September was another weak and volatile month, with equity markets continuing to reassess poorer economic fundamentals, as evidenced by a succession of disappointing macro data releases around the world and the Federal Reserve citing “developments abroad” as a reason for deciding to leave interest rates unchanged.
This reassessment has brought markets closer to our own cautious view of the world but it has not necessitated any change to our strategy. We continue to be concerned about productivity, deflation, debt and the overall global growth outlook, and remain focused on maintaining a portfolio that can prove resilient to these long term structural headwinds.
The portfolio slightly outperformed the FTSE All Share index which declined 2.7% during the month, but could not avoid a negative return.
The biggest detractor over the month was the position in Allied Minds. The stock’s sharp underperformance was due in large part to an opportunistic attack from a short-seller using a piece of self-generated research, which the FT described as ‘strangely shallow’. Although this has been unsettling for market sentiment in recent days, we see nothing fundamental to concern us. Indeed, our confidence has increased in both the long-term potential of its existing portfolio of maturing technology businesses and in the management team’s ability to identify new value-creating opportunities from its relationships with the best research institutions in the US.
Other major holdings that underperformed during September included GlaxoSmithKline, Legal & General and Rolls-Royce. As is often the case over shorter time periods, fundamentals have played no part in these moves. When this happens, the logical thing to do is to buy more, which is exactly what we have done.
Prothena was also a significant underperformer in September, as it was caught up in a widespread sell-off in US biotech shares. Given the way that the sector has traded this year, the sell-off is perhaps unsurprising, but we were disappointed that Prothena became so embroiled in it, as its valuation is very far from the bubble levels that some of its peers had reached. Again, we have seen no fundamental developments to disturb our confidence in the long-term investment case and, as above, we added to the position.
More positively, the portfolio’s tobacco holdings performed extremely well. In uncertain times, the defensiveness and the dependability of these businesses has come to the fore. Furthermore, there was some very positive news from the sector: Reynolds American is selling the international rights to its Natural American Spirit brand to Japan Tobacco for $5bn. As the company has almost no exposure outside the US, this is a very attractive price. Imperial Tobacco and British American Tobacco also performed well.
Another strong performer was Amlin, after the non-life insurer agreed to be acquired by Mitsui Sumitomo Insurance. We sold the holding after the shares soared on the news. We have been keen on the Lloyds vehicles for a considerable time and Amlin has performed well in recent years. There are still a number of very attractively-valued companies in this sector, such as Lancashire, Hiscox and Beazley, all of which benefited in September from speculation that they might become future bid targets. Each of these companies has demonstrated strong underwriting skills and capital discipline in recent years, and we remain positive on the sector.
Other portfolio activity included further additions to the position in US pharmaceuticals company AbbVie. Share price weakness has continued, giving us the opportunity to increase our position significantly at what we consider to be a very attractive valuation. We are increasingly confident that its Humira franchise (a treatment for auto-immune conditions such as rheumatoid arthritis) can be much better protected from competition than the valuation currently implies. Meanwhile, AbbVie’s pipeline appears to be developing well with, for example, a treatment for uterine fibroids progressing into phase III trials. Also within the health care sector, we added meaningfully to the holding in Roche at attractive valuation levels.
Elsewhere, we took advantage of share price weakness to add to a wide range of holdings, most prominently in AA, Essentra and G4S. Incidentally, we have had management meetings with each of these businesses in recent weeks.
As well as our disposal of Amlin noted above, we sold the remainder of the holding in Centrica, which has become the latest victim of the intense fight for capital between existing positions and new ideas. Following Centrica’s disappointing dividend cut earlier this year, we initially added to the position but have subsequently become more concerned about its exposure to the oil price and increasing competition and regulation in downstream energy markets, both here in the UK and in the US. We think the company will now struggle to deliver growth much above low-to-mid single digits, which combined with a reduced cash return, leads to a modest total return expectation. At the prevailing valuation, therefore, the shares can no longer justify their position in the portfolio.
To conclude, it feels appropriate to draw attention to the large grey mammal with the trunk, sitting in the corner of the room. Since month end, equity markets have experienced a profound change of leadership. The sell-off in US biotech has intensified and at the same time, commodity-related stocks have enjoyed a rapid and significant bounce. Ironically, it seems that the Fed’s decision not to raise interest rates and a very weak set of US payroll numbers, has triggered a dramatic rotation into cyclical assets. We’ll just have to wait and see how long it lasts, but it’s a timely reminder that markets do not necessarily act rationally all the time – at least not in the short term.
As long-term investors, we sometimes have to tolerate short-term under-performance in the pursuit of our longer-term goals. This can be uncomfortable but, fundamentally, we remain convinced that our investment strategy is highly appropriate for the current challenging economic environment.
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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The views and opinions contained herein are third party and may not necessarily represent views expressed or reflected by Willis Owen.