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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The Athelney Trust unaudited total return for 2016 was 5.5% and reflected the below-average performance by commercial property shares in the second half of the year. Imagine a time-traveller landing in the City in January 2016, proclaiming that the UK would vote to leave the EU, a presidential candidate who advocated debt renegotiation would be headed for the White House and that Italy would reject the reforms of Matteo Renzi. Surely, the men in white coats would have arrived, bundled him into a van and then disappeared. But the first shock of 2016 was the big sell-off in Chinese stock-markets when an clumsy attempt to calm markets in January back-fired, sparking world-wide turmoil. The price of oil dropped to its lowest in 13 years. All this meant that investors slowly worked out that there would have to be more helpful intervention rather than less. And so it came about that Japan announced a surprise experiment with interest rates below zero, the Bank of England cut interest rates after the referendum and the European Central Bank turned to new measures such as buying corporate debt for the first time. Because of the collapse in the British pound, depressed sectors in London markets such as miners and oils suddenly perked up and finished on a strong note as the Chinese economy started to react positively to yet more economic stimulus having been applied by the government. A big part of these strong markets are economies where growth and employment statistics are improving. In the whole of Europe, the Middle East and Africa, only Belarus and Syria are expected to stay in recession. Europe was not a popular place to invest in 2016 with Germany, France and the Netherlands all facing difficult elections in 2017. There is plenty of scope for new shocks and surprises this year, particularly at election time with populism, anti-immigration and anti-EU to the fore. Markets are likely to react with considerable volatility but we must not be deflected from our task of identifying good companies, with the old-fashioned virtues, which are more than capable of surviving a weaker UK economy as the year progresses.
The Athelney Trust unaudited NAV rose by 0.9% in November whereas the FTSE Smaller Companies and AIM All-share actually fell by 1% and 0.4% respectively although the Fledgling improved by 0.2%. On the face of it, a rather dreary month but there were, in fact, some pretty hefty individual movements, both up and down. The US Federal Reserve will meet shortly and is widely expected to increase interest rates by 0.25%, which would mark its only hike in 2016 whereas three or four had been expected at the beginning of the year. Perhaps two more are in prospect for 2017 although much may depend on the fiscal expansion proposed by Donald Trump. Whatever happens, I believe that the 35-year bull market in bond prices is facing sunset. Income seekers, tormented by low bond yields, may welcome the prospect of rising interest rates. Yet it is difficult to see them rising towards previous levels thanks to global trends such as ageing populations, weak productivity and the debt overhang following the financial crisis. This means that investors should not turn away from equities for income. I believe that dividend growth shares will remain a fertile field for income investors. A rise in rates could, though, hurt ultra high-yield shares on fancy ratings and low growth rates. I see dividend growth shares, quality companies with sufficient cash flow to sustain steady increases in distributions, as being attractive even in the new environment. Both the search for income and the strong case for dividend growth shares are global trends and the need for income remains high as the number of retirees increases world-wide. Rising bond yields are a headwind for ultra high-yield shares but I believe that a focus on dividend growth in quality companies is likely to offer both income and capital growth potential to provide an attractive overall return.
A sliding currency is hardly a new experience for we Britons. The UK led the pack by deserting the gold standard in 1931; Sterling was uncompetitive in 1949 and 1967 and the loss of control of inflation in the 1970s all led to a substantial devaluation. More recently, the pound’s ejection from the ERM in 1992 led to a fall of 18 per cent and, of course, the recent drop of 16 per cent followed the referendum result. Back to 1992, when economic growth quickened to an average of 2.9 per cent over the five years from 1993 and exports grew by 7.7 per cent a year, significantly faster than imports. This neat combination quickly eliminated the current account deficit alongside falling unemployment. So devaluation can be a Good Thing. However, the global financial crisis showed the dangers of a Bad devaluation: after a 25 per cent depreciation, the five years starting in 2010 came with growth averaging only 1.9 per cent and imports rising faster than exports so the current account deficit rose from 2.7 to 4.6 per cent of GDP. So which will we have this time? This question is as difficult to solve as Fermat’s Last Theorem with only half the formula - however, the omens are not auspicious. The lack of global trade growth suggests that there are no easy export markets to conquer. Higher inflation here at home will hit families who can only just cope at the moment. There will be winners, though: home tourism, retailers in London and Northern Ireland and exporters’ profit margins will increase temporarily. But the fact remains that the pound has fallen because the UK has a devalued economy. The pounds in our pocket are worth less and we won’t have more of them.
