The response to COVID-19
We will start with our summary…
We want to emphasise a few simple points:
- The level of uncertainty regarding the virus will remain high in coming weeks
- It will take time for actions by central banks and governments to take their effect
- It will take time for markets to stabilise.
- However, markets are ALWAYS forward looking, they will not wait for perfect calm to begin the road to recovery.
As they do, the value we have been able to capture over this period will become more evident.
You have no doubt seen that markets have remained volatile.
This volatility comes from the uncertainty market participants have about the future. However, short-term uncertainty rarely reduces long term value.
This volatility has not only arisen from the impact of COVID-19, but reflects the impact of a number of investment strategies deleveraging and reducing their exposure.
Source: IRESS: First Samuel
How the authorities responded this week
We saw a noticeable escalation in measures taken to mitigate the impact of COVID-19 this week.
The US government, which demonstrated a dramatic shift in its approach, led this and a much greater appreciation of the challenges faced (noting our quote from Winston Churchill last week...).
Globally, we have seen swift and decisive action including:
- Provision of enormous assistance to intricate, complicated parts of the “plumbing” of financial markets.
- Reduction in global interest rates (including the Reserve Bank of Australia just yesterday).
- Plans to provide direct support to the economy through fiscal stimulus
This should bring greater stability to the financial system and support the global economy in the short term. However, it may take time for these actions to take effect and for markets to stabilise.
What is driving markets’ uncertainty?
The major cause of uncertainty is with regards to the length of time our economies will be shut down or partially incapacitated.
Companies for whom the cost of closure / near closure is very high will be the hardest hit. As too will be companies with risks from high levels of debt.
Examples include airlines (Qantas and Virgin).
Those which are unaffected or benefit in the short-term have seen their share price rewarded.
This includes new positions we have added to the portfolio over the past couple of months including companies in the Consumer Staples sector such as:
- Freedom Foods (milk and cereal)
- Costa Group (berries etc).
It also includes companies in the Technology sector that we have recently added including:
- Appen – which has a flexible, contingent workforce and large, resilient customers in the technology sector.
- PushPay – one of very few companies to upgrade its expected profits this week.
As we noted at our recent CIO events, we remain wary of assuming "nothing will change".
We are aware that for some sectors, changes in behaviour caused by the crisis will accelerate changes in long-term behaviour, such as the shift from brick and mortar to online retailing.
Having said that, it is likely the market is being far too myopic today.
How we are responding
Our focus continues to be on buying companies at prices we are comfortable with in the long term.
The majority of the portfolio cash we have invested has been in well known, large names such as National Australian Bank, ANZ Group (a new addition to the portfolio), QBE, BHP and Mineral Resources.
For each, we see the price paid represents great value over a 3-5-year horizon.
Furthermore, we still retain a substantial portion in of your portfolio in cash to take advantage of any further opportunities.
We recognised that there were heightened risks for companies who have high levels of debt. Thus, we began reducing holdings of such companies in the portfolio (such as MMA Offshore and Challenger) at the beginning of the year - at levels far higher than they currently trade at.
Furthermore, in this environment, there are a small number of positions that remain attractive investment opportunities but may raise additional equity for short term funding. We will look to provide additional support for these positions, as long as we continue to see value and are adequately compensated for the capital we provide.
We are also realistic. Some investments may fall further before better reflecting their value. It is near impossible to predict day to day price moves in this environment and we will not time every investment perfectly. However, we see that the prices paid will be proven to be cheap over the longer term.
- Craig Shepherd & Paul Grace