Confidant Winter 2021 issue

Winter issue 2020/21

Acting for clients as they would want to act for themselves

C O N F I DAN T Save | Plan | Invest

Hitting the mark

Looking East

Understanding pensions

Reducing risk

Three stocks to keep, p8

Our approach to developing markets, p10

Your questions answered, p12

Business beartraps to avoid, p16

Targeting growth How we build global portfolios, p4

C O N TA C T S

Head Office

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Killik & Co is a trading name of Killik & Co LLP, a limited liability partnership authorised and regulated by the Financial Conduct Authority and a member of the London Stock Exchange. Registered in England and Wales No OC325132.

Registered office: 46 Grosvenor Street, London W1K 3HN. A list of partners is available on request. Telephone calls are recorded for regulatory purposes, your own protection and quality control.

This communication has been approved by Killik & Co for distribution to retail clients. The value of investments and the income from them may vary and you could lose some or all of your investments. Past performance of investments is not a guide to future performance. The tax treatment of investments may change with future legislation. Prior to taking an investment decision based on the content of this publication, investors should seek advice from their Investment Manager on the suitability of such investment for their personal circumstances. Killik & Co accepts no liability for any loss or other consequence arising from the use of the material contained in this publication to make investment decisions, where advice has not first been sought from their Investment Manager. Killik & Co has no obligation to notify a reader or recipient of this publication in the event that any matter, opinion, projection, forecast or estimate contained herein changes or subsequently becomes inaccurate, or if research coverage on the subject company is withdrawn.

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You may view our policy in respect of managing conflicts of interest on our website.

2 — Winter 2020/21

FROM THE EDITOR

Investing rationally Tim Bennett Head of Education “Annus horribilis” was how the Queen pithily summed up 1992. Fast forward and it is a phrase that many of us would use to capture the events of last year.

However, for investors looking ahead to 2021 there is a positive lesson to be drawn from the Queen’s consistently sanguine public reaction to even the most testing of years.

Before I come to that, however, it is worth remembering how the more emotional side of our brains can lead us astray, a topic highlighted recently by political scientist and Associate Professor at the John Hopkins University in Washington, Yascha Mounk. In an article written for theatlantic.com, on why the coronavirus was able to spread so far and fast in America, he identifies three behavioural traits as key contributory factors. He also notes that these are particularly strong in younger generations. Since similar “cognitive biases” have a proven track record of tempting investors of all ages into making mistakes, they are worth reiterating.

His first observation is that the younger we are, the greater our tendency

to assume that bad things will not happen to us. That attitude leads to risk taking (socialising rather than isolating, for example) in the context of containing a virus. When it comes to investing, this same trait manifests in relative novices betting too much money on a supposed big stock market winner, convinced that they will bank profits ahead of everyone else. Left unchecked, this “optimism bias” can lead us into trouble.

Next on Mounk’s list is our tendency to follow others in the belief that it is the safest option. He suggests that “super-spreaders” may have unwittingly helped to transmit the virus by copying friends who were socialising regularly, and seemingly safely. Similarly, individual investors who seek solace in numbers can end up performancechasing. It is the resulting “buy high and sell low” pattern that helps to explain their underperformance, according to Berkeley University’s study, “The Behaviour of Individual Investors”.

Mounk’s final observation is that young people are prone to underestimate the

So, how can we counter these emotional biases? Firstly, by remembering the cliché that knowledge is power. Older, wiser, and better educated investors are less likely to make these mistakes. Secondly, by stripping out emotion when investing.

Do not, for example, hold onto a stock simply because you like the brand, if it is not also earning its keep. And thirdly, by being sufficiently self-aware to “know what we don’t know”, as my colleague James puts it (see also page 17) and acting accordingly.

The person I am describing may, or may not, sound a lot like you. In the latter case, I have a suggestion – consider handing over your investment decisions in 2021 to someone with a temperament that is more like the Queen’s. ●

C OMING UP

SECURITIES IN THIS ISSUE

Growth versus value, p6

Accenture, Salesforce, Orsted, NextEra, Abbot Labs, Amazon, Nvidea, Rio Tinto, Nestlé, p4/5 Danaher, Disney, Experian, p8 BlackRock Frontiers, Schroders Asian, Newton Emerging Markets, Stewart Asia Pacific, p11 Redde Northgate, DFCH, Halfords, Cambria, p18/19 Pfizer, Moderna, AstraZeneca, Zoom, Ocado, Homeserve, Pershing Holdings, Equinor, SSE, JP Morgan, Procter & Gamble, p22

Sustainable IOUs, p15 Back on the road, p18 The teachers’ favourite, p20 Paying for the pandemic, p22 Final thoughts, p23

risk of the unknown. During 2020, too many may have dismissed the threat posed by a silent and invisible virus.

Similarly, inexperienced investors may not appreciate the downsides that come with risky, unfamiliar investments, whether new stocks, exotic funds, or structured products.

