Fund Manager's Comments
A collection of the Fund Manager's comments and Chairman's Statements. These are extracted from the original Portfolio Details and Accounts that are published on this website.
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If 2016 was the year of shock and surprise, then 2017 was the year of disruption. A blizzard of tweets followed President Trump’s inauguration (my nuclear button is bigger than yours - all grown-up stuff, of course). Prime Minister (strong and stable leadership) May turned a cast-iron majority into something much more precarious depending on the goodwill of the DUP and the Scottish Conservatives. The general election campaign was an superb example of ineptitude. As far as Brexit was concerned, Britain gave way completely on the Irish border, the rights of EU workers and the divorce settlement so was allowed to prepare for trade talks this year. Let us see how easy they turn out to be! Syria spent its sixth year in civil war and Yemen was not far behind in terms of danger to life. The rise of the populist parties continued in Europe and brought with it an exceptionally unwelcome increase in anti-Semitism. President Maduro of Venezuela continued with his quest to destroy what at one time had been the strongest economy in Latin America. Tanks rolling down the streets of Harare eventually persuaded autocratic President Mugabe to resign while, at the same time, the Generals were claiming no, there is no coup.
For the most part, though, global markets continued their serene progress and thus improved on my hope that we could hang on to our gains of the first half. Austria, Turkey and Hong Kong were the best performing markets of the the year and Russia, China and Mexico the worst. Russia is often touted as a recovery situation but four sets of sanctions have always put me off, resulting from: the arrest and murder of Sergei Magnitsy, the invasion of eastern Ukraine and the Crimea, the shooting down by pro-Moscow fighters of Malaysian Airlines flight number 17 and interference in the U.S general election. A better proposition might be battered and bashed retailers and shopping malls. Westfield is being bought by Unibail-Rodamco, Hammerson has bid for Intu and Brookfield is trying to buy out GGP. Hedge funds are heavily short and therefore vulnerable. The same comment applies, in my opinion, to underrated brewery groups such as Greene King and Marston’s.
A 5-7 per cent return in 2018 plus 3 per cent in dividends would please me greatly.
Not a good month for equities in general and Athelney Trust in particular, with the latter’s NAV falling by 1.3% to 280.1. Cineworld was a notable casualty, dropping by 18.2% on plans to buy the Regal cinema chain in the U.S. This fall despite the company’s statement that it intends to maintain the present progressive dividend policy and that the acquisition would be earnings enhancing. Samuel Heath, Andrews Sykes and KCOM all fell on the publication of (in my opinion) perfectly respectable interim figures, whereas Trinity Mirror decreased despite share buy-backs. Debenhams and Wynnstay seemed to dip on nothing very much. So a rather odd month in retrospect.
Profit warnings have also been to the fore recently as are the painful price falls which accompany them. What is worrying about the recent spate is the sheer number of them and the scale of the market response. With 75 profit warnings in the third quarter and companies lining up to warn shareholders in October and November, it is a fair bet that 2017 will be one of the worst for warnings in recent years. Furthermore, more than 40% of them were warning for the second time and the threat of multiple warnings has increased the average share price drop. Analysts forecasts can be too optimistic and fail to see through the fog of Brexit. More controversially, the fashion for passive investing has, in my opinion, resulted in not enough of us following and analysing companies. There is no silver bullet for all this but, in these odd markets, be well diversified: a 50% fall in a one-share portfolio is painful but in Athelney’s 80-plus holdings a fall of 50% in one of them much less so.
Those Brexiteers are at it again, keen for us to walk away from the EU without a deal and thus fall back on WTO rules. And yet, the car industry, for example, would be hit hard: it’s dominant market is the EU. Without a free trade deal, it would be hit by a 10 per cent import tariff - the car components industry would face a 5 per cent tariff on its exports and these might be held up by customs and face additional duties if there was found to be a large non-British content. Faced with the prospect of a loss of competitiveness, big chunks of the industry would re-locate within the EU. The same would apply to other manufacturing sectors. Then there is the problem of non-tariff barriers such as product safety regulations. Britain runs a huge surplus in services such as financial, accountancy and legal but the WTO has only made very limited progress on liberalising trade in these sectors so that many service businesses may decide to partly relocate to the EU in order to maintain existing levels of trade. A no-deal outcome in the Brexit talks would, in my opinion, be deeply damaging to the UK economy and it is about time that the government should come out and say so.
