1875 April 2020 Entity

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A NEW PUBLICATION FROM REDMAYNE BENTLEY

SPRING 2020

GLOBAL OUTLOOK With an oil crisis in play, not everything is doom and gloom

THE CHAINS THAT BIND As weaknesses of global supply chains have been highlighted, we explore solutions

CASHFLOW CONUNDRUMS

Impact on charities, trusts and pensions

THE EVOLUTION OF EM@IL How we are adapting to COVID-19

BEING PREPARED DOESN’T MEAN HAVING A CRYSTAL BALL

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CONTENTS

INTRODUCTION 2 Being prepared doesn’t mean having a crystal ball

MARKET INSIGHT

4

The chains that bind

CASHFLOW CONUNDRUMS

6

Impact on charities, trusts and pensions

GLOBAL OUTLOOK

8

Too much oil, too little demand

THE EVOLUTION OF EM@IL

9

How we are adapting to COVID-19

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RISK WARNING Investments and income arising from them can fall as well as rise in value.

Past performance and forecasts are not reliable indicators of future results and performance. There is an extra risk of losing money when shares are bought in some smaller companies. Redmayne Bentley has taken steps to ensure the accuracy of the information provided.

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“No, we did not prophesise a pand did, and continue to do, is seek to of investments that will impact t returns…”

demic. What we o find the risks their long term

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BEING PREPARED DOESN’T MEAN HAVING A CRYSTAL BALL JAMES ROWBURY | INVESTMENT RESEARCH COORDINATOR In the midst of a global crisis, we feel it pertinent to be writing to you with the first issue of our new flagship publication. We hope that some of the insights in here give you a sense of the comprehensive due diligence we undertake when considering our investment theses.

The observations we make are delivered with a healthy dose of cynicism and, sometimes, fiery debate. We are proud of the platform Redmayne Bentley gives all our investment professionals; from our placement students to our divisional heads. The forum is open, and we consider the array of opinion and findings. Without this, we cannot truly explore the art of the possible. Many may not have thought the current COVID-19 pandemic possible. Before you ask… we did not prophesise a pandemic. What we did, and continue to do, is seek to find the risks of investments that will impact their long-term returns.

The durability of a company’s supply chain, for example, is the difference between it operating and not. Pandemic, Trade War, or World War are all the same if a firm doesn’t have a check on where its goods come from. We look for resilience in a business’ supply, whether that means it seeks its goods from a diverse geography, or whether it negates this by manufacturing what it can inhouse.

Income remains a key appetite for many of our clients; it may pay your pension, supplement your earned income, or merely be a way of crystallising your returns for that rainy-day savings pot. Whatever your income objective, we need to be comfortable that the securities we invest your money in can continue to pay dividends. Debt obligations have weighed heavily on company profits for some time and, while the sun shines, they are easily masked by growing revenues and swelling pay-outs. We stress-test company metrics to look at the ‘what if?’. After all, shareholders can quickly fall to the bottom of the pile when revenues fall, and debts need paying.

In times like these, we try to remain alert and look ahead. As the great author C.S. Lewis once said “There are far, far better things ahead than any we leave behind”. While we must mitigate the impact the crisis is having on portfolios, we also look for the “better”. We ask ourselves what investment opportunities will emerge from this? If anything, the investments that have our conviction now present more attractive entry points. Beyond this, however, we are seeing trends emerge in the way people interact, consume goods and even work.

Our own firm has a large part of its workforce continuing their day-to-day operations from home. The transition felt straightforward, and frankly, not much has changed. We are conducting meetings through video conferencing, we continue to take telephone calls and collaborate through team management software. We hope this will spark a new wave of productivity and efficiencies when the viral clouds part, and we think this may create some exciting investment opportunities.

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MARKET INSIGHT THE CHAINS THAT BIND HARVEY EAST | INVESTMENT EXECUTIVE

“One solution is the argument for deglobalisation, that is, reshoring supply chains close to the domestic markets to ensure greater control...”