The unaudited Athelney Trust NAV inched ahead in a remarkably quiet September by 1 per cent to 243.6, still shy of the 31 December 2015 figure of 245.
Brexit means Brexit is as concise as it is circular but it is becoming clearer by the day that what Mrs May means is a Hard Brexit, which represents a departure not only from the EU but also from the customs union and the single market. The UK should, however, end up with a free-trade arrangement that covers goods and some business services and liberal travel arrangements. But the passporting of UK-based financial institutions would end and the City of London would cease to be Europe’s unrivalled financial capital. Furthermore, the UK and EU would impose controls on their nationals’ ability to work in one another’s economies. This is not the outcome that many desire: the Japanese, for instance, have expressed their dismay at the referendum result and its likely consequences. Should the UK leave the customs union, then the rules of origin would apply to exports from the UK to the EU. This bureaucratic procedure would be needed to prove that our exports really were ours and not from, say, North Korea. This would put our exporters at a disadvantage to their EU competitors. The aim of Hard Brexit, therefore, must be to get to our ultimate destination with the minimum of damage to both sides so we need a trade pact with the EU, an interim agreement to cover the period between exit and the longer-term deal, apply to the World Trade Organisation as a full member, new arrangements with the 55 or so other countries that now have a pact with the EU and, presumably, with the US and China and, finally, UK-EU ties in foreign and defence policy, police and judicial co-operation and counter-terrorism. Believe me, this is all going to take years and years. The UK has chosen a largely illusory freedom and we must all face up to the fact that the country will be poorer for this grim mistake.
Not at all a bad month for equities in general and small caps. in particular with the Athelney Trust unaudited NAV up by 3.8% whereas the FTSE Small Cap, Fledgling and AIM All-share indices rose by 2.6%, 3.6% and 4.7% respectively. Am I allowed to ask the question again, what will the economic effects of the UK leaving the EU be? Well, the strongest clue to the answer has come from currency markets: on 23 June, sterling reached a high of $1.50 and €1.31 shortly after polls closed. It then plummeted and has averaged about $1.30 and €1.18 ever since. In trade-weighted terms, the pound is down more than 15 % from its level a year ago when Mr Cameron started the renegotiation which would lead to the referendum. Foreign exchange markets are not always a reliable witness - they can be volatile and daily movements can often be impenetrable. But when rates move sharply and then settle down quietly without second thoughts, their judgement should not be ignored. Currency markets are saying that all UK assets are worth less than they used to be. Land, buildings, companies, bank deposits, government debt - everything in the UK has been marked down against the rest of the world. Although the FTSE 100 index has boomed, that is largely because many of its components earn most of their revenue and profits outside the UK. Holiday-makers were the first to notice the difference but all Britons go abroad every day to buy petrol, food, clothes and much more. Imports are equal to 30% of GDP and it is only a matter of time before we are all poorer. Seventy years ago the pound could buy $4.03 and its has been periodically devalued since then. Each devaluation produced a temporary fall in the real exchange rate but it was not long before domestic costs started rising faster than the costs of our international competitors and so the advantage was eroded. Travellers returning from abroad have already tasted what is to come. Whether getting poorer is what 52% of the 23 June voters wanted or expected, it is what is happening.
The Athelney Trust unaudited NAV rose by 7.4 per cent in July compared with the 6.8, 6.5 and 6.8 per cent rises for the FTSE Small Cap, Fledgling and AIM All-share indices over the same period.
The Bank of England had not changed base rates in seven years but, when it finally moved, it cut rates by a quarter of a point to 0.25 per cent. Not only that, it also expanded its quantitative easing scheme and introduced a new funding wheeze for banks. The move came on 4 August - three prime ministers, two disappointing European football campaigns and two referendums since the last change. The news lately has been almost uniformly bad. Manufacturing, service-sector and construction activity all shrank sharply in July, the latter two at the fastest pace since 2009. Economic confidence has taken a hard knock with surveys of business revealing a broad pessimism across all sectors as orders dry up. The British economy seems destined to suffer a mild recession, if not something far worse. The MPC has restarted QE and is pledged to buy up to £60 billion in government bonds and £10 billion in corporate bonds over the next 18 months. The new funding scheme is designed to help banks and building societies which might otherwise struggle to cut their lending rates in line with base rates. Heavy lifting, however, will have to be undertaken by fiscal policy:a bold new programme of investment in energy, the environment and public housing plus cuts in employers’ and employees’ National Insurance costs would be a good start. A lower level for the pound might indicate that exports to Europe could be expected to pick up but European firms will be reluctant to spend more money in the U.K. until the future of the trading relationship between the two is clearer. For now, the rest of us must sleep in the dashed uncomfortable bed made for us by the Leavers. The search for income goes on - in fact it has intensified since 4 August - so equities and commercial property still seem to be the only games in town.
