April 4, 2010

Flashback to June 2009: After a slight falter, markets seem to be continuing their inexorable rise upwards. However, the undeniably optimistic trend in asset prices seems opposed to the flow of news. Commentators are comparing those guiding the economy with tightrope artists teetering over a vertiginous drop [1], everyone is discussing the precarious timing of the withdrawal of fiscal and monetary stimulus that is propping up the economy [2].

Nothing much has changed in the last 9 months; these issues are just as relevant today as they were in June 2009. One could argue that the disconnect between share prices and news was even more marked in 2009: in the three months to the middle of June, global markets were up over 20% in pounds sterling (by comparison, in the last 3 months, markets are only up around 7%).

There is an understandable temptation to move out of the markets and hide one’s wealth under the proverbial mattress (with interest rates being what they are, the mattress may not necessarily be proverbial). But we are reminded that an investment in equities is a long term asset allocation – a core exposure should be maintained regardless of short term market fluctuations.

The lack of return on cash, and the difficulty in timing a move away from equities (the MSCI World index is up a further 35% since June 2009) leads to the need for a risk adverse exposure to equities.

We are conscious that the elixir of “100% of the equity upside with none of the downside” is not realistic. With a focus on value rather than growth, we are likely to lag a market that continues to rise beyond its fundamental value (as we believe the current market has). In the 6 months to March 2010, our Strategic Value Fund was up 8% compared to a market up approximately 12%. Given the nature of the rally (the recovery of leveraged assets priced to go bust), we are happy with this performance.

Most investors can make money in rising markets. At Kennox we aim to deliver outperformance over the cycle – to outperform in the long term one must preserve through more difficult times the gains made in the good times. We have positioned the Strategic Value Fund portfolio to protect capital should markets correct:

  • Our biggest exposures are to defensive sectors (telecoms and healthcare)
  • A clear focus on value
    Approximately 50% of the Strategic Value Fund portfolio stocks are trading close to tangible book value/replacement cost – a solid valuation underpinning
    The majority of our holdings pay healthy dividends
  • Very few of our companies have debt on the balance sheet (only one has more than 25% of its market value in debt). If times do get tough, un-leveraged companies are best placed to survive and should emerge stronger
  • We currently have 17.7% of the fund in cash – this is close to our top level of 20%
    This level of cash gives us good spending power should the markets correct and allows us to act quickly as and when genuine value opportunities arise

We feel better placed than most to talk about protecting capital – our portfolio made money in 2008 (+6%), compared to a market that was down 21% (in pounds sterling). We don’t promise absolute returns (we are a long-only equity investor after all), but we do guarantee that our focus will remain on capital preservation.
1. Authers J. (2009) ‘Long View: Daredevil balancing act for the world economy’, The Financial Times, 26 June [online]. Available at: http://www.ft.com/cms/s/0/1933cc86-6278-11de-b1c9-00144feabdc0.html 2 Wolf M. (2009) ‘Rising government bond rates prove policy works’, The Financial Times, 

2. June [online]. Available at: http://www.ft.com/cms/s/0/0e151612-4fa8-11de-a692-00144feabdc0.html

Authorised and regulated by the Financial Conduct Authority (FRN: 475658)
The Company is based in Scotland, UK with the above registered address (Registered Number: SC302037).

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