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With much of the world in some form of lockdown or practicing strict social distancing, businesses around the world have been compelled to act to protect their workers and follow government guidelines to close or to restrict working. The short-term future for businesses is precarious and unknown, especially given the amount of uncertainty that surrounds how we come out of lockdown.
What is the way forward?
Conversations have changed in recent weeks and debate has turned from how we restrict movement and manage the virus spread, to how we emerge from lockdown. Experts and politicians have become aware of the huge cost of lockdown - not just economically - but on the general wellbeing of the population. Several academics and politicians across the globe have articulated the path to easing the lockdown as:
1. Lockdown until hospitalisation rates and fatalities start to decrease.
2. Increase the capacity of Intensive Care Units.
3. Increase the capacity of antigen tests.
4. Introduce mass antibody tests and possibly start issuing some sort of “immunity passport”.
It’s still very difficult to guess the timing of when these measures could be satisfied, as it’s determined by the progression of the disease and individual country progress on rolling out testing.
China does offer us some hope, after a strict lockdown period spanning several months, they’re now emerging, and life is returning to some sense of normality - we have seen the Honda factory in Wuhan is back at close to full production and McDonald’s Wuhan is allowing an eat-in service.
So, what does this all mean for investors?
With the promise of an emergence from lockdown in the not-too-distant future, I can begin to validate my strategy of not selling good businesses that are impacted by Covid-19 and moving into healthcare and consumer hoarding.
I haven’t changed my approach to investing, I am still looking at the balance sheet and liquidity positions of companies in the portfolio. I then adjust positions where necessary to reflect my level of conviction in their resilience. I have continued to add to businesses which I think are resilient to a three-to-six-month shutdown where valuations have fallen to particularly attractive levels.
Traditional classifications make no sense
Traditional ways of grouping stocks such as defensive and cyclical makes no sense in today’s investing landscape. Some defensive stocks like food producers are short-term beneficiaries, while others like Diageo have seen a good portion of their revenues disappear in lockdown.
Even within a single sector, the impact of the virus can be totally different - if we look at UK chain Restaurant Group which has closed all of its outlets and put Chiquito into administration. Meanwhile, Domino’s Pizza is desperately trying to recruit staff to meet surging demand.
In order to help me think about fund positioning during this period, I have devised a new method and grouped all fund holdings into the following seven categories:
1. Virus beneficiary or low impact + less economically sensitive. A company like Unilever is included here as I believe the case remains strong to hold the stock, whilst Diageo is not as we know that pubs will be closed for the duration of the shutdown.
2. Virus sensitive but not shutdown. Diageo is included here as are most industrial companies whose operations are still running. Demand will be impacted, and some are already seeing orders down by up to 25% as supply and demand chains are impacted. However, despite conditions, these aren’t “zero revenue” stocks during the lockdown.
3. Geared financial market exposure. Asset managers and platforms have seen their assets under management fall as a result of the sell-off, but still earn management fees. I have been adding to the Fidelity UK Select Fund’s exposure here, funded by reductions in the banks.
4. Banks and financials. I have reduced exposure here given the “privatisation” of economic losses into the banking sector through payment holidays etc, which is particularly an issue for short-term, unsecured lending such as credit cards.
5. Shutdown today: leisure-related, so less essential. This includes hotels, airlines and retailers like WH Smith and Burberry where a large proportion of revenues comes from travellers. These shares have fallen sharply. I reduced this group in January and February before the large falls but, with hindsight, I could have cut exposure further.
6. Shutdown today: construction-related, so more essential. This is the group of stocks that were impacted when we moved into lockdown in March. This group includes the construction-related companies and housebuilders - a group I had been adding to over the previous six months, as I increased the fund’s domestic exposure.
7. Oil-related. I have added a little exposure here but not too much. On a longer-term view I remain fairly sceptical of the industry’s prospects beyond a possible quick patching up of OPEC / Russia relations brokered by President Trump.
Recent performance drivers
In terms of how this has impacted recent performance, the low exposure to oil, and in particular a lack of exposure to large index constituent Royal Dutch Shell, has proved positive in light of the oil price collapse.
The fund’s meaningful exposure to category (1) holdings seen either as beneficiaries from the current crisis or where there will be a low impact also helped. Key contributors here included diabetes care leader Novo Nordisk, oncology specialist Roche and consumer good group, Unilever. A sizeable underweight in financials, in particular a lack of exposure to Lloyds, Barclays and life insurers also benefitted the fund.
On the negative side, the fund’s exposure to category (5) businesses - those considered non-essential shops and therefore had to close such as WH Smith and Meggitt (aerospace) proved costly. Also, the lack of exposure to utilities and household goods firms, combined with an overall underweight in pharmaceuticals, proved detrimental.
Overall, a high exposure to consumer stocks was offset by a general bias toward those with stronger balance sheets which proved more resilient than their peers. For instance, Ryanair is the only airline to own its planes and therefore is expected to be far more resilient than peers that lease or effectively have “mortgages” on their planes. Hence Ryanair is far less vulnerable to an extended shutdown and, despite being in the eye of the storm, stocks such as this fell much less than those with debt on their balance sheets like Meggitt and WH Smith.
More on Fidelity UK Select Fund
Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Overseas investments will be affected by movements in currency exchange rates. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.