Gresham House's Gulston: Differentiating the durable from the doubtful
At the height of lockdown earlier this year, investors were apprehensive about deploying capital into the market. This sentiment has sharply reversed course, with investors now increasingly concerned about missing out on the continuing rally.
However, the current market rebound should be tempered with a level of cautiousness and uncertainty. The global pandemic is still far from over, with many parts of the world experiencing an uptick in cases and renewed restrictions. The outlook remains incredibly challenging and the businesses impacted moving forward may vastly differ from those initially affected.
We have systematically stuck to our process throughout the period, identifying quality, resilient businesses able to calmly navigate through the ongoing uncertainty, and maintaining our disciplined risk mitigation processes. By focusing on companies operating in structurally attractive or niche markets, characterised by financially robust business models and net cash positions, or low financial gearing - investors can construct a portfolio resilient in the face of further potential pandemic pains - without breaking the bank.
Differentiate durability
A detailed understanding of how different companies perform in times of stress is an essential component of managing and adjusting your portfolio. When Covid-19 hit, we initially and swiftly undertook a comprehensive review of our investments; throughout the crisis, we continued to closely monitor these investments given the dynamic and fast-moving environment for UK businesses.
Are pandemic changes in property markets temporary or permanent?
Businesses operating in niche markets, such as Strix, the global leader in kettle controls, and specialist UK motor insurance provider Sabre Insurance, traded durably through the pandemic. This corresponds to a large number of our portfolio companies, where earnings streams and dividend payments were largely unaffected. Healthcare-related companies, such as EMIS Group, which has a strong market position in providing mission-critical software to GP practices in the UK, also fared particularly well.
Meanwhile, there was a cohort of companies suffering a short-term hit from the pandemic but which continued to display strong long-term fundamentals. While some of these businesses decided to pause income distribution, in some cases, this did not represent a structural issue, but rather an exercise in prudence. These companies, largely in sectors with attractive long-term market drivers, have demonstrated signs of recovery and a consequent resumption of dividends. For example, UK residential real estate business, Belvoir Group, through their lettings focus and franchised operating model, navigated the crisis well and exited lockdown strongly despite the short-term closure of the UK housing market. Belvoir recently reinstated their dividend policy with an interim dividend as well as announcing an additional dividend as partial compensation for the suspension.
Schroders' Kirrage: Is value investing really dead?
Finally, there was a small group of companies with a less visible path to recovery. These included companies reliant on higher ticket consumer spending, such as Norcros and Epwin, or companies with disrupted fundamental drivers. We swiftly exited these investments, which have yet to reinstate dividends. As uncertainty still clouds the horizon, it is necessary to differentiate the durable from the doubtful.
Identify outperformers
At the same time, there has never been a better time to unearth undervalued gems in the UK market. With the UK out of favour, the pandemic has deepened the discount on offer for UK micro and small caps, which were already trading at vastly cheaper valuations relative to larger cap UK stocks and international earners.
Specialist insurance business Randall & Quilter is one such appealing opportunity. Despite its c. £350m market cap, the company is relatively unknown due to its domain-specific, technical nature - it is a specialist insurance business operating in the legacy insurance space and has a growing programme management business.
The business is a relatively uncorrelated asset and plays into structural tailwinds, such as regulatory change driving corporates with non-core liability books to optimise capital structures, which has been reinforced by the onset of the global pandemic. With many more liability books expected to come to market and a limited competitor group, Randall & Quilter is well positioned to take advantage of the market dynamics.
The other strand of the business is programme management, effectively acting as the fronting company between a reinsurer and an MGA. This division has been growing strongly as the quantum of fronted policies has increased significantly. This division benefits from an attractive margin profile; we believe this could be a material driver of profit growth as the business scales.
Brendan Gulston is co-manager of the LF Gresham House Multi Cap Income fund
More on Markets
Most read
