benchmarks as well, so in both absolute and relative terms it has been a good twelve months.
We have talked many times about working hardest for you when things are challenging and we hope the results in 2020 stand testament to that. It would be wrong to say it was easy, and we of course needed a bit of luck along the way, though we are pleased that our pragmatic strategy helped navigate the portfolios through some of the most extreme markets we have ever seen.
Recovery. Revival. Rotation. Reset. These are the words dominating the 2021 outlook for the year ahead. Caveats abound, but the consensus is that after the COVID-19 spurred crash, the vaccine is setting the stage for a new period of economic growth—and rising asset prices.
COVID-19 remains the only real game in town and any upcoming recovery will have a requirement for herd immunity to get it going. Again, sticking with the UK as an example, based on 2 million vaccinations a week, a 70% take-up, and 2 vaccinations per person, we are likely to need the vast majority of this year to get everyone across the line. However, absent of further virus mutations, by the summer we would expect restrictions to be easing somewhat significantly, and it should continue to get progressively better from there. The recovery may well be slower than others therefore, picking up steam in late 2021 and into 2022.
We also have huge amounts of debt to contend with given the unimaginable stimulus we have needed just to get to this point. A slower recovery and more debt will mean interest rates need to remain lower for longer, and although there are likely to be taxation changes afoot, policymakers will first need to stimulate growth, so we expect more spending to come alongside them. That cocktail of improving virus trends, better economic data and ongoing support for policymakers is the perfect storm for riskier assets like equities.
However, outside of that volatile asset class it becomes much harder. At the start of the last economic recovery (using 1st January 2009 as an example), investing in a 10-year UK government bond would give you a 2.8% annual income return. When as a low-risk investor you only need 3-5% to make your life work, that is a great starting point. Today however, that same investment only offers 0.2% per annum. Moreover, the commercial property market; a core alternative asset class; continues to look increasingly challenged given the accelerated shifts to online shopping and work flexibility. We therefore expect to continue to need to work hard with all non-equity parts of the portfolio to add value.
Geographically we are finding opportunities across many regions. Emerging markets look attractive, particularly in Asia, where the virus is retracted more significantly. Given a more predictable US administration, a weaker dollar, and a more positive economic trajectory. The UK has similarly removed its political handcuffs and should benefit from global investors allocating more on our shores than at any time since the Brexit referendum. The US continues to host the fastest growing companies in the world, and Europe is also set to have a better year as global trade starts to pick back up.
Moreover, there are also a number of themes that are likely to continue to gather speed over the coming years. Healthcare advancements particularly around ‘genomics’, our need to solve the climate change problem, and the digitalisation of money, are all huge areas of opportunity and innovation. Each of these is a blog on its own, though needless to say we are excited to build exposure in the portfolios.
Overall, our starting point for 2021 is therefore one of optimism for the opportunity set ahead of us, but also an understanding that it will not be easy and will require ongoing diligence. As 2021 matures though, we would expect the road ahead to start to look clearer, and in this sense, after a year of chaos in 2020, the coming year will eventually feel more normal – let’s hope so, not just from an investment perspective!