Market commentary – August 2019

Unless otherwise stated, returns are MSCI price indices expressed in local currency terms. UK equity market performance is represented by the FTSE All-Share Index in GBP. 
Equity markets were modestly lower following an escalation in US-China trade tensions. Global stock markets fell 2.0% in US dollar terms, down 1.6% in sterling terms. All major regions were lower with emerging markets the worst performer. More defensive sectors, such as real estate, utilities and consumer staples outperformed, while energy was the largest faller.
The US led sovereign bond yields lower as the 10-year Treasury yield fell over 0.5% to just below 1.5%. There were positive returns across corporate bonds, despite a small widening in credit spreads, though emerging market debt was more mixed. The prices of oil and gold moved in opposite directions, with the latter rising over 7%. Poor sentiment meant that the Japanese yen was the best performing major currency, while emerging market currencies broadly weakened.
The suspension of Chinese imports of US agricultural products and the labelling of China as a currency manipulator by the US began a month of broadly negative trade headlines. This was bookended by China retaliating against earlier US tariffs and the immediate reaction by the US to raise tariff levels by 5%. The ratcheting up of the trade war left emerging market equities over 7% lower at one point and helped to send German bund yields to record negative levels.
In Italy, the League pulled the plug on its alliance with the Five Star Movement (M5S), leading to the resignation of Prime Minister Guiseppe Conte. This led to a spike wider in Italian sovereign spreads over German bunds, before a subsequent rally as the Democratic Party agreed to a new alliance with M5S. The UK faced the threat of a potential constitutional crisis as Prime Minister Boris Johnson looked to prorogue the British Parliament in his attempts to achieve Brexit by the end of October. The move was justified by the need to set out the legislative agenda of the new government and put greater pressure on the European Union to provide concessions at mid-October’s summit. The pound plunged back towards early 2017 lows.

Performance and activity

Over August the fund’s Net Asset Value (NAV) fell 2.9%, the share price fell 1.5%, and the Company’s Association of Investment Companies (AIC) Flexible Investment peer group returned -2.0% in share price terms (source: Morningstar). The FTSE World Total Return Index, which the Company aims to outperform over the long-term, returned -1.7%.  The Company’s NAV is up 3.6% for the year at end August 2019.
The best performing sector over the month was the hedge fund exposure.  Both Sagil Latin American Opportunities and BlackRock European Hedge produced good results in a difficult market both contributing 0.1% to performance.  The hedge fund sector was the only positive contribution during the month.
The public equity sector produced the largest losses over the month, detracting 2.0% to performance.  The largest detractor was Burford Capital Ltd (“Burford”).  Burford fell 53.5% in August.  The sharp fall in Burford’s share price was concentrated over a two-day period in which a short note was published by short seller Muddy Waters.  The report alleged that Burford misrepresented returns, had poor corporate governance and could potentially be insolvent.  We believe that Burford reports returns accurately and has sufficient capital.  Whilst we have been aware of Burford’s governance issues we did not believe that they were severe enough to prevent us holding a position in a company generating high returns, is the leader in an industry that has high barriers to entry and uncorrelated return streams.  We also believe that Burford have moved quickly to address governance concerns.
Private equity also detracted from returns, detracting 0.4%.  This was driven solely by the performance of Riverstone Energy Ltd.  Riverstone has suffered over the past year.  Whilst oil prices have fallen since the start of October 2018 the share price has materially underperformed.  The discount has widened to 30% and valuation multiples have contracted sharply as shale investors focus on free cash flow rather than growth.
Trading activity was low during the month.  We opened a small position in Oakley Capital Investments Ltd.  We reduced our exposure to both emerging market debt and financial debt during the period.

Outlook

Since falling sharply in May, world equity markets have recovered strongly.  Two key reasons are apparent. First, central banks have become more dovish, suggesting that financial conditions will remain favourable.  This has driven a sharp re-pricing of interest rates and increased the attractiveness of equities.  Second, recent comments from Trump and Xi suggest that they will meet at the G-20 Summit at the end of June which has spurred hopes for a trade war truce.

We believe that after the sharp rally in the first half of 2019 that returns will be muted in the second half.  The markets are pricing in significant action by world central banks leaving little room for markets to be surprised on the upside.  Whilst it is positive that Xi and Trump are meeting in person we are not convinced that we are past trade war volatility in the markets.  Last of all we also note that world economies have weakened in 2019 and this has been reflected in earnings estimates.

Glossary

Bund: A bund is a debt security issued by Germany’s federal government, and it is the German equivalent of a U.S. Treasury bond.

Sovereign spread: the difference between the yield on a country’s bond issue and the yield on a comparable bond issued by a benchmark country

Uncorrelated return: Correlation is a statistic that measures the degree to which two securities move in relation to each other. A correlation of 0 means that the returns of assets are completely uncorrelated.

Five Star Movement: a political party in Italy