Fund manager April commentary – Lowland Investment Company

Following a very difficult period for equities in March as varying degrees of ‘lockdown’ were imposed globally, April showed encouraging signs of recovery. The FTSE All-Share rose 4.9%[1]. Small and medium sized companies outperformed; the FTSE 250 index of medium sized companies rose 9.2%[2] and the FTSE Small Cap index (excluding investment trusts) rose 9.5% (all measured on a total return basis)[3]. The focus of the market shifted from the lockdown to the phased re-opening of economies across different countries as new daily cases in most countries showed signs of peaking. There were also a number of capital raises that were generally well received by the market in sectors that are among the most impacted such as leisure companies.

The largest contributors to performance during the month included companies positively exposed to UK construction and infrastructure spend, as housebuilders held such as Bellway announced plans to begin construction work again in a phased manner. It also became clear that the government intended to continue with its existing infrastructure investment plan including HS2. This meant some of the best performers during the month included contractor Balfour Beatty, Hill & Smith (which manufactures crash barriers for roads), and building materials company Epwin.

The largest individual detractor (that was actively held rather than an underweight versus the benchmark) was insurer Hiscox, which writes a significant amount of small and medium sized business insurance in the UK and US. This includes business interruption and event cancellation insurance, where there is currently a significant amount of uncertainty around the level of claims in both areas. While Hiscox has reinsurance cover in place to cap an upper limit on claims, in the short term there is likely to be further intense debate around the wording of policies and whether such an unprecedented event should be covered by insurance.

The largest individual trade during the month was reducing the position in Royal Dutch Shell. This was reduced both before and after the dividend cut. The reason for the reduction in the position is that in our view at the newly rebased dividend level there are better total return opportunities elsewhere in the UK market. Other notable changes during the month included adding to the existing position in Anglo American, which is well diversified by commodities with a strong balance sheet, and adding a new position in specialist consultant Alpha Financial Markets Consulting.

The outlook for dividends continues to be difficult. Towards the end of April, Royal Dutch Shell reduced its dividend by two thirds. While this was logical in that the dividend is no longer covered by cash generation at the current oil price, the dividend cut came earlier than the market was anticipating. This added to a long list of companies in the UK which have already cancelled or suspended dividends across a broad range of industries. While there are some mitigating actions we can take, in our view it would be wrong from a total return perspective to materially shift the portfolio towards those sectors that are continuing to pay dividends. A number of the dividends that have been suspended are in our view genuine deferrals rather than cancellations. Therefore while the short term outlook for dividends will be difficult, there could be a ‘catch up’ period (perhaps later in this calendar year or in 2021). Following this catch up period some companies may choose to re-set their dividend payout ratios to lower levels than they were prior to Covid-19, therefore we do not expect dividends to return quickly to 2019 levels.

Glossary

Dividend: A payment made by a company to its shareholders. The amount is variable, and is paid as a portion of the company’s profits.

[1] Datastream, 30/04/2020

[2] Datastream, 30/04/2020

[3] Datastream, 30/04/2020