Lots of uncertainty, but an abundance of investment opportunities

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

What has been remarkable about this crisis is the level of dispersion in financial performance across industries and companies. Some companies have been hit hard while others have been able to take market share at an accelerated rate. This in turn has reinvigorated the ongoing debate about “growth versus value”, and whilst there have been many attempts to call the top for growth and the bottom for value, these calls have generally been incorrect as in our view they fail to appreciate the profound structural changes affecting cash flows on a medium-term basis.

Understandably, the economic outlook remains uncertain, but that is an opportunity rather than a problem for this strategy. There remain sizeable opportunities for companies that can differentiate themselves and/or are exposed to long-term secular trends, while the pressure on balance sheets and cash flows for struggling companies is intensifying. This dispersion of returns between sectors and within sectors is likely to persist.

History has shown that crises accelerate industrial trends, market share shifts, and changes in consumer behaviour. We thought this would be the case with COVID-19, but, even so, we have been surprised by the sheer speed and scale of the level of dispersion of financial performance created across industries and companies.

The importance of a company’s financial strength

For us, the financial strength of a company has long been one of our key considerations when evaluating shares. Companies with strong balance sheets and a high conversion of profits to cash have generally been able to respond far better to this crisis, investing in their offering and products, or indeed evolving their business model where necessary to compete more effectively. When financial strength is combined with attractive industry dynamics, a compelling product offering and a proven management team, good things tend to happen! These are the companies we think will emerge in an even stronger position as this pandemic accelerates “Corporate Darwinism” on an unprecedented scale.

Conversely, we have long argued that too many companies, often in large and mature industries, were in effect starving their business of the much-needed investment required to compete more effectively given the rise of technological disruption, regulatory change, and/or changes in consumer behaviour. In many cases they are hostage to dividend payments they can ill-afford and are sacrificing the long-term growth potential of their business. Even before this pandemic we had seen many high-profile profit warnings and dividend cuts, but the crisis has really exposed the frailties of weak business models that have underinvested with unsustainable levels of debt. In several cases we see long-term impairment of value.

Finding the differentiated

We are strongly of the view that there remain sizeable opportunities for well financed companies that can differentiate themselves with a compelling product offering. Take Games Workshop as an example, (a top 10 holding), who have been able to grow their sales and profits through this crisis. They have been very successful in investing behind their product offering, growing their online presence, and attracting increasing levels of new customers, which should lead to higher levels of repeat ordering. Other companies we think are well placed to benefit are those driving and/or exposed to long-term secular growth trends like digital marketing and data analytics (e.g. YouGov), or cloud enabled communications (e.g. Gamma Communications). Conversely, the pressure on balance sheets and cash flows for struggling companies in structurally challenged industries is intensifying. We expect these trends to persist.

Risk: The specific companies identified and described above do not represent all of the companies purchased or sold, and no assumptions should be made that the companies identified and discussed were or will be profitable.

Digital transformation

Digital transformation is one secular area of spend where growth rates have meaningfully accelerated during COVID-19 as corporates continue to invest in their digital capabilities in order to drive demand and win share, adapt to changes in consumer behaviour, and remove costs and complexity from their operations. It remains a key focus for every board globally. We have deliberately sought exposure to these trends in recent years and have increased our exposure recently as we think the growth outlook has improved, notably in digital payments, software-as-a-service, online learning, and cloud enabled audio and visual communications. Video Gaming is another industry where we think the outlook for growth has improved, where we see the value for content appreciating, a growing installed base of players and a long-term increase in player time and in-play monetisation. With major US tech companies launching streaming services for video gaming and acquiring games studios we see a positive outlook for the industry, and the UK is fortunate to possess some attractive companies at the forefront of this rapidly evolving but growing industry.

High rates of uncertainty yet compelling opportunities abound

The level of dispersion in financial performance across many industries and companies that this crisis has created is incredibly exciting for fundamental active investors, and we will do everything we can to continue to ensure the BlackRock Throgmorton Trust capitalises on these opportunities both from a long and short perspective.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy. The opinions expressed are as of October 2020 and may change as subsequent conditions vary.

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