March was a painful month for Alliance Trust shareholders. The Trust’s NAV fell sharply amid panic about the coronavirus (Covid-19) before rallying towards the end of the month as governments and central banks injected unprecedented amounts of stimulus into the global economy. Even so, the NAV returned -14.6% in the month, underperforming the MSCI All Country World Index (MSCI ACWI) which returned -10.9%. The Trust’s underperformance versus the benchmark was partly due to gearing, which amplified the decline in asset values.
The performance in the month of March was sharp enough to unwind the Trust’s gains versus the market since the start of the multi-manager investment strategy in April 2017. As at 31 March, the Trust’s NAV total return since 1 April 2017 was 0.6% against 5.5% for the MSCI ACWI, although this return reflects the impact of owning investments other than global equities prior to 30 June 2019, which had a drag on performance. Between 1 April 2017 and 31 March 2020, the performance of the equity portfolio before fees (a good approximation of the NAV total return after costs had these legacy investments not been included) was 4.2%, reducing the level of underperformance to -1.3%. Whilst this is not the level of performance we expect to deliver in the long-term, we think it is understandable given the headwinds faced by active equity managers in the last few years and not something that alters our confidence in the ‘diversified and high conviction stock selection’ approach.
Over much of the last three years, the market has been driven by a narrow subset of the very largest quality growth stocks, many of them US technology companies, such as Facebook, Amazon, Apple, Netflix and Alphabet (formerly known as Google). Indeed, the stock market value of these five companies is now greater than the whole of the French and German stock markets combined. Meanwhile, the rest of the market has languished, opening up a huge performance gap, exemplified by the 53% difference in returns between global large cap growth stocks, which rose 29% between the start of April 2017 and the end of March 2020, and small cap value stocks, which fell 24% over the same period.
This extreme pattern of performance continued in March, with investors fleeing, as the market fell, to the assumed safety of the same stocks that led the market on the way up.
As a result, specialist growth funds were more insulated against the market drop. Indeed, the Trust’s quality-growth-style managers outperformed the market. Nevertheless, the Trust invests with a long-term view and aims to be generally style, sector and country neutral relative to the market because over the long run, the market’s leadership will vary and we don’t want to be locked into a segment which may go in and out of favour. Our managers are not constrained by sector or geography restrictions. They are able to access a wide opportunity set, and in many cases have found interesting opportunities in smaller and medium sized companies which the market has not yet appreciated, and this has been a drag on performance recently.
To illustrate the recent performance impact of size on a market capitalization weighted benchmark, such as the MSCI ACWI, we can compare the cumulative performance over the last 3 years of the MSCI ACWI Index of 5.5% to the -7.2% return for the equivalent Equal Weighted index. This disparity in returns between the two indices, that have the same stock composition but a different weighting methodology – one based on the market capitalization of the company, the other treating all stocks equally - illustrates the dominance of performance of large and mega cap companies. This is clearly a headwind for many active strategies that tend to select stocks from the full market opportunity set rather than restricting themselves to only considering a small number of large-mega-cap stocks (there are over 3,000 stocks in the MSCI ACWI index and 50% of its market cap comes from the largest 150 companies in it – that’s less than 5% of all the stocks in the index). The headwind for active managers can also be illustrated by the difference between the median stock return within the index, and the index return itself. If you were to take all the stocks in the index and rank them by return, you would expect that over the long term, the median stock return should be more or less aligned with the index return. However, over the last few years, there has been a growing disparity between the index return, and the median stock return as illustrated by the table below. The median stock return has been significantly lower than the index return, implying that the index’s performance is heavily skewed towards the largest stocks in the index.
We don’t believe the extent of the differences in performance between mega cap stocks, and the rest of the market can persist indefinitely. Indeed, the magnitude of the trend has now led to a truly extraordinary opportunity for patient, long-term investors to make significant gains from the economic dislocation caused by the Covid-19 crisis.
We can’t claim to be able to time shift from growth to value styles of investing, large to small caps, or between regions and sectors, and believe that anyone who does is likely to get caught out. However, after the fastest equity market decline of this magnitude in history, quickly followed by one of the largest 3-day gains, and more volatility expected to come, it is unlikely that every company in the world is perfectly priced relative to its long-term economic prospects, providing fertile ground for skilled stock pickers.
Due to the disruptive impact of Covid-19, we have kept in close contact with our managers to understand how they are dealing with lock-down procedures and market volatility. We are pleased to report that it is business as usual for all of them, despite having to work from home, and that all managers have been re-examining the investment theses of the companies they have selected for the Alliance Trust portfolio. As expected, this has led to some turnover in holdings, as managers exit the companies which suffered deterioration in fundamentals and purchase other higher quality names that are more attractively priced. Several managers have described this as the most exciting time to be an active stock picker, as suddenly many companies that they had closely followed but could not justify the price of purchase have now become very compelling long-term investment opportunities.
A position was established in late March in Booking Holdings, a US listed online travel agent and the global leading company for online accommodation reservations. The manager believes the company’s balance sheet remains sufficiently strong despite the weakening share price due to the collapse of global travel. Furthermore, the company has a strong market position which is expected to dominate the travel industry when business recovers. Siemens, a large conglomerate operating principally in industrial engineering, energy, healthcare and infrastructure, also has a strong balance sheet with positive cash generation. It has interesting long-term opportunities in pioneering energy-efficient technologies. The company was also purchased in late March, at a valuation close to its historical lows.
At the total portfolio level, we would describe our position as very optimistic about the long-term prospects, although still cautious about the near term. We continue to retain a balanced portfolio, ensuring that we maintain a well-diversified exposure to a range of styles, sectors and regions. Through careful management of the portfolio positioning, we ensure that stock selection is the key driver of risk and performance, and that our active risk is controlled. Our aim is to deliver superior returns than the benchmark in the long-term, without significantly higher risk and the predicted volatility of the portfolio was 16.7% at the end of March 2020, roughly in line with the benchmark’s volatility of 16.5%. Indeed, whilst the recent period was challenging, the performance remained within our expected ranges given our risk management approach.
Notwithstanding March’s performance setback, we think that the increased market volatility and dispersion of valuations have allowed our managers, each with its own unique investment style, to collectively build a portfolio that will deliver significant long-term value to investors in the Trust.
Stock market history shows that, over time, share prices have recovered from setbacks and have subsequently set new highs, as seen after the 2001-02 dotcom bust and the global financial crisis in 2007-09. Although further volatility can be expected in the short term, we are confident the Trust will achieve its objective of delivering higher capital gains than the market over the long term and rising income with similar volatility to the market.