James Carthew for Investment Week, 17 March 2022:
In the run up to the end of 2021 and into the early part of 2022, investors’ attention was focused on the growing threat of interest rate rises as a way of combating inflation.
That triggered a sharp rotation out of growth stocks. In the space of a few weeks, funds that had dominated performance tables for years lost a quarter or a third of their value. Premiums evaporated. Some of this was logical, much was not.
The Russian invasion of Ukraine has compounded the inflation problem. Oil, gas, wheat and a range of metals have soared in price – benefiting non-Russian producers, but straining valuations in countries and stocks dependent on these commodities. Markets have had another lurch down as a result.
Where I think these moves are counter-intuitive, is with trusts that focus on quality as well as growth.
Simplistically, the impact of interest rate rises on valuations of growth stocks comes from an increase in the discount rate used to value future cash flows. Money in the bank now and near-term cash flows – from companies paying out high levels of dividend, for example – are then worth more to investors than distant cashflows. Stocks that are loss-making and not expected to produce meaningful cashflows for many years should be particularly badly affected.
However, many of the funds investing in growth stocks also focus on high quality companies. One important factor in determining the quality of a stock is its ability to generate sustainable and growing levels of cash now.
Funds like BlackRock Throgmorton, Montanaro (UK and European Smaller Companies), and Smithson investment trust look for growing, high-quality businesses and then back them for the long term. Turnover on these funds is relatively low, as the managers of these funds think that trying to time markets is a dangerous game (as the Ukrainian invasion is teaching all of us).
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