UK Sustainable Equity strategy - January 2022
2022 started with a style rotation from growth to value
- Our approach remains centred on owning high quality businesses
- Sustainably run companies that we own have continued to report good earnings
- We added a new position in industrial and electronic parts company Electrocomponents
2022 started with a sharp style rotation as ‘growth companies’ fell indiscriminately as a result of central banks changing their rhetoric on inflation from temporary to more entrenched. Expectations of interest rates rises resulted in 10-year Treasury yields rising from circa 0.5% at the low (August 2020) to 1.8% at the end of January 2022. This has led to investors purchasing ‘old economy’ companies in sectors that have historically provided inflation hedging such as oil and gas and banks and ‘long duration’ assets such as software and clean technology companies have been sold.
Inflation at its simplest level is generated by an imbalance of supply and demand. Covid has provided a myriad of micro economic events that have culminated in market distortions, leading to unpredictable supply of many goods and services. Demand on the other hand has bounced back dramatically in many areas, resulting in demand outstripping supply. It is logical to assume that over time, supply issues will ease. It is also possible that a slowing economy or inflation induced demand destruction will contribute to balanced supply and demand, thereby reducing inflationary pressures. It is also worth noting that US Treasuries are not forecast to rise above 2.5%. This remains at the low end of the range over the last 10 years, a time in which ‘growth’ stocks have performed well. Far from steepening (at the time of writing) the yield curve has flattened, perhaps telling us something opposite to what the ‘value’ rotation is making us believe. Rates are moving higher because central banks are increasing rate expectations in an attempt to control inflation rather than as a result of rampant economic growth.
When speaking to companies, we are certainly hearing of improving supply chain conditions. Wage inflation and second order effects may persist for longer and these effects will need to be monitored. However, the implications of a flattening yield curve and easing supply constraints may result in stock market participants moving away from focusing on cyclical, ‘value’ stocks to those that can grow their earnings over the long term.
When we look at businesses, we are interested in the ability of a company to give shareholders exposure to the power of compounding profitability and cash flows, where company management have proven competence and the balance sheet is sufficiently strong to support growth. The companies we own who have reported in January, Pets at Home, Experian, Marshalls, Gamma Communications and Dechra have all reported such characteristics but in some cases are up to 20% below the level they traded at on 31 December 2021. We remain alert to these sort of price moves and have been taking advantage. Many ‘growth’ stocks have compressed from a multiple perspective but their prospects continue to improve. In today’s market environment, that is easy to dismiss but we firmly believe that opportunities are compelling and can provide strong returns over the longer term, even if short-term returns are volatile.
The stock market dynamics of 2022, have had profound short-term impact on the valuation ascribed to growth stocks. Given that the FTSE 100 is more exposed to value stocks than the FTSE 250 or FTSE Small Cap, the disparity of performance can be seen when the UK Indices are compared. The FTSE All Share (-0.3%)1 , FTSE 100 (+1.1%)1 , FTSE 250 (ex-Investment Trusts, -6.4%1 ) and the FTSE Small Cap (ex-Investment Trusts, -3.4%1 ).
Portfolio positioning and performance
Our conviction to high quality sustainable growth companies who are aligned to our target markets (defined by our People, Planet, Progress thematic lens) means that we are naturally underweight companies considered to be value and cyclical sectors and overweight technology, healthcare and industrials. This has meant short-term performance has deviated from the FTSE All Share, which is heavily represented (30%+) by cyclical and value sectors.
During January the strategy added to its position in Auction Technology Group, GB Group and Blancco Technology group (Progress theme – Connecting People). The January stock market sell off was most acute in the technology sector this month and valuations have fallen considerably in these companies, yet the prospects for material earnings growth remain undiminished. This was reinforced by the January trading update of Blancco (digital erasure specialist preventing e-waste) which highlighted 20% revenue growth and significant upgrades to market estimates.
We started a new position in Electrocomponents (Progress theme – Connecting People). Electrocomponents is one of the world’s leading distributors of industrial and electronic parts with strong and improving responsible business practices. Their technology advantage, which they have been investing in over a numbers of years, could lead to accelerating growth as their digital advantage will be increasingly important post the pandemic and should enable them to take significant market share in a growing market. They also play a critical role in helping their customers be more sustainable through responsible sourcing, bringing the supply chain closer to customers and less carbon intensive delivery mechanisms.
The remaining position in Clinigen was sold following its takeover approach in December 2021 and some profits were taken in BP, SSE and Astrazeneca.
As in January, market direction seems likely to be shaped by Covid and inflation. Inflation data seems likely to continue increasing in the first half of the year from already high levels and central banks are likely to continue their hard line on it. However, striking the right balance between controlling inflation and not slowing the economy as it recovers will be hard to achieve, especially while governments withdraw their fiscal support.
There are of course reasons to be optimistic about equities in 2022. Economists are forecasting that global real GDP growth will remain above trend. In addition, global inventory levels remain low and the process of rebuilding them will be a further tailwind through 2022. Earnings forecasts are modestly set and valuations are in many instances trading at multi-year lows.
Our approach remains centred on owning good quality businesses that can reinvest and compound their returns over time. We continue to believe that understanding longer term structural trends and identifying responsible, reliable and ultimately sustainable companies, in a targeted, focused and active approach, remains the key to longer-term success.
No assurance can be given that the UK Sustainable Equity Strategy will be successful. Investors can lose some or all of their capital invested. The UK Sustainable Equity strategy is subject to risks including; Equity; Smaller companies risk; Liquidity risk; Investments in small and/or micro-capitalisation universe; Investments in specific countries or geographical zones.