Turning to equity and commercial property markets, which are currently performing very well, it seems to me that they are quite different from the equity boom of the late Nineties and the real estate boom several years later in that they were fuelled by over-optimism and an unhealthy wish to speculate. Today’s investors seem to be much more interested in dividend income and capital preservation. This has driven them into so-called safe havens such as transatlantic technology shares and consumer brands and trophy assets such as buildings in the City and West End of London. Such investors should ask themselves whether it has ever been more risky to play safe. The flight to safety in the property market can be seen in the huge difference in yields available on prime buildings (low) and secondary properties (high yields). Prime properties are considered lower risk and are therefore worth paying up for in a risk-averse world. The reality is, I believe, rather different because the bulk of overall returns comes from income not capital growth: the former is high and stable and the latter volatile and unpredictable. Similar comments can be made about the equity market: investors have bought investments that they perceive to have low volatility and reliable and predictable growth prospects and the more that such shares go up, the more money that they attract to the point where they are decidedly over-valued. To my mind, it is more important than ever to look for value in the less fashionable sectors of the market that risk-averse investors have over-looked. When the price is right for a building or a share, investors may find that taking on risk is the safest strategy to follow.
Since the referendum vote in June 2016, the British pound has lost 15% of its value against other currencies. Some see an upside to this slump: with products more competitive abroad, so the argument goes, the economy will re-balance away from consumer spending towards export-led growth. For the last three centuries, Britain has run a trade surplus. Its greatest, at the height of the British Empire, was 6% of GDP in 1881. However, in recent years, Britain has run large trade deficits. The impact of sterling’s devaluation has been distinctly underwhelming. Firms are locked into global supply chains and rely on foreign imports. Half the components in a British-made car come from abroad so if exports rise then so do imports. The economy is also highly geared to value-added things like pharmaceuticals. Buyers of these and legal and financial services are insensitive to price changes: design and customer service quality are much more important. Profitability is near record highs yet business investment is stalling - last year non-banks stuffed an extra £74bn on deposit. The tentative behaviour of businesses should be a wake-up call to ministers who have been banking on a re-orientation of British trade away from Europe after we leave the EU. Following a period of stability, the pound has started to fall again but it would be a brave and optimistic Leaver looking through rose-coloured glasses who would believe that an export boom is just round the corner.
Setting interest rates in the UK is a delicate business these days. The hawks on the Monetary Policy Committee cite falling unemployment, surveys suggest that companies are keen to invest and export and that economic models from the past predict that joblessness this low will soon push inflation higher. To head off these inflationary pressures, hawks think that there is an urgent need to remove the quarter point cut of last August to slow spending, prevent unemployment falling further and keep prices and wages under control. By contrast, the doves on the MPC urge wait-and-see. Businesses might talk about investment but few have opened their wallets and there is no export boom that I can see. Although unemployment is at a 40-year low of 4.6%, there is no sign of wage pressure with pay growth slowing even as inflation rises close to 3%. Household finances are also stressed with the savings ratio at a 54-year low. Any rate rise, they say, would be reckless in the extreme and risks causing a crisis in confidence that the MPC worked so hard to avoid last year. My view, for what it is worth, is that the need for insurance against a downturn is paramount. For now, the economy cannot stand the nasty-tasting medicine of a rate rise. We should wait-and-see.