Interim 2016 Chairman's Statement
Chairman’s Statement Interim Accounts 30 June 2016
First, the plain facts unattractive as they are. The unaudited NAV of Athelney Trust fell by 6% in June which was markedly worse than the various indices that I track. The FTSE Small Cap fell by 2.7%, the Fledgling by 2.6% and the AIM All-share by 4.1%. The result would have been even worse but for take-over bids which arrived for Wireless Group (+73.2%) and Premier Farnell (+41%). There were some really bad performers such as Trinity Mirror and Matchtech but most of the problems surfaced in the property sector post the referendum. Retail investors have panicked and rushed to sell their holdings in open-ended commercial property funds. Standard Life, Aviva, M&G and Henderson, having run through their liquidity (which apparently varied from about 15% to 25%) have now shut the gate and said that investors will only be paid out when orderly disposals of the underlying properties have been made. Buyers will see these funds coming and will bid low for the properties that they like - this will give the property valuers the opportunity to call these transactions willing buyer/ willing seller, which they are not. Nevertheless, expect sharp mark-downs in asset values in the near future. As you can imagine, this has spooked the property market right across the board. Going back to the open-ended funds again, that liquidity was often held in REITs shares because of exceptionally low interest rates - naturally, all these shares have now been sold in the stock-market, thus depressing prices even further. Selling has continued into July so expect more shocks of this type. Having said all that, I am determined not to join the Gaderine swine by selling our property shares. They will be reviewed one by one and, if any are wanting, they will be replaced by better choices but do not expect the substantial commitment to the sector to fall by much, if anything, first and foremost, they are great dividend payers (expect quite a few cuts in FTSE 100 divvies) and, second, there is virtually nothing in the overheated London commercial and residential markets. As for the referendum, I think that it was a disaster in both political and economic terms: I do not believe that the country has been in such a dreadful state since the aftermath of Suez. No doubt I shall be returning to the subject in the coming months but now we can see that HM Treasury was right in forecasting a recession, falling house prices, no investment in plant and equipment, reduced consumer confidence, rising unemployment and so on and so on.
The Athelney Trust unaudited NAV rose by a modest 0.3% in May whereas the FTSE Small Cap and AIM All-share increased by 0.2% and 1.2% respectively but the Fledgling actually fell by the latter percentage, so not a great month for small caps. as the 23 June started to loom large in investors’ thinking. On which subject, everyone in the saloon bar seems to have a favourite complaint about EU regulation; how many bananas are allowed in a bunch or whether children may blow up balloons. All rubbish, of course. Yet even hated regulation can bring benefits and should be considered to be standardization not regulation. Again, the costliest burdens are home-grown such as the tight planning laws, the new living wage and the apprenticeship levy. By international standards, Britain is lightly regulated - according to the OECD, it has the least-regulated labour market and the second least-regulated product market in Europe. It also comes high in the World Bank’s rankings for ease of doing business. Assuming that we turned our back on the single market (a disaster, in my opinion) and traded from outside, exporters to the EU would still have to comply with most regulations. In short, Britain would not find it easy to scrap many its regulations and businesses may find that there are two sets of rules to follow - London and Brussels. An important point is being lost in the increasingly bitter debate is that the European Commission’s better regulation agenda limits new regulations and results in existing ones being withdrawn. It is surely ironic that we may be about to turn our back on Europe just when the EU has come round to our way of thinking.
Two serious profit warnings from St Ives and Sprue Aegis, plus capitalising the professional fees relating to the recent private placing, has turned what should have been a comfortable positive into a negative. The unaudited NAV declined from 233.2 to 229.8 during the month. In the year so far, we have grappled with Brexit, war in the Middle East, negative interest rates, energy prices, Vladimir Putin, Brazil and the Chinese debt bubble and, since the last has the potential to overturn everything, we should be forewarned and forearmed. Back in 2008, as the western financial crisis spread, China tried to insulate itself with a huge credit stimulus. Nevertheless, by 2011, the growth rate had peaked with the decline led by property then manufacturing. Further measures have not altered the trend for long: one constant, though, is the build-up in the debts of property companies, state-owned enterprises and local governments. Credit growth may be running at 25-30 per cent, or twice as fast as the official figures would have us believe. Banks possibly have as much as 20 per cent in non-performing loans or, to put it another way, about 60 per cent of GDP. Growing dependence on volatile forms of funding sources (e.g. overseas), makes the banking system more prone to sudden shocks. With a slowing economy and rising financial instability, it is hard to see Beijing changing course any time soon. Yet, without such a change, China is likely to experience greater turbulence than before - perhaps not this year but maybe 2017 or 2018. That represents a real policy dilemma without any obvious, comfortable solution.
