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JPMorgan Claverhouse underperformed in run up to Brexit vote

JPMorgan Claverhouse has announced its annual results for the year ended 31st December 2016. During the period, the Trust provided an NAV total return of +11.3%. The Trust says that the return for its benchmark, the FTSE All-Share Index, was +16.7%, reflecting a good period for UK investors. The share price rose from 602.5p to 622.0p over the year to 31st December 2016, reflecting the rise in NAV. However, the discount of the share price to NAV widened during the year and the shareholder total return for the year was +7.2% (2015: +3.6%). Revenue for the year to 31st December 2016 declined marginally to 25.3p per share (2015: 25.9p). The Board has decided to increase the total dividend for the year from 21.5p to 23.0p, a rise of 7.0%, significantly above inflation and growing the total dividend for the 44th successive year. The chairman says that the dividend was more than covered by the revenue generated by the Company’s portfolio and this has allowed the board to make a modest transfer to the Trust’s revenue reserves (these stand at approximately 28.0p per share, after the payment of the recent dividend).

The managers (William Meadon and Sarah Emly) say that all of the underperformance came in the first half of the year, principally around the Brexit vote when share prices were particularly volatile and that the Company performed much better in the second half of the year but not sufficiently well to make up all the lost ground of the first six months. The most positive contributor to performance during 2016 was the overweight position in Fever-Tree, which was introduced to the portfolio in 2015. As the managers hoped, Fever-Tree continued to deliver strong growth and, as it sell its products in 55 countries, the managers say that Fever-Tree was a beneficiary from the fall in sterling during the year. The managers comment that, despite its success Fever-Tree has maintained a very lean cost base, only employing 50 people and that this ensures that most of the firm’s sales success is also reflected in its profit growth. Fever-Tree’s share price rose 90% during the year and the managers remain very positive on the company’s prospects for the coming year. Another positive contributor was long term holding, Rio Tinto, the lowest cost global iron ore producer. The mining sector recovered strongly during the course of 2016 and the Trust’s overweight position in Rio Tinto and other mining stocks was very beneficial for the portfolio. Another strong performer was an overweight position in Micro Focus, the acquisitive software company.

By contrast, the biggest detractor from performance during 2016 was the long term position in the television broadcaster ITV. The managers say that ITV has consistently delivered both strong underlying dividend growth and special dividends to its shareholders, but was a very poor share price performer in the aftermath of the Brexit vote. Its share price fell significantly as sentiment turned against such domestic, economically sensitive stocks, with particular concerns over the television advertising cycle were the UK to fall into recession as a result of the Brexit vote. The managers say that ITV’s operational performance proved to be resilient and the share price recovered towards the end of the year, but not enough to offset its earlier underperformance. The managers say that ITV remains one of their favoured stocks, particularly on valuation grounds. The deteriorating sentiment post Brexit towards retailers badly affected the share price of Dixons Carphone which was subsequently sold. The Trust’s holding in ARM was sold a few months before it was bid for by the Japanese technology company, Softbank but the managers say it was, nonetheless, a profitable investment.

New holdings introduced during the year included several mining stocks (Glencore, BHP Billiton). The managers say that, having performed very poorly for several years these stocks were completely unloved. In the managers’ view, these companies management had been profligate with shareholders’ money during the good times often embarking on shareholder value-destructive acquisitions and putting on new capacity at just the wrong time. Profitability suffered and balance sheets became strained. However, the managers say that, at the start of 2016 there were signs of some financial discipline returning to the sector. Dividends were cut, new excess capacity mothballed and new finance raised. This coincided with a pick up in commodity prices as world growth proved stronger than expected. Share prices responded accordingly with the shareholder returns in the sector doubling over the year. The managers say that although they did not call the exact bottom, the significant purchases they made in the sector ensured that they captured most of that performance.

Melrose was another new holding. The managers say that this company has an excellent track record of generating strong shareholder returns from buying, improving and selling-on previously underperforming businesses. The managers say that the latest acquisition of the US company, Nortek, looks another good addition and they have high hopes for the value that the Melrose management team can add for its shareholders. The new holding in Electrocomponents reflects a similar confidence that the new management team there will deliver, too.

Although the managers did not anticipate the result of the Brexit vote, it was viewed as an unpredictable event and portfolio risk was reduced ahead of the referendum. The managers say that they significantly reduced the gearing of the portfolio through the sale of several domestically orientated stocks, many of them mid caps stocks. These included Restaurant Group, Dixons Carphone, Berkeley Group, Savills and Shaftesbury. Post the referendum result they increased the gearing of the portfolio again but did it through the addition of many large stocks (Ashtead, Compass and HSBC) as they anticipated them being amongst the main beneficiaries of a weaker sterling. At the end of the year the portfolio therefore had a much higher exposure to large FTSE 100 stocks than it did at the start of the year.

In terms of outlook, the managers say that the events of 2016 have made forecasting the future even more difficult than usual. Taking the United Kingdom out of the EU will provide the toughest of challenges for the new May administration. Unwinding 40 years of EU legislation and negotiating new agreements with EU countries and around the world will be complex, exhausting and leave little time for other matters. However, as was seen in 2016, despite the uncertainly that comes with such a new era, the immediate consequences of Brexit (a cheap currency, lower interest rates and fiscal loosening) have been taken well by the UK stock market. The managers say that, similarly in the US, whilst President Trump is clearly a maverick who seems to thrive on confrontation and doing the unconventional, much of his mooted macro and micro economic policies are likely to be equity-friendly. Cutting red tape, reducing taxes and increasing expenditure on infrastructure may all stimulate both the US economy and stock market. Accelerating US growth may lead to a couple of small interest rate rises in America this year, but monetary policy generally shows no sign of tightening significantly in the near term. The managers say that this, too, is a good backdrop for equities, the effect of which may be felt globally. However, they point out that President Trump is also promising to increase tariffs and trade barriers and his confrontational style communicated via Twitter may not be fully appreciated in the more diplomatic halls of geo-politics. A wrong move by him here could be globally destabilising and outweigh the benefit of any equity-friendly policies at home. The managers say that such an unprecedented political and economic backdrop on both sides of the Atlantic leads them to tread carefully in the portfolio. Moreover, the looming elections in France, Germany and the Netherlands have the potential to cause more turmoil and unsettle investors further. The established global order feels under threat. However, such a tumultuous political backdrop will inevitably throw up investment opportunities. The managers say that, on a medium term view, there are many clouds forming on the investment horizon and, should they darken further, they will not hesitate to reduce gearing and move the portfolio onto a much more defensive footing. However, in the short term, radically stimulatory measures in both the UK and US coupled with continuing low interest rates may lead this nine year old bull market to have a further leg up. Consequently, they are currently running with a gearing level of around 12%.

JPMorgan Claverhouse underperformed in run up to Brexit vote : JCH

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