Liontrust Macro Equity Income Fund

March 2020 review

The Liontrust Macro Equity Income Fund returned -18.2%* in March, compared with the FTSE All Share Index return of -15.1% and the -18.3% average return made by funds in the IA UK Equity Income sector.

 

March was dominated the continued spread of coronavirus, the increasingly desperate efforts of governments to limit its human cost and the bearing this had for both economies and financial markets.

 

The example of the UK is instructive. As at the beginning of March, the UK had 35 cases of COVID-19 and no deaths. By month-end, disease incidence has spiked to more than twenty-five thousand and the death toll approached eighteen hundred.

 

Confronted with this unique threat, Boris Johnson’s government invoked emergency measures. To limit contagion, freedom of movement was restricted and swathes of the UK economy were mothballed with immediate effect. The economic impact will be huge; Capital Economics, a research consultancy, estimates that UK GDP could fall 15% quarter-on-quarter in Q2 with quarterly output potentially shrinking by as much as 20-40% given the complete shutdown of the construction, manufacturing and real estate sectors. For context, UK GDP contracted by 6% (annualised) over the six quarters of the Global Financial Crisis (GFC); and 7% over the ten quarters of the Great Depression.

 

After March, the adjective ‘unprecedented’ seems well-worn to the point of being threadbare. But the scope and immediacy of the UK’s policy response demands its use. Between the 12th and 26th March, Chancellor Sunak pledged £110bn (5.3% of GDP) of fiscal support (business rate holidays, cash grants for businesses, Job Retention Scheme, assistance for the self-employed); and a further £330bn (14.8% of GDP) in loan guarantees to ensure the flow of credit to enterprise. In sum, this is a multiple of the fiscal stimulus deployed during the GFC.

 

Per the policy textbook, fiscal assistance was amplified by monetary easing. Notwithstanding limited room to manoeuvre, the Bank of England cut the base rate to 0.1% and undertook a further £200bn quantitative easing; a dose as large as any administered in the GFC.

 

But what’s the upshot of this ‘kitchen sink’ response? Aside from the sharp deterioration in UK public finances, this offers clear proof that fiscal policy is now the primary lever of economic policy. As argued in recent blogs, we have long anticipated the return of full-blooded, Keynesian demand management. Whilst the immediate shock of coronavirus is disinflationary, a bigger economic role for the state promises a more inflationary future.

 

This begs the question of how effective this change will prove in the interim. It’s likely that the UK’s economic shock and awe approach has curtailed the risk of a financial crisis. It’s also probable that the scope and speed of the response lends itself to a meaningful economic recovery. What’s less clear, is the trajectory of any bounce. For us, a V-shaped recovery is improbable because of the inevitable lags and errors with which stimulus will be deployed. There’s also a risk that the virus proves more difficult to control and that economic lockdown is extended, which says nothing of the damage wrought to ‘animal spirits’ – the appetite of consumers to spend and businesses to invest.

 

The impact on sentiment was immediately visible in equity market weakness. Intramonth, the FTSE All Share fell by more than 27%. At the sector level, March’s worst performers were those most immediately affected by the government’s suspension of economic activity. Retailers, restaurant and pub operators, airlines and civil aerospace businesses all declined sharply. The portfolio is zero-weighted to these sectors and this gave a fillip to relative Fund returns.

 

However, the Fund did not go unscathed. We are overweight UK housebuilders on grounds of the structural undersupply of newbuild housing and our conviction that the return of fiscal activism promises higher volumes and rising shareholder returns. Clearly, with restrictions on movement in effect, building and selling houses is temporarily impossible. Coupled with the uncertain length of any restrictions on activity, housebuilders took the rational decision to cancel, or defer dividends in the interests of preserving cash. Amidst March’s panic, holdings like Persimmon (-32.5%) and Taylor Wimpey (-41.9%) went from being some of the FTSE’s best-performing companies, to suffering heavy year-to-date share price losses.

 

This seems unwarranted. Typically, these are net cash businesses and balance sheets look sufficiently robust to weather a temporary shutdown. Low fixed costs and a common working capital discipline mean that liquidity should not be an immediate concern. Foregoing dividends is disappointing, but it does guard against permanent capital loss in ensuring the continued health of these companies. Assuming normalisation, these remain high-return, cash-generative businesses, with attractive shareholder returns policies.

 

As the example of housebuilders suggests, dividend security was one of March’s prominent issues. By our estimate, 98 (16%) FTSE All Share companies cancelled or deferred dividends in response to the economic shock of Covid-19. The cancellations were concentrated amongst builders, industrials, travel and leisure companies, financials and retailers.

 

Stylistically, dividend cancellations seemed skewed to cheaply rated, or value-style companies. But this is less a consequence of any innate vulnerability and much more to do with the fact that mature, or cyclical value stocks are more likely to pay dividends. We hasten to add that quality was represented amongst the list of dividend-cutters (Rentokil, Rightmove etc). Moreover, growth companies are unlikely to remain immune, in that accretive share buybacks, the growth investors preferred method of return, are equally discretionary and therefore vulnerable.

