SORBUS VECTOR: Manager commentary January 2022

Jan 17, 2022

We are currently quite pessimistic about global equity markets but very positive about the returns we can generate.

At first reading this may seem completely incongruous. Let us explain.

Firstly, we have been long term equity bulls for many years. However, as regular readers will know we have become increasingly concerned about the speculation that has been growing over the past couple of years and which has become, for want of a better word, rampant.

This has been led by a new generation of novice investors, enticed by the lure of easy returns that many have made by speculating in the likes of Tesla, bitcoin and the so called meme stocks.

The huge amounts of stimulus money that has been thrown around by Governments worldwide has added even more fuel to the fire and created an enormous amount of new day traders, many of whom have taken up this new hobby through boredom and a bank account stuffed with this Government stimulus money.

We are increasingly convinced that this will end dismally, both for those investors and also for global equity market indices.  And what is more, it may end soon.

If we are right then how can VECTOR prosper in such an environment?

Well we believe that if such an outcome occurs, investors will return to the virtues that right now are considered old fashioned but we think still remain valid; virtues such as relatively dependable profits regardless of economic conditions, genuine free cashflow to pay decent dividends (another metric that investors these days seem to think are old fashioned) and very strong balance sheets with little debt.

This means businesses that provide goods or services that people consume or use on a regular basis and are not dependent on large discretionary purchases or business investment that may quickly disappear in a harsher economic climate. 

Businesses that have stood the test of time with proven business models developed over (in most cases) decades if not a century or more of trading.

And finally, and most importantly, they are currently available at very low prices compared to a) the rest of the stock market and b) by historical standards. 

We consider that the VECTOR fund has an outstanding portfolio of such businesses. We have been gradually selling some of our holdings where we believe prices reflect their intrinsic value or more and buying those businesses as described above.

Their share prices are depressed not because they have become poor businesses, but because they are currently out of favour as investors relentlessly chase growth. Growth in sales regardless of any profits attached to them. In many cases businesses which are not yet even profitable!

They have also been chasing them regardless of the price they are being asked to pay and ignoring the potential for disappointment and huge losses if such growth does not materialise.

When and if investors turn to the kind of companies we own, we consider that there is much room for their share prices to rise even in a prolonged bear market.

This is one of the main reasons we have recently been underperforming our benchmark MSCI UK IMI All Companies (which in effect is virtually equivalent to the FTSE All Share Index).

Believe us when we say that this is as painful for us as it is for our unit holders, given we have significant skin in the game with substantial amounts of our own money invested. 

However, despite this recent bout of underperformance our very strong longer term record shows that our methodology works regardless of the wider investment environment or themes or styles that may be in vogue at any particular time.

Finally, we recently added another stock to the fund,  Avon Protection (or Avon Rubber as it was known for many years).

Avon Protection designs and produces life critical personal protection solutions for the world’s militaries and first responders. It has a portfolio that includes Chemical, Biological, Radiological, Nuclear (“CBRN”), respiratory and head protection products and is a market leader in most of these categories.

The share price has fallen from over £46 in 2021 to around £11 when we purchased our holding. 

The primary reason behind this fall was an issue with one part of a US company they acquired a couple of years ago and which will impact profits for the next couple of years (when the contract can be fully wound down and costs taken out) and has resulted in a significant write off in net assets.

It also dents the reputation of management which hitherto had been very highly regarded.

From being rated as a growth stock the market has now rerated it as a business with problems and priced it accordingly.

In one way the share price fall is a prime example of the folly of paying high multiples of annual profits for future growth. On the plus side it gives us an opportunity to invest at what we feel to be an attractive price.

Attractive because we believe that these problems are temporary and the core protective mask business is of a high quality with strong margins, good returns on capital and excellent cash generation. 

These are the characteristics we look for and which we believe in this case are worth much more than the current market price.