Athelney Trust’s total return for the first quarter was a rather uninspiring -1.6% compared with falls of 2, 3.6 and 1.2 % in the FTSE Small Cap, AIM All-share and Fledgling indices. I make no apology for returning to the subject of the 23 June referendum since the result, particularly if it is to leave the EU, would have a profound effect on the stock market and the British pound. Specialists say a 15% fall in the latter would accompany a negative vote and I dare say something similar might occur in equities. Much has been said about a newly ‘independent’ Britain being able to negotiate a free-trade zone with the rump of the EU. Yet the EU’s single market is deeper than a free-trade zone. It dismantles both tariffs and non-tariff barriers involving standards, regulations and rules of origin. That explains why joining the EU boosted Britain’s exports to West Germany so that its share of the latter’s imports doubled from 8 to 16% in a few short years. Brexiteers claim that a good deal would be easy to negotiate but the climate would be frosty in the extreme and Brussels would be anxious to avoid ‘give-aways’ in case others might wish to leave. I am sure that Germany would wish to continue to sell cars to us but what about those other countries with a trade deficit with the UK or who hardly do anything with us at all? A unanimous vote would be required. Hopes of good deals with the rest of the world look illusory: Britain would have to replace all 53 free-trade pacts and South Korea and Mexico, to name only two, are notoriously difficult to talk to. Several big countries, notably America, China and India, are negotiating new deals with the EU from which we would be excluded. My conclusion is that we would end up with fewer and worse trade deals than we have now.
After the wild gyrations of January, February was a quieter month with the unaudited NAV of Athelney Trust and the three relevant benchmarks barely altered. Which gives me the space and opportunity to have another rant about Brexit. Perhaps the biggest issue in the 23 June referendum is the question of whether 43 years in the EU has helped or hurt the British economy. Britain joined what was then the EEC in 1973 as the sick man of Europe. By the late 1960s, France, West Germany and Italy, the three founder members closest in size to the UK, produced more per person than we did and the gap grew bigger every year. Between 1958, when the EEC was set up, and Britain’s entry in 1973, GDP per head rose by 95% in these three countries compared with only 50% in Britain. After becoming an EEC member, we started to catch up so that GDP per head has grown faster than in Germany, France and Italy. In 2013, Britain became more prosperous than the average of the three other large European economies for the first time since 1965. For almost half a century, Britain has benefited from a greater openness to world markets, which has fostered greater economic dynamism. Economists have demonstrated again and again that the main cause of the change was membership of the EU which brought with it gains from trade, foreign direct investment, competition and innovation. Surely there are enough challenges in running a business these days so why would you vote to put yourself in a more difficult position?
Equities and oil both experienced a pretty awful January, indeed the first two weeks were the worst start to a year that I can remember in half a century: Athelney Trust’s unaudited NAV fell by 3.8% during the month whereas the FTSE Small Cap, Fledgling and AIM All-share indices did even worse, being down by 5.8%, 4.6% and 5.5% respectively. Huge price declines were experienced in wild volatility including intraday swings. Some say that weak global growth is the reason for all this but the lower oil price has put enormous potential spending power in the hands of consumers yet airlines’ and retailers’ shares, which would be expected to benefit from a $30 dollar barrel of oil, have fallen along with the rest. To look a little further, uncharacteristic policy mistakes by the Chinese government have hit confidence. Then again, we now have rising interest rates in America - if Janet Yellen really did go ahead with four rises this year and a similar number in 2017, then we are sunk. Luckily, I do not believe that we will get anything like that and suggest that one rise will be enough for this year. Finally, those of us who have been buying on dips have refrained from doing so this time because of the rise in volatility but I continue to believe that it is still the correct strategy. There is value out there in small caps and, increasingly, blue chips if only one can start to think like a contrarian.
Year End 2016
Chairman’s Statement Year End Accounts 31 December 2016 (PDF Link)