 

For our part, there will be three categories of companies foregoing dividends. Firstly, the distressed – those businesses where balance sheet leverage demands that cash is preserved. These are the easy ones to spot, as pre-COVID numbers will flag this vulnerability. Secondly, the prudent – companies that have passed on dividends because of a lack of visibility. Housebuilders are a very good example. Finally, we have the mandated, or those companies required by government to defer dividends because they are in receipt of state aid. In the main, this will apply to those seeking assistance for furloughed workers.

 

As at March month end, Fund dividend deferrals were largely limited to housebuilders. This will have some impact on Fund disbursements. But the effect extends to our peers and the UK market more broadly. Moreover, it’s likely that market-wide dividend cancellations will grow. If we use the GFC as an imperfect proxy, we can see that 60% of European companies (STOXX 600) cut their dividends in 2008/09 and that dividends per share fell by 34%. The violence of Q2’s GDP shock suggests that total dividend cancellations are a long way short of where they’ll end up.

 

The job of dodging a dividend bullet is complicated by the fact that cancellations due to prudence follow discretionary management judgements while the mandated cancellations come from arbitrary decisions of politicians. Seen in this light, measures of dividend cover are only fitfully useful.

 

So what can we do mitigate any ill-effects? There are several strands to our approach. Firstly, we have taken a knife to those portfolio companies that look prone to falls in earnings and dividends. The SME-focused bank, Close Brothers, has been sold; and Smurfit Kappa, a highly cyclical paper and card business, has been reduced. Secondly, we have increased Fund exposure to sectors with a record of dividend maintenance under duress. The addition of supermarket WM Morrison is representative of this strategy. Thirdly, we are adding to those rare companies that offer some immunity to falling GDP, or financial market volatility. Our increased weighting to spread better IG Group, epitomises this approach.

 

In respect of March attribution, Fund winners consisted principally of defensive pharma – GlaxoSmithKline (-3.1%) and AstraZeneca (+6.2%) – and auto insurance Admiral (+5.6%), Direct Line (-3.6%), Sabre (+3.4%) and Hastings (+13.2%) holdings. Broadly, these are companies where earnings and dividends demonstrate a significant degree of resilience to fluctuations in the economic cycle. IG Group (+2.8%) also featured amongst the portfolio’s best performers and warrants mention by virtue of a strong Q3 statement that illustrates the link between market volatility and earnings growth.

 

Macro-Theme Allocation (as at 31.03.20):

Liontrust Macro Equity Income March 2020 Theme Allocation

Source: Liontrust

 

Macro-Theme Changes [1]:

 

Digital Economy

The economic consequences of Covid-19 require a more defensive strategic bias so a new position in WM Morrison was added (in the first days of April). Morrison’s stable earnings and cash flow underpin persistent dividend distributions, while its experience of the GFC demonstrates dividend maintenance under duress. These shares are modestly-priced while the company offers defensive earnings.

 

We also added Greggs to the portfolio. This is a quality growth business trading on a market-average multiple. It has £60m of cash on balance sheet and no debt which instils confidence in Gregg’s longevity beyond the present shutdown.

 

The holding in Smurfit Kappa was reduced as its rising e-commerce demand can’t offset the deeper impact of a Covid-19 recession. Its balance sheet leverage also poses a threat to dividend maintenance.

 

Rising Rates

While Close Brothers is a prudent steward of its front book, this is not enough to cushion rising back book defaults, so we closed out the investment. Its SME focus amidst an economic shutdown, also leaves the business looking prone to rising impairments and a potential dividend cut.

Exposure to IG Group was increased in March. The link between revenues and market volatility makes the spread-better a beneficiary of present weakness in equities. Its recent update demonstrated this effect, revealing Q4’s revenue run rate to be more than twice that of Q3. In consequence, IG seems a comparative dividend haven.

 

The Fund has an income Target Benchmark of 110% the yield on the FTSE All-Share Index. The Fund’s most recent income distribution was announced on 31 January 2020. Its distributions over the 12 months to 31 January 2020 – expressed relative to the Fund’s price on 31 January 2020 – give a 12 month yield of 5.8%. The FTSE All-Share Index yield on the same basis was 4.5%.

 

Discrete years' performance** (%), to previous quarter-end:

 

 

Mar-20

Mar-19

Mar-18

Mar-17

Mar-16

Liontrust Macro Equity Income I Acc

-22.7

4.8

-1.6

14.3

-3.4

FTSE All Share

-18.5

6.4

1.2

22.0

-3.9

IA UK Equity Income

-20.6

3.6

0.3

15.1

-1.2

Quartile

3

2

3

3

3

 

*Source: Financial Express, as at 31.03.20, total return (net of fees and income reinvested), bid-to-bid, institutional class. Non fund-related return data sourced from Bloomberg

 

**Source: Financial Express, as at 31.03.20, total return (net of fees and income reinvested), bid-to-bid, primary class.

 

[1] The omission of a Macro-Theme expresses the absence of notable portfolio activity.

 

For a comprehensive list of common financial words and terms, see our glossary here.



Key Risks

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. Investment in Funds managed by the Macro Thematic team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The Fund’s expenses are charged to capital. This has the effect of increasing dividends while constraining capital appreciation. The performance of the Liontrust GF Macro Equity Income Fund may differ from the performance of the Liontrust Macro Equity Income Fund and is likely to be lower than its corresponding Master Fund due to additional fees and expenses.

Disclaimer

The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.

Wednesday, April 15, 2020, 10:01 AM