Summary

• The global equity market declined largely due to concerns over the spread of the Coronavirus. With the exception of oil sector positions in BP and Shell, the operations of the portfolio’s holdings have to date been relatively un-impacted. Anecdotal reports indicate that Chinese manufacturing has begun to improve from a low base. However Government efforts elsewhere to reduce the spread of the virus are set to reduce economic activity.
• The Global Equity Income model portfolio declined 7.9% over the month which was in-line with the global index.
• At, and following, the end of the month Global central banks indicated a willingness to support economies through short term turbulence that the Coronavirus may produce.

Efforts to contain the spread of the Coronavirus further lowered expectations for economic growth and sparked fear in financial markets. The Global Equity Income model portfolio declined 7.9% over the month. While this performance was in-line with the global market the team is somewhat disappointed with the result.

As we wrote last month the operations of most portfolio holdings are relatively well immunised from the effects of the virus. The speed of equity market decline was rapid and saw mega capitalisation stocks somewhat more severely impacted than smaller companies. This was likely due to withdrawals from passive funds which sell stocks regardless of underlying valuations and growth prospects. Two portfolio holdings that have seen their operations directly impacted are the oil companies Shell and BP. The WTI crude oil price fell from $52 to below $45, a level last seen in December 2018.

This was due to a reduction in oil usage both in China and more broadly from lower amounts of air travel. Shell and BP shares fell 17.5% and 14.5% respectively. During the month BP’s new CEO

outlined plans to further de-carbonise the company by 2050. Both firms continue to generate substantial cash flow which they are putting to work in lower polluting projects. With free cash flow yields now approaching 10% we envisage that as oil prices and end markets recover, so will the share prices of these companies. In addition, to stabilise oil prices OPEC is likely to agree on further production cuts when members meet in the first week of March.

Financial sector holdings, Allianz, Legal & General and Standard Life Aberdeen, also performed poorly. The sector tends to be much more exposed to market moves than other areas of the market and for this reason our holdings are relatively more modest than the global index, and we have considerably more modest exposure than high dividend global indices. Following calls with management the position in Allianz was exited. We were concerned that the reduction in investment yields available makes new business sales relatively unattractive to consumers. This is particularly the case in Germany where long dated Government bonds now offer guaranteed losses in nominal terms, that is even before accounting for the effects of inflation.

From a historical perspective, the world is overdue a nasty pandemic. At the moment this is not it. While there is a chance that this evolves to be that, the pathogenicity of Coronavirus is relatively mild so far.

Concerted efforts by governments to reduce the spread of the virus are however reducing economic growth. Equity markets typically see through temporary earnings impacts such as this relatively quickly so recognising that such sell offs present an entry opportunity is key. Are we at the trough of the sell off?

Historically for both Ebola and SARS virus we can observe in hindsight that the bottom picking of share prices occurred at peak negative news. Also historically when the World Health Organisation announces a pandemic, stock market reaction has tended to be large. Our belief was that the Chinese were underreporting numbers of cases and this has been borne out.  An important issue now is if other countries will successfully contain the small number of cases they have. We are monitoring some interesting companies with large current direct exposures to the virus. We remain unsure that we’re at peak negative sentiment.

To date we have been somewhat surprised by the relatively small share price moves of some of these companies, especially relative to those observed for some quality, mega capitalisation stocks whose operations have seen minimal impacts.

Market turmoil often produces opportunities for long term investors to pick up assets at much reduced prices. The portfolio continues to hold elevated levels of cash which the team is looking to deploy.

Around the end of the month central banks indicated their intention to support financial markets. This will most likely come in the form of further interest rate cuts and increases in quantitative easing.