Globalisation and technological change have accelerated over the past two decades to the point where we are now more interconnected than we ever have been. Global supply chains are a product of this, but their potential weaknesses have been highlighted amid COVID-19. China, the ‘global factory of the world’, has a vast majority of countries dependent upon its industrial production (See fig.1) and thus when China announced mass shutdowns of factories in late January/early February, management boards went into panic mode and markets plummeted.

Since then COVID-19 has grown from an Asia-centric problem into a global crisis and getting goods to consumers efficiently has become a thorn in the side of businesses; supermarkets have had their shelves ransacked as consumers stock up on essentials, while fashion retailers are considering burning soon-to-be outdated stock. Delays at the borders due to stringent checks have resulted in trucking bottlenecks globally and automotive shipments to Europe from Asia have arrived with no production line running or anywhere to stock components.

Unlike the financial crisis of 2008, this crisis is a natural phenomenon. However, as always, there are lessons to be learned, and while no one could have accurately predicted this series of events, business supply chains should now adapt to

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become more resilient to such shocks in the future.

Typically, the focus of a business’ procurement function is linking all the component parts to make a finished good in the most efficient way possible, with success judged on its ability to cut costs. Just-in-time (JIT) manufacturing, introduced by Toyota in the 1970s, is a prime example and seeks to minimise costs by ensuring components only enter the production line at the exact moment they are required, therefore reducing the cost of storage. This model has been extremely popular and highly successful in many industries, however, the drive to cut costs at the expense of all else has led supply chains to become increasingly high risk in the event stock gets delayed in transit. This desire to minimise costs has resulted in businesses concentrating activities in single suppliers and countries, which subsequently increases their dependence on a smooth production and delivery.

Manufacturing is a complex system of supply chains; Toyota itself claims each car requires around 30,000 parts. Its JIT models focus on outsourcing and are non-integrated in nature, meaning it is difficult to monitor beyond its tier-one suppliers i.e. the ones a business directly contracts. This is crucial as a business is unable to detect risks present in suppliers that sit further down the chain and still play a vital role in the delivery of the final good or service. One solution is the

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HOW A PANDEMIC CAN INFECT SUPPLY CHAINS GLOBALLY Share of all imports of intermediate products coming from China

RUSSIA

USA

INDIA

10% 15% 20% 25% AUSTRALIA

30% 35% NONE

Source: OECD TiVA, Bloomberg Economics

argument for de-globalisation, that is, reshoring supply chains close to the domestic markets to ensure greater control. However, this untangles all of the good work globalisation has done in increasing prosperity and binding nations’ fortunes while also preventing businesses from shopping around, hampering any competitive advantages available. So what then? Companies may need to change their focus away from efficiency towards making the chain more resilient.

Supply chain mapping is something a small minority of companies invested in pre-pandemic, but could now become a core focus to drive resilience. Mapping offers businesses full transparency of their supply chains and can provide information on all layers within minutes. A stark contrast to this pandemic where a survey from Resilinc highlighted that many companies were having to manually identify which of their suppliers had a site in the specific locked-down regions of China. If full mapping visibility was available, businesses would have been able to act proactively, instead of reactively, by identifying those areas most at risk and securing constrained inventory at alternate sites ahead of competitors.

Even in the absence of a crisis, supply chain mapping will allow businesses to become more flexible in the face of shifts in demand, thus avoiding empty shelves or huge inventories.

Supply chain mapping doesn’t come cheap and will not be suitable for all

businesses. For those where mapping isn’t a viable option, a change in attitude away from costs towards resilience needs to be at the forefront of conversations to protect against any future disruptions.

As long-term investors, we don’t run straight for the exit during difficult periods but instead, look to find comfort in management who are taking the necessary steps. Many consider

Customer Demand

Value Chain to the Final Customer

Fig. 1

COVID-19 a one-off disaster, and maybe to some extent it is, but we argue more that it is an extreme event that highlights weaknesses that were already present. Economically, similarities can be drawn between COVID-19 and the US-China trade war, military conflicts, nuclear disasters and other global disruptions all of which have serious implications for opaque, and frankly, weak management of supply chains.