One year on from the referendum it is time to look at the economic consequences so far. The economy has grown at an annualized rate of 1.8% in the three quarters following the poll and unemployment has fallen from 4.9 to 4.6%. So far so good but the bad news is the type of growth the UK has experienced and developments in living standards. Household consumption accounted for more than 80% of economic growth, business investment did not contribute at all whereas net exports actually detracted from growth. The latest numbers indicate that prices are rising at 2.9% but wages only by 1.7% and most working-age benefits are frozen. Households will, on balance, be worse off a year after the referendum. As for the forecasts made by the Treasury on the Remain side, the shallow recession did not arrive but there were serious errors on the Leave side. The Economists for Brexit forecast almost no immediate drop in sterling, inflation in mid-2017 of 1.5% and average earnings growth of 3.5%. The voting public punished the government in the recent general election but does not realize that the British pound’s fall is likely to prolong the Brexit squeeze on living standards for another two years or so. Negotiations with the EU27 will be tricky: each protectionist move will raise costs, undermine competition and duplicate processes. The less Britain is willing to contribute to the EU budget, the less will be the access to our largest market. Reflecting the more difficult trading environment, the Bank of England has cut its assessment of future GDP growth from 2.25% to 1.75%. Even worse, ministers seem to be ploughing on with a hard Brexit: oiled cogs and buckets of sand come to mind. Do they really know what they are doing?
There is too much cash chasing too few good shares. Three important factors (and myriad others) have driven this large liquidity support for markets: first, profits have surged in recent years, especially in the UK where the weakness of the British pound has caused international sales and profits to increase when translated back into Sterling. Many companies have accumulated cash on their balance sheets, some of which will be distributed to loyal shareholders via increased dividends or share buy-backs. Second, inequality is increasing since the better-off benefit from rising markets far more than those who are just managing. The former use their wealth to buy yet more financial assets whereas the latter have rent, food and clothing to pay for before anything is left over for discretionary purchases. Third, and most important, central banks have been huge buyers of financial assets which, stating the obvious, has pushed prices for such assets higher and higher. The result of all this is that, after spending years on the side-lines, retail investors are now coming back into the market-place. Passive investing, i.e. buying funds which track share indices, is, in my opinion, in danger of over-shooting - just because it is popular doesn’t make it right. By contrast, risky hedge funds used to taking huge gambles are struggling to show a decent return because, seemingly, everyone is trying to do exactly the same thing at the same time (i.e. a crowded trade). As a contrarian, these two matters worry me a lot. Over the long term, these three sources of liquidity will probably erode. What we need to replace this source of cash is sensible economic reform to produce sound money and as-near-as-we-can-get to free trade. I see no signs of such policies in the Conservative or Labour manifestos or the Trump tweets. Contrarians amongst Athelney shareholders will be relieved to read that I still believe that there are sufficient bargains in smaller companies out there to keep me going for a while yet.
Theresa May repeated 11 times in parliament on 26 April that Britain boasted a strong economy that depended on her strong and stable leadership. Is that the case and will any perceived weakness in the economy hamper our efforts to negotiate a good deal with Brussels? Certainly, our economy is no basket case and, based on current exchange rates, Britain is the world’s fifth-largest economy but on a purchasing power basis we drop to ninth. The UK’s prosperity is not even in the top 15 per cent. While Britain enjoyed a relatively strong period between 1979 and 2007 the performance in the following decade was weak. That strong economy hailed by Mrs. May had one of the deepest recessions and weakest recoveries of its peers. We often think that the UK cleverly combines American levels of taxation with a European welfare state. The truth is that we sit uneasily somewhere between the two. At 36 per cent of national income, the tax burden is six percentage points higher than in the U.S. Spending on public services is severely constrained : at 39 per cent of national income, it is 5 percentage points below that of Germany. And then we come to productivity: the US, Germany and France are way ahead of us and output per head and worker does not even match that of Italy. We are stuck in the middle without low taxes, great public services or high productivity. Nor is it easy to see a way out - the public gets angry about increases in taxation, stories of inadequate public services and becomes incandescent at things that would increased productivity such as building projects in its own back yard. What has all this to do with the negotiations to leave the EU? Simply this, if we go in like a card sharp with a poor hand we may never get the deal that we seek.
