Coronavirus – an update from Octopus AIM Inheritance Tax Service
From Octopus Investments
Richard Power, Head of Smaller Companies at Octopus, answers some common questions on the impact of coronavirus on the Octopus AIM IHT Service (1 Apr 2020). Below we reproduce his article, with the permission of Octopus Investments.
The most important point to make is that it is business as usual for us, and the management of the portfolios continues, albeit rather more remotely. We miss the face-to-face meetings that we usually have with the management teams, but they are all still giving us an hour of their time via a conference call, and all of the members of the investment team are able to dial in and ask questions. We also continue to have access to all of the analysts on these companies and of course the research they are producing.
We have diverse portfolios of 25-30 established and profitable companies, however, share prices of all companies quoted on the stock market are being impacted and have fallen in response to the COVID 19 crisis, which is a typical reaction to a shock in the market. The eye of the storm is yet to pass, but it will, and once we start to look past the worst-case scenario and restrictions start to be lifted, sentiment will shift rapidly and we expect share prices to recover quite quickly, just as they did in China.
Below are some of the questions the team has been receiving.
Are you making changes to the way you manage the portfolios?
No. We are continuing to run the portfolios in exactly the same way as we always have. The team running the AIM portfolios has been doing so for 15 years, so had the experience of running the product through the 2008 financial crisis, which gives us confidence in our approach. The portfolios have and will remain fully invested in order to qualify for Business Property Relief and we have confidence that share prices will recover in due course. We take a long-term view and expect the companies in the portfolio to be able to double revenues over the next five years.
What are you doing with more recently invested portfolios? Can I sit on cash?
We became increasingly concerned about the impact of the virus in mid-February. Our concern at that time was limited to China and the impact to the supply chain for UK companies. Events have moved faster than we could have imagined, but that initial concern did result in us holding back from investing the portfolios too quickly. We are of the view that share prices will experience a ‘V’ shaped recovery, meaning that we expect share prices to bounce quite quickly once we get a bit more visibility of the virus being contained. What is very difficult to predict is whether the market will be spooked further between now and then and test new short-term lows. For that reason, we have taken the prudent decision to purchase half holdings for new clients getting invested at this stage, with a view to completing the investment over the next few weeks. As a result, new investors that came into the product towards the end of February will now be about 50% invested. The investment team is monitoring this strategy on a daily basis.
What has been the recent performance of the portfolios?
The portfolios have been impacted in line with the wider stock market, with the median portfolio down 19% in March, which is line with the broader FTSE Small Cap and FTSE AIM Indices. The speed of the correction has meant that the market has not been too discerning this month on a stock-by-stock basis. As you know, the AIM portfolios are invested in a selection of companies which are profitable and have an appropriate capital structure. We therefore expect them to have more resilient qualities than the broader stock market. We would also expect the share prices of these companies to recover relatively efficiently once the stock market starts to look through the current crisis and we can enjoy a return to normality. The portfolios have no direct exposure to the Travel Sector, which has been particularly hard hit, and we have very limited exposure to the Leisure and Retail Sectors. There is also no exposure to Property, Oil & Gas, Mining or the Banks.
It is also important to highlight that nearly all of the companies across the portfolios are continuing to operate, and remain confident of getting through the current situation, and indeed many still expect to grow profits this year in line with analysts’ original forecasts. The reason for this is the high exposure in the portfolios to companies providing business services or supplying intangible products (such as financial services or software) which often have the additional benefit of high levels of recurring revenue. For those companies that have been more affected by the lockdown, the Government’s stimulus plan has been extremely well received and will provide meaningful support over the next few months. The rates holidays and the ability to retain loyal staff through the worst of the crisis will be critical to companies getting back up to full speed as fast as possible later in the year.
What are portfolio companies telling you?
March is a busy reporting period, and a number of our Octopus AIM Inheritance Tax Service holdings have announced figures or released statements in the last few weeks. In addition, almost all of the portfolio companies have released a statement in relation to COVID 19. We are of course talking to all of our companies, and we have been impressed with the way management teams have been communicating. It is particularly admirable in view of the fast-changing situation and the unknown of how long the current lockdown will continue for.
A few further observations
- Liquidity is tighter than usual and it is difficult to buy shares in companies at current levels.
- Institutional investors have not suffered redemptions, so there’s limited selling pressure.
- We have seen a spike in Director share purchases – certainly a positive.
- Dividends are being cut or deferred. Companies are conserving cash, even those with very strong balance sheets.
- Markets remain extremely volatile, and 5% moves in the FTSE AllShare have been a daily occurrence. We will continue to buy selectively on the red days, with our sights set on the underlying value of the business on a 12-month view.
The more management teams that we speak to, the more it cements our belief in the longer-term opportunity for the companies in the portfolio. We are aware that the recent market moves will be causing concern amongst some of the investor base, and we are always available to talk to clients who have further questions or who need reassurance around our management strategy.
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