Following this crisis, businesses will have two options: they can do nothing and hope that not only will they not experience disruption to this extent again but also that their competitors do nothing. Alternatively, businesses can take action and revolutionise the management of their supply chains to ensure they are well prepared for any risks or opportunities that lay ahead.

We now look for those companies with a proactive approach to do the latter.

0

Car Manufacturer

TIER

1

Components Supplier

2 3

TIER

TIER Sensors Supplier

TIER Raw Materials Provider

Fig. 2

Source: Deloitte

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GLOBAL OUTLOOK TOO MUCH OIL, TOO LITTLE DEMAND ROBERTO FARRINGTON | RESEARCH ANALYST

“Consumers may be happy, but who are the main winners and losers from low energy and commodity pricing?”

There is an oil crisis in play, but it’s an oversupply and lack of demand that is causing it. The prices of oil and that of other energy commodities have collapsed since the start of the year, with Brent and the Bloomberg Spot Energy indices falling by over 50% since the start of 2020 to near 20-year lows.

Disagreements between Russia and the Organisation of Petroleum Exporting Countries (OPEC) around cuts to oil production to cope with reduced demand has sparked a full-scale price war between Saudi Arabia and Russia, which has further compounded the problem at hand. Consumers may be happy, but who are the main winners and losers from low energy and commodity pricing?

Energy ETF (which consists of the major oil players) fell by less than half that of the former. In the late 2000s the US shale oil revolution was reborn and promised to make America rival the likes of Saudi Arabia and Russia to become the world’s largest oil producer. This has largely played out, with the world’s largest oil consuming country declaring that they had become a net exporter of the commodity in November 2019.

While US shale oil output has remained 160

140

120

100

80

The obvious losers in the fall in oil prices are the miners and exploration companies, with US shale producers being hit especially hard given that the majority of producers need the price of oil to be around US$50 just to keep the lights on. The best indicator of this would be the performance of the Invesco S&P SmallCap Energy ETF (which is considered a pure-play on US shale producers) falling by 68% since the start of the year, while the MSCI World

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60

40

20

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31/05/1990

31/05/1993

31/05/1996

31/05/1999

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CRUDE OIL

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relatively constant, the dramatic price drop of the commodity has posed significant risk of bankruptcy of these companies. These fears have stressed the US high-yield (sometimes called junk) bond market, as just over 8% of the market has energy exposure. In April, investors have been conducting a mass sell-off of these bonds, leading to the iShares Broad USD High Yield Corporate Bond ETF (which tracks the US high yield bond market) to fall by

1/05/2002

31/05/2005

31/05/2008

31/05/2011

10%, causing yields to spike 6.8%.

However, not everything is doomand-gloom and cheaper oil does provide benefits to consumers of the commodity. Although many of the heaviest oil-consuming industries, such as manufacturing and the airlines, are seeing distress in their own right, many net importers of the commodity are beginning to harvest the benefits; such as China. Although China may have been the epicentre of the original

31/05/2014

31/05/2017

COVID-19 outbreak, it is believed that the worst is over for the country as it reports single digit increases to the virus death rate. Furthermore, Chinese equity markets have surprisingly been the most resilient to the outbreak, having fallen only 7% year-to-date, and with lockdown measures beginning to relax, it is likely that Chinese business will work as normal.

“...not everything is doom-and-gloom and the cheaper oil does provide benefits to the consumers of the commodity....�

BRENT ($/BBL) - PRICE

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CASHFLOW CONUNDRUMS ALISON HUGHES | INVESTMENT MANAGEMENT DEPARTMENT MANAGER

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As governments around the world have come to the rescue of businesses, equity markets have rallied strongly. It seems like the printers at the Royal Mint will be at full speed to guarantee livelihoods and avoid the economy falling even lower. On the face of it, the support to sustain the economy has been adequate and prompt.

