A Curate’s Easter Egg?

As we approach the weekend where kids – and our Marketing Director – eagerly anticipate their chocolate Smarties eggs (with complimentary mug, that will undoubtedly make its way into the office), it seems as good a point as any to take stock and look back at the year so far.

 

For all the unbridled optimism that ended 2013, the current calendar year has much more reflected the kind of environment that was consistent with us ending last year with almost 12% liquidity in the fund.  It wasn’t that we were bearish – more that we perceived that the general rerating of the market had taken place; what came thereafter was likely to be much more determined by what companies themselves did.  And how that has happened.  A cursory glance at sector performances so far this year throws into sharp relief how stock (or sector) specific issues have dictated outcomes.  At the time of writing, the Food & Drug Retailers have fallen by 13.6% so far in 2014, yet General Retailers have risen by 7.4%.  General Industrials are down by nearly 10%, but Industrial Engineering is up by 2%.  Food Producers have made 4% gains, and Beverage producers have slipped by an equivalent amount.

 

Within this, entire sub sectors have been laid waste – most notably the specialist individual annuity providers who have seen much of their raison d’etre undermined with Mr Osborne’s decision to abandon the compulsory purchase of individual annuities.

 

2014 has also seen the halos of some of the stock market’s darlings slip (particularly on AIM).  It yet again shows us that no business is bullet proof, and no business is perfect.  Yet, when they are priced as if they are, then at some point it will come back to hurt.  One of the things that the current year has reminded us of, is that valuation still matters.

 

This has been writ particularly large in the flood of new issues that have come to the UK market in the first quarter.  It is worth saying up front, that we have not taken a single new issue over the period.  This is partly philosophical – how much can you truly know about a business from a single one-hour meeting (if you even get that far!)?  But it is also a reflection of the fact that many at first glance looked like very ordinary businesses at extraordinary valuations.  That so many are now sitting at discounts to their flotation price may be rationalised by their sponsoring investment banks as bad luck by coming to a market at a time of increased volatility, but the root issue is more likely that these were business whose valuations were stretched, and that got their flotations away with the help of a lot of hot money.  So another thing this year has reminded us of: there is no easy money to be made in the stock market.

 

All of this has had a remarkable impact on the distribution of performance on the peer group of funds investing in the UK market.  Looking at the IMA UK All Companies sector year to date performance shows a remarkable symmetry to returns, with the best performing fund delivering a positive 8% return, and the worst performing delivering a minus 8% return.  When the average return is -2%, that is quite a wide distribution over a short period of time.  When one looks at the last twelve months, the distribution of returns covers almost 50 percentage points; that kind of volatility in outcomes makes fund selection equally as important as asset allocation.  Adding yet another layer of complexity to navigating the current environment.

 

Against all of this, however, one cannot forget that the underlying drivers to corporate performance continue to get better.  The UK economy is getting to a position where sustained growth is achievable – business investment is picking up, employment is rising, inflation is under control and as a consequence real disposable income is increasing.  The strength of the US economy has probably been masked by a freak winter, and European economies are grinding out some growth finally.  Yes, emerging markets continue to offer cause for concern, but not enough to undermine the good stuff going on elsewhere.  So there is none of the foregoing that needs to make us truly nervous – the backdrop for equity investment remains attractive.  But 2014 so far has demonstrated some of equity investment’s eternal truths.  And it pays to remember them.

 

I hope everyone has a great Easter break, and don’t think too much about the fact that it is almost May by the time we come back!