Covid-19: A fund manager’s diary
Before the momentous events of Q1 and Q2, few investors were prepared for a pandemic that derailed global growth. Here, Walter Scott fund manager Murdo Maclean provides his account of how events unfolded.
For Murdo Maclean, fund manager with investment firm Walter Scott, the months preceding the Covid-19 pandemic were a period of intense due diligence. “It might be hard to recall given subsequent events,” he says, “but if you cast your mind back to 2019, people were worried about valuations. Even against a backdrop of macro-economic uncertainty, equities remained on a tear. This posed a fundamental question: had markets outrun themselves?”
For the investment team, the response was a year-long exercise of re-evaluating not only every current holding but also companies on the watch-list. It meant each of the stock champions revisiting their stocks and carrying out due diligence to justify current exposures. The question, says Maclean, was whether the team felt comfortable with maintaining those positions given the then-elevated prices.
It was against this background that the first news of a new virus spreading in China began to filter through. As day followed day, and news of the spread of the virus became more worrying, the team began to wonder whether the market was fully pricing in risk. “We knew there would be knock-on effects but at that stage couldn’t be sure exactly what they’d be,” says Maclean.
As events unfolded, the team began to apply worst-case scenarios as a natural continuation of their earlier due diligence exercise. They looked at the strength of balance sheets and how resilient companies were likely to be as lockdown measures came into effect. They also scaled up dialogue with company management to get a direct line on how their holdings might respond to future stresses.
“We had a close line of communication – not just with company leaders but also trusted sources in the market,” says Maclean. “We wanted to know how companies were planning to manage staffing, whether they’d applied for furlough, what their debt covenants were, what their cash balances were like and whether they had access to revolving debt facilities. Really, it was a search for red flags as much as anything.”
A focus on fundamentals
In the event, he says, changes to the portfolio were relatively few – and those made were often based more on fundamentals than anything pandemic-related. The investment team exited holdings in a global coffee brand, for instance, not simply because of Covid-19 but more on the view that management had misallocated capital which meant a weaker-than-expected balance sheet.
They also reduced exposure to the energy sector. Again, this was stock-specific and reflected diminished confidence in that company’s ability to deliver growth in the coming years – rather than anything directly related to the pandemic. In the pharmaceuticals sector, the team believed speculation about a treatment for Covid-19 had pushed one holding to somewhat unrealistic levels and so reduced exposure there.
On the flipside, the team added exposure to select holdings in the healthcare and technology sectors, on a view that those companies were fundamentally sound and possessed an exciting long term growth outlook.
“Did we carry out a wholesale revision of holdings?” asks Maclean. “No. We took a view: there are risks all the time. We wouldn’t own companies in the first place if we didn’t think they’d be able to deliver. The fact that we made so few changes to the portfolio during the largest market dislocation for a generation is testament to the strength of those companies and the decision-making process that led up to us taking those positions in the first place.”
When history rhymes…
Here, Maclean points to the lessons of history. Companies with staying power are those that, as likely as not, have already experienced crises and thrived on the back of them, he says. “Our due diligence at the start of 2020 showed that. We looked at how successful companies had weathered the storm through the Global Financial Crisis and whether they shared any characteristics.”
This, then, is the lesson learned from the pandemic, according to Maclean: that companies already on their knees are unlikely to gain market share let alone survive when a crisis comes along. “It’s how companies are positioned heading into the storm that’s important; not what they’re doing as the crisis swirls around them,” he concludes. “As an investor you can accept falling revenues during periods of market stress but what you need to know is how that company’s positioned once the worst has passed. Are they well placed not only to survive but to thrive as well? That’s really what you’re looking for when the crisis hits.”