However, the support for corporations does not minimise the potential extent of the looming recession and is not able to sooth the needs of those investing in the same way. Although those investing for capital gain could see the current market as the prime time to contribute to their investments, many clients who rely on regular income to sustain their quality of life or support those around them are not able to retain the same optimism.

There are fears that smaller charities, trusts and pension schemes may face significant challenges in enduring the upcoming environment.

WHAT IS THE IMPACT? The impact is likely to be felt for some considerable time, with certain sectors having to rethink their entire business models in order to survive. Many companies have already indicated their intention to cut or suspend dividends totally, as preserving cash is essential to their survival. When there is time to reflect, such reasons as excessive executive pay, high dividend yields

and over-borrowing may be blamed, and more emphasis will hopefully be placed on building capital buffers and resilience.

When the economy gets back to a form of normality those businesses which were quick to put employees on state support may be vulnerable to government intervention. The UK Banking regulator has already showed its teeth by instructing banks to suspend dividends and insist on less stringent requirements regarding borrowing.

Early indications of dividend freezes were cemented as the Prudential Regulation Authority instructed top banks to suspend plans for 2020, including any buyback plans. As the threat of recession looms, we expect many other companies to follow suit, especially in sectors such as mining, retail and tourism which have experienced heavily reported volatility.

The impact of this will be amplified by the working impacts entities are likely to experience. The Institute of Fundraising suggest that voluntary charity contributions are set to be cut by 48%, causing immediate cashflow tightening and creating a greater reliance on investment income. The Pensions Regulator has asked that Trustees of Defined Benefit Pension Schemes consider allowing extensions to deficit repayment plans as companies reevaluate their profitability in the coming periods which could see the investment reliance increase too.

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The consensus is that clients should review their investment objectives to ensure that these are consistent with the current environment and financial requirements. As always, we are happy to help you update your Investment Policy Statement where necessary and work with you to ensure your portfolio is aligned with the clear long-term objectives.

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2011 S&P 500

Sadly, portfolios structured predominantly for income have been hardest hit. With interest rates at alltime lows before the crisis, and bonds producing negative real returns, monies invested in assets perceived as ‘value plays’ such as oil, mining, property, and insurance have taken the brunt of the collapse. The only glimmers of hope have been the utility companies and pharmaceuticals. In contrast, technology and growth businesses with leaner structures have held up much better and will probably emerge stronger.

Going forward, the reality is that dividend income will fall. For investors who rely on this income, they will be forced to eat into capital to continue making these payments. To enable it to grow some may consider placing more emphasis on growth, as well as some dividend income to drive returns. This will allow investors to benefit from the changing trends likely to come out of this crisis, rather than being left with companies which have few prospects and a dwindling income.

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YOUR INCOME OBJECTIVES ARE KEY TO OUR PROCESS

UNDERSTANDING YOUR OBJECTIVES

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THE EVOLUTION OF EM@IL Given the current COVID-19 world we live in, now more than ever we are reliant on email as it has recently become the number one communication channel of businesses that are still able to operate. At the moment a staggering near-50% of the world’s population is ‘on email’, with that figure set to continue to grow over the next couple of years.

We have made great strides over the last month or so to collate email addresses and to promote and encourage increased usage of Client Web Access (CWA), for which an email address is a prerequisite.

Quite simply, the more email addresses we can obtain, the more it allows our business model to continue to adapt in an agile fashion and keep this ever-important communication channel open.

new publication 1875. We would like to also introduce our new monthly publication, Market Insight. It is published on two months in each quarter. The aim of Market Insight is to explore a current investment theme by looking at the UK and global backdrop, to provide insight as well as give ideas for gaining exposure.

Market Insight is available only by email and you can subscribe at: www.redmayne.co.uk/publications.

In times of uncertainty, communication is king.

For our full guidance on how we are adapting to COVID-19, please see: www.redmayne.co.uk/ covid19 If you are not yet signed up to CWA, please contact your usual Redmayne Bentley office.

We hope you continue to subscribe to and read our

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