March saw a remorseless sell-off in the first 2 weeks, followed by a sharp bounce as the market took comfort from the scale of economic support from governments and central banks. However, in the last week, markets have resumed the downward trend as economic data starts to show the damage caused by the current societal lockdowns and the news from the US continues to worsen. As the month progressed, we’ve seen many management teams withdraw previously issued guidance until there is more clarity on the length of the lockdown and how it will affect them. Unlike previous economic downturns, many companies face the prospect of either zero or very limited revenue, meaning normally cash generative businesses with moderate levels of debt will see a rapid escalation in their liabilities as they fund their fixed cost bases. Therefore, we expect to see a high level of fundraisings around the market, as companies seek to re-equitise their balance sheets.
Our worst performers in March were consumer stocks relying on customer footfall, like Rank Group and Ten Entertainment, and industrials exposed to global economic activity with relatively high levels of leverage, such as Elementis, Weir and RPS. These industrials all have strong business models and high levels of cash generation in a normal trading environment, but the higher leverage makes them more exposed if trading grinds to a halt over the coming months. However, in most cases, we would expect banks to relax debt covenants, as we’ve already seen at Elementis, and be accommodative through this difficult period. On an Enterprise value to sales multiple, these companies now look extremely cheap in anything resembling a normal economic environment in our view.
We have been adding to several holdings this month. We increased our Travis Perkins position as we would expect, given its exposure to the construction sector, for a quick rebound once the crisis is contained and the government pulls the fiscal lever to jump-start the economy. Also, we added to our holding in Aptitude, which has good structural growth dynamics as Finance departments need quicker access to better data and to cope with increasingly complex accounting regulations. Finally, we added to a number of our less correlated holdings like Augean and Equiniti, whose revenue should be less impacted by the current shut down.
The month end cash position was exceptionally high, reflecting cash receipts from an earlier takeover bid and some healthy inflows at the end of the month. These inflows coincided with the sharp rally in the market, which we didn’t entirely trust, so we only made selective purchases where we could still see relative value. Funds are now being deployed, but we would still expect to maintain higher than normal cash balances. This will allow us to support holdings that need to raise funds to get through the current conditions and be able to take advantage of the eventual return to normal trading, whilst preventing the Fund from being diluted at discounted valuations. Furthermore, the cash position will allow us to take advantage of ongoing volatility in the market. We believe that, whatever the short-term performance is from here, in the long-term this sell-off represents a great opportunity to accumulate quality assets for longer term capital appreciation.