At the start of the first quarter we gave back some of the very strong performance from the end of the previous year as the euphoria surrounding the Tory election victory began to subside. Ultimately however events were overtaken in March as the effects of the Coronavirus spread globally and equity markets crashed around the world as equity risk premiums rose dramatically. As a small and mid-cap fund we were particularly badly hit as we are essentially ‘value’ investors with a relatively overweight exposure to domestic earnings. The lockdown brought home to investors the sheer scale of the short-term problems for consumer facing stocks such as retailers, leisure companies and housebuilders and this was rapidly reflected in share prices within our portfolio. In the absence of buyers a number of our holdings in these sectors initially fell between fifty and seventy percent, although by and large they have now started to recover.
Main drivers of performance in the Quarter
Unsurprisingly amongst our worst performers were stocks immediately affected by the lockdown such as Restaurant Group, which has subsequently raised capital to ensure its survival beyond the current furlough period and retailers Halfords and DFS. Our housebuilders all sold off , Bellway, Crest Nicholson and Vistry, as customers were prevented from viewing and mortgage offers were withdrawn from the market. Prices initially fell to levels below stated asset values. Two of our transport stocks fell, National Express which runs the yellow school buses in the US amongst other things and Go Ahead which runs buses in London and trains, as investors worried about the obvious shortage of passenger revenue. Since then both companies have received various government subsidies to keep transport links open to accommodate essential workers and their prices have bounced strongly from the lows. Our worst performer was Pharos Energy an oil producer as the oil price crashed. On the positive side Chesnara, Pennon, Devro and Sabre all held up relatively well.
As the worries over the virus began we raised the cash position in our fund to 6%, up from below 3%. We have learnt from our two previous significant drawdowns, the financial crisis and Brexit vote that this is an appropriate short-term response for liquidity purposes. We sold Watkin Jones where we were worried about occupancy levels in student accommodation, and Pennon as we are concerned about the ability of utilities to pay dividends in the current environment. We also sold the majority of our holding in Brewin Dolphin after receiving the dividend, and Tatton and Polypipe. All sales were at what we would deem to be historically good levels of value and we are always careful not to sell assets at distressed prices as this in effect crystallises losses and hinders the capital recovery prospects of the fund. At the same time we are careful not to fall into short-term value traps and invest monies raised too early. We are now comfortable to recycle cash selectively and have recently topped up Sabre Insurance and Contour Global, where we believe the dividends to be safe. We also have a list of potential new holdings we are currently analysing, most of which we have owned before.
With the virus and the unprecedented cancellation of corporate dividends we are in uncharted territory with respect to income. Whilst we have a number of stocks that we believe will continue to pay good levels of dividend both in the short-term and for the year as a whole the majority of our holdings have deferred or cancelled short-term payments for reasons of financial prudence. We believe a reasonable number of these companies would like to, and will be able to pay, a partial or even in some cases a full dividend by the year end if some sort of normality returns by then, probably requiring an easing of lockdown rules by the middle of June. Whether or not they will pay and at what potential level is foremost in our analysis and talks with companies. On the one hand we have companies like Ultra Electronics who have stated that subject to an improved outlook they will pay the dividend that they have just cancelled alongside their interim in the last quarter. On the other we have Go-Ahead whose profits are holding up well due to tax payer subsidies of buses and trains and we believe would like to pay a full dividend, but have to decide whether it would be politically acceptable to do so. This political acceptability applies to the majority of our companies who are making use of furloughing or government finance, and obviously no dividends can be paid to the private sector whilst still accepting public monies. Any new investments are currently focused on stocks that can add to short-term income with scope for capital appreciation, and we will avoid buying ‘expensive’ income. We are still at a time of huge uncertainty with respect to dividends and we will react with appropriate diligence until the outlook becomes clearer.