Jonathan Brown and Robin West have used the coronavirus sell-off to pick up cheap and unloved shares as they warn of slow route to economic recovery.
The board of IPU, a £140m trust, recently slashed its target dividend from 4% to 2% next year as half of the companies in the portfolio suspended and cut their dividends as coronavirus halted trading and reduced revenues in many businesses to zero.
Fund managers Jonathan Brown and Robin West believe the dire economic conditions will continue for some time and are not banking on a V-shaped recovery.
Brown said there had been a ‘dash to trash’ and there had been ‘a very strong rally in low quality cyclical stocks’ as investors believe a V-shape recovery is coming.
‘We do not think we are going to get a V-shape recovery,’ he said. ‘There is some pent up demand...but we feel that there will be a pick-up in unemployment and the furlough scheme is masking the true level of job losses.’
He added that unemployment ‘could be quite sticky’ and this will have a secondary impact on businesses that will suffer reduced demand.
Brown, who also runs the £571m open-ended Invesco UK Smaller Companies fund, said the plan was to focus on company fundamentals to ensure the businesses they invest in can grow through a difficult trading environment.
The managers used the March sell-off to add new names they thought fit the bill. One of these is low-cost gym chain The Gym Group, which West said was ‘genuinely disruptive and a market leader in its space’.
However, before the crisis it had been expensive and stood on a higher valuation than they were prepared to pay.
‘When we saw the market correction, The Gym Group fell over 76% and at that stage we felt it was a high quality business, and the valuation at that level was discounting in a huge amount of negativity regarding the recovery from lockdown,’ said West.
He added that Gym Group was well placed to deal with social distancing rules due to its technology enabling it to monitor and control the number of users.
The duo also added Mitchells & Butler to the portfolio despite pubs and restaurants being hardest hit by lockdown restrictions. The shares plummeted 78% during the sell-off and were ‘trading 20-25% of underlying asset value’.
‘Clearly there are issues with lockdown but furlough has been helpful in managing the cost base as well as assistance from landlords, and the government deferring tax payments,’ he said.
He said that looking at the group on a ‘two to three-year view’ then people ‘will go back to the pub and to socialising’.
‘Quite when people will feel confident and when the business will return to historic levels of profitability I don’t know, but I feel it will come through as we recover from the pandemic,’ said West.
The fund remains invested in companies that fall into four categories:
- those with the capacity for self-help;
- those that can ‘roll out and roll up’, meaning they can either expand the business organicaly or can consolidate by buying up competitors;
- ones with structural growth opportunities;
- and cash compounders that are high quality and generate a good return on capital.
The trust and fund are currently overweight industrials, healthcare and technology, which Brown said means they are ‘well positioned for the next two to three years’.
‘I don’t see it as the easiest time but I think through stock selection there is money to be made from the UK smaller companies market,’ he said.
Brown said the government had done a lot to save small businesses and ‘the carnage we would have seen without [the furlough scheme] would have been extraordinary’.
However, he said companies will have to repay any government loans before resuming dividend payments.
West confirmed that despite the cut to the dividend earlier this year, the trust has ‘significant reserves’ that means it can pay ‘decades worth’ of dividends.
The trust beat its Numis Smaller Companies benchmark in its last financial year, delivering a net asset value (NAV) total return of 30.4% in the 12 months to 31 January, versus a 13.7% increase in the index. The latest five-year figures up to 26 June are more subdued, reflecting the impact of the coronavirus crisis, with a total shareholder return of just 24%, although that is ahead of the 19% sector average.