SORBUS VECTOR: Manager commentary March 2022

Mar 8, 2022

We have warned previously that the market conditions (and stock valuations) that investors enjoyed during 2021 were unsustainable.

The Ukrainian crisis is a terrible human tragedy for those caught up in it. Whatever the political repercussions it is inevitable that the huge spike in raw material and energy prices will accelerate inflation. It has also increased the likelihood of recession, given that nearly all recessions are preceded by a significant run up in the price of oil.

Having said that, we try to avoid spending too much time trying to decipher the impossible, i.e. exactly where interest rates and the economy are heading in the short term.

Instead we devote our energy more productively to trying to find quality companies that fit our investment criteria and, most importantly, that are available at prices that limit the possibility of permanent loss of capital for our investors.

Those investors of course include ourselves, given that we have significant skin in the game through our own personal investment in the fund.

The benchmark we are measured against, the MSCI UK IMI All Companies Index, (the MSCI equivalent to the FTSE All Share Index), has proved very difficult to match over the past six months for the vast majority of active funds, including such industry luminaries as Nick Train, Terry Smith et al.

It has also outperformed the US markets so far this year (down 2.6% in capital terms).

Indeed both the US tech laden Nasdaq and the US smaller company index, the Russell 2000, are down (at the time of writing on 9th March) by 17.5% from their peaks reached in November and the broader S&P 500 is negative to the tune of almost 11% thus far this year. 

This gives a flavour of the damage inflicted upon investors in the US recently, albeit after some very strong performances since the start of the pandemic.

Returning to the UK, the FTSE Mid cap and Small cap company indices are down by 15.0% and 17.7% respectively since their highs reached in September. 

Our VECTOR fund has not been immune to all this, falling by 15.5% over the last six months. However, as our factsheet clearly shows, we remain significantly ahead of the benchmark both on a 3 and 5 year view and also ranked 6th and 7th out of over 230 competitors again for both periods.

Here in the UK it is passive funds (i.e. trackers) that have captured the returns from the FTSE100 and been the real very recent winners (around 80% of the FTSE All Share is represented by the FTSE100) whilst as already mentioned, nearly all actively managed UK funds have struggled to achieve anywhere near these returns.

There are two reasons for this:

Firstly, VECTOR and many other active managers have larger exposures to the small and mid cap growth companies than the FTSE All Share.
Secondly, the index’s significant weighting to big oil stocks (BP and Shell), raw material producers (global mining stocks) and financials including insurance and bank stocks. Indeed just the two oil majors, Shell and BP, together represent 11% of the total index. All these stocks have enjoyed tremendous recent gains.

Given these constituents, the FTSE100 (and by extension the FTSE All Share) has been called a dinosaur index by some market commentators recently, made up of cyclical companies with few prospects of long term growth in real terms compared with the kind of new technology businesses that the US has.

We disagree with such a bearish analysis, as it contains many companies outside of those above that are decidedly not cyclical and are instead true world beaters. Indeed we own several of them.

However, with oil and bank stocks it is true, as the old expression goes, that a stopped clock is right at least twice a day. We have never purchased an oil stock for VECTOR as they do not meet our investment criteria, and are unlikely to ever do so.

It is not our remit or even desire to criticise other investment funds that have done well recently by owning such businesses. Everyone has their own approach. However, we would say that given both Shell and BP have had to rebase (that is permanently reduce) their longstanding dividends by half or more in 2020 one has to question the durability of the dividends and the earnings that support them.

Even after the recent run up in oil prices, the fact remains that Shell’s share price is around the same as it was at the start of this century. Further, BP’s share price stood at over 600p in 2000 whilst today it stands at only 370p. This indicates to us the capital misallocation and poor returns on investors capital that such companies and their management have been responsible for over that period.

With such poor financial returns, allied to the huge cost involved in transforming such businesses into renewable energy companies fit for the next century, we do not believe they represent an opportunity despite the current high oil price.
Finally we echo what we said in our last letter.

We remain confident that we have the right companies for the harsher economic environment that is undoubtedly coming; we own companies that have pricing power and can therefore ultimately pass on the costs of inflation. Companies that produce and sell everyday goods or services that people or businesses want to purchase and that are not huge discretionary item decisions. Companies that have enduring earnings and dividends and strong balance sheets that will not disappear overnight. 

We truly believe that these are the stocks that other investors will start to value much more highly and want to own in the coming months.