Apr 28, 2020
For the quarter, the portfolio delivered negative absolute returns, but strongly outperformed the benchmark.
Stock picking in financials – particularly not holding banks – overweight exposure to IT and avoiding the underperforming energy sector all proved significant contributors over the period. Software maker Microsoft delivered the biggest relative returns. The company did reduce its quarterly outlook for its ‘More Personal Computing’ segment due to coronavirus-related supply chain issues, but broader positive sentiment remained intact, in part related to persistent demand for the company’s cloud-based solutions, especially Azure.
Internet domain registration company VeriSign also contributed. Two key metrics in the company’s results – renewal rates and regulatory changes – provided support that the business model remains intact and the business continues to reinvest in the very same infrastructure which underpins its competitive advantage. In addition, the company announced an amended agreement in March that allows it to increase the maximum price of .com domain name registrations.
Health care company Roche outperformed, with its diagnostics business expected to benefit from COVID-19 testing. This comes after the firm delivered strong fourth-quarter results, and its outlook suggested plenty of opportunity still exists for future growth, whether that be product innovation in the current in-market drugs, new indications for existing drugs or entirely new drugs. Margins were very strong on a core basis.
Credit rating agency Moody’s contributed to returns. Recent results beat consensus estimates, and the company also raised its quarterly dividend by 12%, in addition to January’s announcement that it plans to buy back about US$1.3 billion of stock in 2020. Despite the fact Visa shares were heavily sold in the early stages of the COVID-19 sell-off – the more profitable cross-border aspect of the global payment provider’s business was hit by the travel restrictions – its strong performance earlier in the quarter meant it was an outperformer and contributor to relative returns. In January, Visa announced the US5.3 billion purchase of Plaid, marking a further link into the fintech industry.
More negatively, stock selection within consumer discretionary and communication services proved the largest detractors to relative performance. Shares in online booking portal Booking Holdings came under pressure due to the coronavirus outbreak. Management said bookings were tracking ahead of expectations up until early-February, before slowing after widespread concerns became a global issue. The company has announced a range of actions to stem cash burn, including salary reductions, cutting events and marketing spend. We continue to believe Booking has enough financial flexibility in its financial model to navigate the difficult travel environment.
Amadeus, which provides IT software to the global travel and tourism industry, has been heavily impacted by the coronavirus outbreak. Global travel volumes are expected to decline significantly this year and potentially only recover to only half of 2019’s level by next year. We believe management have been prudent in shoring up the company’s financial position, and Amadeus is likely to emerge from this period of uncertainty in a stronger competitive position, especially given many rivals are more levered, and have less flexible business models.
Wealth manager St. James’s Place had a difficult quarter amid the coronavirus sell-off and accompanying shock to investor confidence. The decline in equity markets negatively impacts St James’s Place assets under management and therefore expected revenues. Media company Fox Corporation also detracted from returns, as investors perceived some cyclical risk to the company’s advertising revenues amid uncertainty regarding the impact of coronavirus on US cable subscribers.
Drinks company Anheuser-Busch InBev also came under pressure. Following its forecast in February that first-quarter earnings would drop 10%, its relatively high leverage came into focus, with the current environment likely to weigh on cash flows and their ability to pay down debt.
The year started positively, as the US and China signed into effect ‘phase one’ of their trade deal. However, before long, news of the worsening coronavirus (COVID-19) outbreak in China began to drive fear into markets. Then came an oil price war, as cooperation within OPEC+ broke down. As COVID-19 spread outside of Asia, progressing to pandemic status, the global economy in effect froze as governments across the board restricted movement to combat the virus, prompting one of the fastest ever sell-offs in a number of asset classes.
Equity investors shifted away from cyclical sectors as the global economic outlook worsened. Defensive spaces including health care, consumer staples and utilities significantly outperformed the wider market, with energy and financials notable laggards.
What the world is facing now is genuinely unprecedented, with a distinct lack of past experience to take guidance from. Forecasts are even more prone to error than normal, as a result, with traditional models made redundant and the range of variables and possible outcomes too wide to predict with any kind of accuracy. The myriad inputs and factors prioritised by different market participants has resulted in volatility not seen since 2008. Patchy and inconsistent data on the coronavirus itself has also contributed to uncertainty.
We acknowledge the decisive nature with which governments have acted in the face of this crisis. The speed and magnitude of fiscal and monetary responses have been encouraging against a backdrop of plunging economic activity. That being said, even in the best case recovery scenarios, we expect this crisis will have multiple second and third order impacts on industries, some of which may not become apparent for some time; not to mention the financing and investment implications of rapid capital flows and extreme asset price moves we have seen in recent weeks.
Rather than attempt to make top-down forecasts, our assessment of the macro and market environment is typically made at the underlying stock level. We have been fastidious in our analysis of portfolio companies’ ability to navigate these challenging times, assessing their ability to emerge from the crisis in positions of strength with business models intact. Overall, we are comfortable that the Quality attributes we seek (enduring competitive advantages, dominant market positions, strong balance sheets, lower cyclicality, low capital intensity, sustainable cash generation and disciplined capital allocation) are all well suited to both current conditions and for any structural changes sparked by this crisis.
The Quality businesses we seek in our portfolios have historically proved resilient in times of uncertainty and have often led the recovery following indiscriminate sell-offs. These companies may be well placed to capture significant upside at some point in the future as investors once again recognise their Quality fundamentals. Additionally, given the substantial moves we have seen in share prices, significant opportunities likely lie ahead. We continue to monitor the situation very closely and remain front-footed in terms of portfolio positioning.