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February 2020 Newsletter: Woodhill bucks the trend, rising 2%

Fund value at midday 28th February 2020 was 87.0247
Assets under management: £27.566m

Source: Morningstar

In February our fund was up just over 2% versus the UK stock market which was down almost 10%. So far this year we are up over 0.3% versus the market that is down around 13%. We were exposed to the market at the start of this month, when after an initial fall, our analysis indicated a bounce back of some sort was likely.

However, given our long-standing concern about the level of equity market valuation, as well as the truly overextended nature of equity markets in some parts of the world, especially the US, we were quick to re-hedge1 and fully protect the portfolio. As soon as equities were no longer oversold, and as soon as positive sentiment had re-established itself, our analysis lead us to the conclusion that the balance of risk and reward was no longer favourable. In addition to the market bouncing back in the early weeks of February, there were also a couple of other aspects of news flow and data that helped us to make the decision to re-hedge the portfolio. The first was that much of the coverage of the Coronavirus outbreak did, to us, seem both a little optimistic as well as seeming, at times, not quite right. In some ways our decision making around the current virus issues does illustrate how we work. We think differently to most investment managers. We try to assess the balance of risk and reward embedded into asset prices rather than trying to predict the future. We know that we cannot predict the future, and we believe that other investment managers cannot see the future either. This doesn’t stop most investment managers from building much of their decision-making processes on unreliable predictions of the future.

Sometimes they are right and sometimes they are wrong. The success or failure of their predictions is, from our perspective, something of a random walk. As the old saying goes ‘making predictions is difficult, especially when they concern the future’. By contrast we have resisted the temptation to try and become instant experts on the virus. Instead, our analysis has concentrated on what we believed the market was discounting. By the early weeks of February sentiment, which had been negative, had recovered, and stock markets themselves had also recovered. To us this implied a notable and unfavourable shift in the balance of risk and return. The potential problems related to the virus may have passed, or they may not have done, but, so many of the data series we analyse was telling us that the market believed that the problem was essentially over. To us this was somewhat concerning. If the risk had passed then the market had already discounted this news, however, if there were going to be further problems then the market would be vulnerable. This meant that without having to accurately predict future developments in the outbreak we were able to act sensibly and protect the portfolio. It is also worth mentioning that we have also been following monetary developments quite closely.

There does seem to have been a clear correlation between the US Central bank acting to put money into the system to calm down the repo market in the October of last year and the subsequent dramatic run up in US equities. The relevant monetary data is published weekly, and we have been watching it closely. In essence the liquidity provided by the US Central bank has started to lose momentum, and, to us, this meant that a powerful underpinning of the US stock market, and by association, markets around the world, including the UK, was falling away. This data, as well of all the other data series we analyse also helped us to make the decision to protect the portfolio. From where we are now there is, of course, the possibility of a bounce back in equities and more central bank action. We do however get the sense that much is changing in the world of investment. Ever since the 2008/9 financial crisis investors have become used to the idea that if a problem of any sort arises that Central banks will provide more liquidity so that it is always safe for investors to ‘buy the dip’. It is certainly possible, probable even, that in response to a virus-related economic slowdown that central banks will cut interest rates and act to increase liquidity. This may work, but, unlike  more normal economic slowdowns, it may not be that effective.

The decline in economic activity has an unusual cause and the solution to it is through medical action, not through monetary action. It is possible that this may be the moment when the perceived omnipotence of central banks starts to be broken. If this does turn out to be the case, then we could probably expect greater volatility and less certainty than investors have been used to. Investors would have to get used to the idea that they would now be investing without the benefit of the safety net that they have become used to. From our perspective this sort of environment would make our approach more and more relevant. Investors would no longer be confident in taking large amounts of risk, of always ‘buying the dip’. It would be a world in which being fully invested may be less of an obvious decision. This would be a world that suits us and our approach. We will, of course continue to follow developments closely and as always, we would like to thank-you for your continued support. We will continue to do all we can to produce low volatile and steady positive returns while taking as little risk as we can.

Fund manager: Paul Wood 3rd March 2020