The first quarter of 2022 has been very difficult for UK equity funds focussed on investing in quality growth businesses. The mood music probably changed around September 2021 with growing expectations of rising interest rates as inflationary pressures built up. Growth companies were the worst hit as profit growth projected well into the future was discounted back to the present by the market at a higher interest rate. In addition, wage pressures appeared particularly severe in the technology sector, silicon chip shortages were acute, and supply chain pressures built up as the world recovered unevenly from the Covid pandemic. On top of all this, the invasion of Ukraine has added fuel to the fire, with fears of shortages and attendant price increases in oil, gas, wheat, and sunflower oil, to name but a few vital commodities.
There is every likelihood that these pressures will persist for some time. The macro-economic background remains an important influence on businesses, but we are among those who do not claim any ability to forecast the future. The most that can be said is that if there is a sharp squeeze on consumers and businesses from resource price inflation, perhaps this will not necessitate such significant increases in interest rates as were previously feared.
There is, of course, a huge temptation when quality growth companies are out of favour to shift part of your portfolio towards resources, or renewables, or banks, or big pharma. However, being a follower of fashion in investing is dangerous. As my colleague and fund of funds manager Simon Evan-Cook recently pointed out in an article published in Citywire, fund buyers want the certainty of knowing that a manager will stick to their style and investment philosophy, as they combine different funds into portfolios.
After the savage sell-off in quality growth companies in January and February this year, taken overall, share prices have settled down in absolute if not yet in relative terms. Bottom-fishing is never a comfortable pastime, but reassurance can be taken from four angles.
Firstly, and most importantly, quality companies with highly defensible market positions and sticky customers continue to generate profits and cash, and many are passing on inflationary costs in higher selling prices - albeit sometimes with a few months lag, depending on contract terms. Most have resumed dividends post-Covid, and some are paying out special dividends on top. In my VT Downing Unique Opportunities Fund, only two companies have now not paid a dividend since the Fund launched two years ago, and one of those hasn’t had a strategy to do so.
Secondly, we are seeing directors purchasing shares, or choosing not to sell any to fund the tax on their LTIPs. At the last count, in my own fund this year there are eight companies out of 33 where director purchases outside of the ordinary pattern have been spotted (Aptitude Software Group Plc, AG Barr Plc, Dotdigital Group Plc, Dunelm Group Plc, Elementis Plc, Mortgage Advice Bureau Holdings Plc, Strix Group Plc and Tatton Asset Management Plc).
Thirdly, companies are buying back their own shares, and we actively encourage this at least to offset the dilution of issuing shares under incentive schemes. The most satisfying example this year has been EKF Diagnostics Holdings Plc, which had issued $10m of shares to a vendor last autumn (valued at 81.6p per share) to fund an acquisition, and has now bought them all back in at 43.29p, thereby effectively halving the initial acquisition cost to the company.
Finally, corporate activity continues. While IPO activity has gone quiet, and most of last year’s crop are underwater (we declined to participate in any), private equity has in recent weeks announced a number of bid approaches – Ideagen Plc, Homeserve Plc and RWS Holdings Plc to name a few. Companies continue to have the confidence to announce bolt-ons but also more major moves, and it seems likely that in the aftermath of Covid, with a war in Europe and share prices lower, many private company sellers may now decide that it is time to accept that cash offer that has been patiently held out to them by a cash-rich public company.
For all these reasons, and because fund buyers need to know where they stand, we will be sticking to our knitting. Rather than buying and selling for short-term profit, we make investments at valuations we believe will provide shareholder value over the intended long-term period of investment.
Manager, VT Downing Unique Opportunities Fund
Risk warning: Opinions expressed represent the views of the fund manager at the time of publication, are subject to change, and should not be interpreted as investment advice. Please refer to the latest full Prospectus and KIID before investing; your attention is drawn to the risk, fees and taxation factors contained therein.
Please note that past performance is not a reliable indicator of future results. Capital is at risk. Investments and the income derived from them can fall as well as rise and investors may not get back the full amount invested. Investments in this fund should be held for the long term and are higher risk compared to investments solely in larger, more established companies.
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