After a poor start to the year, the UK stock market produced a positive return in March. Movements continued to be dictated more by flows rather than fundamentals, however, with the rotational move into commodity-related stocks that began in January still evident, at the expense of the more dependable areas of the market that have performed so well in recent years.
To some degree, the desire to pile back into oil and mining stocks is understandable, driven as it has been by a rally in the price of the commodities on which the profits and cashflows of these businesses depend. It could also be argued that the share prices of companies in these industries had reached oversold levels in recent months. Nevertheless, we are far from convinced that this rally is sustainable: many industrial commodities remain structurally over-supplied and the prevailing economic headwinds are likely to continue to weigh on demand for the foreseeable future, particularly if the outlook for Chinese economic growth deteriorates further, as we fear it will.
It has, however, led to a challenging backdrop for the fund’s performance so far this year. During March, the fund’s net asset value rose modestly but underperformed the FTSE All Share index.
Among the largest detractors from performance was Next, which was very weak in the last week of the month after announcing its full year results. The results themselves were in line with expectations, but the company’s outlook statement pointed to a difficult year ahead, with management citing both changes in consumer behaviour (reduced clothing purchases) and more caution on the consumer economy. Next has a habit of managing expectations well, but this guidance has clearly worried the market. We are less concerned, however.
We see the comments from Next’s management team as negative for the wider retail sector and indeed for consumer cyclical stocks more broadly. But, as far as Next itself is concerned, we think that the market has reacted inappropriately to the update. We invest in Next because it is an exceptional retailer with strong free cash flow generation. All of this free cash flow is returned to shareholders via the dividend and, depending on the share price level, either share buybacks or special dividends. We continue to believe that Next will deliver a very attractive long-term total return through a combination of its current dividend yield and continued growth in its free cash flow generation. As such, we took the opportunity to add to the holding.
Elsewhere, BT underperformed during the month on no material news. Some of our larger health care holdings also declined, with AstraZeneca and Roche among the weakest contributors. This is, in part, the corollary of the market’s charge back into commodity-related parts of the market but the US presidential election process also continues to weigh on ‘big pharma’. GlaxoSmithKline was less affected, as the market reacted favourably to the announcement of a change of CEO next year. We hope that this will be the prompt for a fundamental change of strategy, which should unlock considerable long-term future value for its patient shareholders.
More positively, Allied Minds made the largest individual contribution to returns in March. There were no especially noteworthy developments over the month, but news has continued to be incrementally positive. Shares in the company have been volatile in recent months, largely as the result of short-selling activity*. Although this has represented a short-term distraction, we are increasingly confident in the long-term investment case, which is based on the considerable future potential of the exciting young businesses that Allied Minds is nurturing and the management team’s ability to identify new value-creating opportunities from its relationships with the best research institutions in the US.
Our tobacco stocks were also among the best performers. Despite all the recent volatility in equity markets, the tobacco sector continues to be seen as a reliable and high-quality area. In a world of ultra-low interest rates, its dependable dividends are increasingly highly-prized and still represent attractive yields. British American Tobacco, Imperial Brands and Reynolds American all reached new all-time highs during the month. US biotech business Prothena also rallied strongly following profound and unjustified weakness earlier in the year.
Turning to portfolio activity, we took advantage of groundless share price weakness where possible, including adding to the positions in AstraZeneca, Roche and Provident Financial. We also continued to build further the positions in AbbVie, Legal & General and Capita.
In terms of new positions, Thin Film Electronics joined the portfolio during the month. This Norwegian company specialises in printed electronics, an innovative new technology with a huge range of commercial applications, especially in relation to the ‘internet of things’. We have known the company for a long time and are confident that it is poised for substantial growth as its technology becomes more widely adopted.
We also introduced small positions in Mafic, a composite manufacturing company that specialises in the production of basalt fibre and long-fibre thermoplastic pellets, and Autolus, is a pre-clinical-stage biotech company that focuses on immuno-oncology. Both are new unquoted holdings.
Much of this portfolio activity was funded through net inflows but we also took advantage of the strong share price performance from our tobacco holdings by trimming the positions in Reynolds American and Imperial Brands.
Overall, our investment strategy remains broadly unchanged. We remain convinced that the portfolio is positioned appropriately for the challenging economic environment that we foresee. We are not in the least bit tempted to join the stampede towards commodity-related industries that has been so evident in recent weeks. On the basis of fundamentals, this looks more like a sentiment-driven short-term ‘trade’ than a well-thought-through, conviction-based investment decision. That is not to say it won’t persist – it may well persist in the near term but, in the pursuit of attractively positive long-term returns, we have to accept that risk.
* The sale of a stock that is not owned by the seller, motivated by the belief its price will fall.
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The views expressed in this article are those of the author at the date of publication and not necessarily those of Woodford Investment Management LLP. The contents of this article are not intended as investment advice and will not be updated after publication.
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