During February, the relatively modest -0.5% fall in the FTSE All-Share masked steep declines in some areas of the market as the repercussions of the conflict in Ukraine was felt. In this uncertain backdrop, the best performing sectors were those either exposed to rising commodity price (energy, materials) or those that are perceived to be ‘safe havens’, such as utilities. The financials sector, on the other hand, performed poorly. Some financials, such as fund management companies are directly exposed via their fee structures to stock market levels. Therefore if there is a fall in the market, all else being equal this will lead to earnings downgrades. The current level of uncertainty is also likely to weigh on capital markets activity (such as companies listing on the stock market), therefore for companies exposed to this area such as Barclays, if this uncertainty persists it could result in lower earnings than expected. In this backdrop the Trust underperformed the benchmark, falling 4.4% relative to a 0.5% fall in the FTSE All-Share benchmark and a 2.4% fall in its AIC UK Equity Income peer group (all figures are on a total return basis).
Within the portfolio the largest individual detractor at the stock level was online retailer Studio Retail, which entered administration and was written down to zero. While the company had in recent months downgraded earnings expectations as a result of supply chain problems, the company was, in its latest estimates, expected to remain profitable in the current financial year. This outcome was therefore highly unexpected. Elsewhere in the portfolio stocks more broadly exposed to the consumer such as Halfords and Marks & Spencer were also among the weakest performers due to the expectation that the current rise in commodity prices will worsen the existing pressure on real disposable incomes.
During the month, the existing position in Reckitt Benckiser was added to. Recent results have shown an improved organic growth trajectory outside of products that have been directly impacted by Covid. The positions in Hiscox, Phoenix Group and HSBC were reduced for portfolio balance reasons.
It is very difficult to draw firm conclusions given the current backdrop. However, it is likely that inflation will be higher than expected and persist for longer than was expected a few months ago given the current rise in commodity prices. In this type of environment, it is crucial to be invested in companies with pricing power, where there is a greater likelihood of input cost pressures being passed on, albeit often with a time lag.
Bloomberg as at 28/02/2022