The real Brexit process is (at last) underway. For half the country, the triggering of Article 50 was a moment to celebrate: for me, it marked a bleak day. The task of unwinding Britain’s place in Europe is fiendishly complicated: time is desperately short and neither side is well organized. Voters have been given wildly optimistic expectations of what an ultimate deal might look like and first contact with the reality of losing preferential access to the single market may be traumatic. The timetable is even tighter than it looks. The EU wants to fix the divorce bill, Irish borders and the rights of EU/ UK citizens before even starting to look at a trade deal. There may be long arguments about process. It is true that many voted to leave because they had felt that immigration was too high but I do not believe that Britain will be able to cut the numbers without damaging the economy. Mrs. May is not just making the wrong choices by opting for a hard Brexit, she has also been downplaying awkward trade-offs. By telling the population of this country that we can maintain barrier-free access to the single market while stopping EU immigrants and ending the jurisdiction of the ECJ, she is saying that we can have our cake and eat it. We must remember that the highest barriers to entry to the single market are not tariffs or customs checks but non-tariff barriers such as standards, regulations and state-aid rules, the referee of which is, yes, the European Court of Justice. Is Mrs May stepping back from her other error, that no deal is better than a bad deal. Only partially: to revert to trading only on WTO rules would cause serious damage to Britain’s economy. Furthermore, an acrimonious break-up would make it even harder to co-operate on things like foreign policy, defence and security. A proper transitional period during which existing rules would apply is likely to be highly necessary in order to avoid falling off a cliff. There is a possibility of a deal that minimizes Brexit’s harm but, in a negotiation against the clock where both sides start so far apart, there is also a big risk of one which maximizes harm instead.
The unaudited NAV of Athelney Trust rose by a satisfactory 3.7 per cent in the month of February.
With the New York markets hitting a new high last week, we are all wondering just how long this upward swing, christened the Trump Reflation Trade, can possibly last. To give you my conclusion first, I now believe that market ratings for blue-chips are looking rather stretched but there is more to go for in small caps although it would be idle to pretend that there are no substantial risks. Much will depend on announcements about tax reforms and monetary policy where it is quite possible that Janet Yellen, no lover of President Trump, might seek to push up rates faster than we have bargained for. On foreign policy, Trump’s tweet might be worse than his, er, bite but protectionism is almost certain to draw retaliatory measures which would be bad for growth in major exporting countries like Japan, South Korea and Germany.
The problem is that Messrs’ Dimson, Marsh and Staunton of the London Business School, masters of the statistic, have provided convincing evidence that low real interest rates mean low future returns on world-wide equities and bonds. Their estimate for the long-term return on equities is only about 5 per cent per annum but I trust that the return on a portfolio of small caps would be comfortably better than this.
Theresa May’s private opinion of Donald Trump goes recorded but I doubt that she is a natural fan. Looking backwards, Margaret Thatcher put up with Ronald Reagan’s invasion of Grenada, a Commonwealth country, Tony Blair’s eagerness to be close to George W. Bush cost him European allies and took Britain into the Iraq war so some flummery could have been expected during her visit to Washington but, to my mind, Mr Trump is different. Whereas Reagan and Bush cherished the economic and security order in which Britain was a junior partner, Mr Trump threatens it. So why did Mrs May rush to visit him? Because Brexit compels Britain’s leaders to show that the country has powerful friends. The curious thing is that Brexit was supposed to be about taking back control and asserting national dignity and independence. Increasingly, that looks like a bad joke. Britain’s leaders feel that they have to prostrate themselves before a president that they find odious. To keep businesses moving elsewhere, Britain may have to shadow EU regulations and pay into EU programmes without the chance to shape either. A fact of the modern world is that control and autonomy are not the same thing. Britain is party to about 700 treaties, a member of countless international organisations and spends billions on a nuclear deterrent unusable without America. In each of these cases Britain had traded pure self-determination for real influence so had the ability to shape its economic, security and environmental circumstances. Leaving the EU club gives us back some control (I suppose that I’m thinking about deep-water fishing policy) but requires us to trade away control in other ways. Will Britain be a country able to chart its own course in future? Watch the prime minister holding hands with Mr Trump and decide.