Investment Trusts

Stock picking to protect

Phil Webster, Fund Manager, explains why picking stocks that protect in times of market falls is as important as investing in companies to grow.
March 2020

Philip Webster

Director, Portfolio Manager, European Equities

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Risk Disclaimer

Past performance should not be seen as an indication of future performance.

The value of an investment is dependent on the supply and demand for the trust’s shares rather than its underlying assets. The value of the investment will not be the same as the value of the trust’s underlying assets.

Opinions expressed by individual authors do not necessarily represent those of BMO Global Asset Management and should not be considered to be a recommendation or solicitation to buy or sell any companies that may be mentioned.

Having delivered a solid return for 2019, in January 2020, the BMO UK High Income Trust posted an even more pleasing outcome. The UK market was down a notable amount in the first month of the year, but the portfolio lost much less.

Downside protection is key for capital preservation

Two immediate caveats here, first: fund managers are never really ‘pleased’ with negative performance, and second: the aim of this trust is to provide shareholders with an attractive return over the longer term, and as such, short time periods such as one month should not warrant discussion. However, in this case, the month merely serves to illustrate a characteristic of the trust that is important to the longer-term objective – that of downside protection.

Whilst we need to deliver performance when markets are rising, it is arguably more important that capital is protected when markets are falling. I’ve long felt if you pick the right stocks the upside will take care of itself, but the best sign of a quality portfolio is outperforming in weak markets.

Risk Disclaimer

Past performance should not be seen as an indication of future performance.

The value of an investment is dependent on the supply and demand for the trust’s shares rather than its underlying assets. The value of the investment will not be the same as the value of the trust’s underlying assets.

Opinions expressed by individual authors do not necessarily represent those of BMO Global Asset Management and should not be considered to be a recommendation or solicitation to buy or sell any companies that may be mentioned.

Assessing fundamentals, not short-term noise, can lead to superior stock picking

Another factor to throw into the mix is that market sentiment can often be fickle. When the economic backdrop or news headlines are positive, then it is easy for markets to take note of good fundamentals, such as better-than-expected earnings numbers, positive management guidance etc. However, if the backdrop and prevailing ’noise’ is negative, then the importance of these fundamentals often seems to fall away.

This can be illustrated by a holding in the trust, Ireland-based Cairn Homes. The housing company recently delivered numbers ahead of the guidance, but the market doesn’t seem to care. Sentiment appears to be being driven by the short-term political headlines.

 
Case study: Cairn Homes

Sinn Fein have a policy to deliver 100,000 social houses in Ireland. They are seeking to increase site allocation for social housing from 10% to 25% per site. There are a lot of hurdles to clear before this ever becomes policy, but in my discussions with the Cairn management team, an unintended consequence of this policy could be a reduction of homes being built for the first-time buyer. As a reminder, current rents are around 40% above the previous peak, and house prices 20% below, which tells you all you need to know about the limited supply and tightness in the housing market.

As history tells us, politicians don’t always implement the policies they promise on the campaign trail even if they do end up getting into power. It is important to be aware of any potential change to future government policy when weighing up the fortunes of a construction company such as Cairn, but we believe a full analysis of the actual fundamentals is the best way to determine the investment case for a particular stock.

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