Winter 2020/21 — 3

I N V E S T M E N T S T R AT E G Y

Thinking globally Simon Marsh Deputy Senior Partner In his role as Chief Investment Officer, Simon explains the core principles that support thematic investing, stock selection and portfolio construction within Killik & Co’s Global Equity Model.

The Global Equity Model can be best described as the key driver of our core investment services. It is derived from an investment approach that is focused on the identification of the world’s best businesses. These, in turn, provide our client portfolios with a truly global orientation.

The underlying stock selection process is built on fundamental bottom-up analysis, overlayed with a thematic approach. This seeks to identify those enduring secular global trends that can provide a tail wind of growth and opportunity for the businesses which are best positioned to take advantage.

As such, whilst we are macro-aware, the focus of our attention is on discovering the winning businesses of the future, rather than attempting to second guess the next quarter’s GDP or inflation number. We are happy to then do the careful and timeconsuming hard work that is needed on behalf of our clients.

In essence, it is this marriage of great businesses within strong secular growth areas, that defines the core of our investment strategy.

Identifying themes The selection of specific companies that play to our chosen themes is the responsibility of the Investment Committee. It is comprised of Senior Research Analysts and some of our most experienced Investment Managers and, as such, brings together the best of some broad and 4 — Winter 2020/21

varied perspectives. This is how we combine our expertise in fundamental research with our ability to identify the key themes that we will seek to capture through our investment in related businesses.

This approach means that we are under no obligation to put money to work in unappealing sectors simply to ensure that we hug an index. We have always challenged the validity of this sort of “closet tracking”, given that the conventional classification of many sectors has failed to keep up with the extraordinary pace of technological change.

Many of the themes that we have actively chosen to be positioned within have been accelerated by the coronavirus pandemic. Digital Transformation is a great example – few sectors of the economy have escaped the need to rapidly adopt new technologies and processes.

That is why key holdings for us include global consultancy group Accenture, alongside the likes of Salesforce whose platform is fast becoming the de-facto choice for many of the world’s largest businesses as they scramble to accelerate digital change.

Another example of an emerging trend, which will touch all our future lives, is the shift towards renewable energy. We are therefore investors in both Orsted, the

world’s largest provider of offshore wind, and NextEra, a leading clean energy company located in the US.

Selecting stocks Next, a summary of the stock selection approach which is central to our thematic thinking. It is built on the identification of businesses that benefit from certain key factors; strong management, a competitive advantage over peers, business model superiority, solid financials, and an attractive valuation.

Strong management comes in many forms, but for us a culture of innovation is vital. As a result, we look for teams led by individuals who display an innovative edge. A great example is Marc Benioff, the founder and CEO of Salesforce, who has disrupted the software industry through the delivery of software as a service (SaaS).

Another is Abbott Labs, a business founded 130 years ago and which continues to deliver life-changing innovation to improve patient care through the clever application of technology. Its FreeStyle Libra, for example, is the leading product in diabetes care and has enjoyed the fastest adoption curve of any medical device in history.

As for valuation, we recognise that it is relative. Therefore, we will not shy away from paying a premium price for attractive businesses that offer a superior runway of growth.

This principle lay behind our thinking when we published our first buy note on Amazon back in 2011. Given that we aim to hold our investments for the long-term, we were confident at the time that higher than average

I N V E S T M E N T S T R AT E G Y

growth, which we felt the business could subsequently deliver, would ultimately be reflected in its share price performance.

Constructing portfolios It should be clear, from this synopsis of our approach, that our portfolios are much more than simply a collection of stocks. Further, we like to look beyond the traditional parameters of sector diversification and employ instead what we call a “Three Pillars” approach to growth. This is built around dividing our equity positions into three categories, being Fast Growth, Cyclical Growth and Defensive Growth (please also see page 8).

A great example of a fast growth businesses is Nvidia. This pioneer in graphic processing units (GPU’s) is helping to redefine modern computer graphics and deep learning-ignited AI. As part of the next era of computing, the firm’s technology is paving the way for intelligent robotics and selfdriving cars.

Meanwhile, a classic cyclical growth business for us is Rio Tinto. As one of the world’s leading producers of iron ore, it plays a key role in the manufacture of steel and aluminium for cars, as well as copper for wind turbines and EV motors.

As for defensive growth, Nestlé fits the bill well. This Swiss multinational food business is led by the highly respected Mark Schneider. He is busy driving the product innovation and new direct-toconsumer models that are generating rapidly growing e-commerce sales,

alongside a better understanding and engagement with customers.

The key to our success in building portfolios lies in combining these different categories of growth together. In doing so, we aim to deliver consistent portfolio performance across the economic cycle, given that each category tends to fare differently at various points within it. This type of approach can iron out some of the more pronounced peaks and troughs that are an inevitable feature of global markets and therefore give a portfolio greater resilience.

of our equity approach with their Investment Manager.

Summing up We believe that portfolio construction, driven by a rigorous but also flexible approach to thematic research and stock selection, can deliver high levels of performance for investors.

Delivering performance Our performance data offers a clear insight into the results of blending the right mix of dominant and innovative global businesses, within a carefully structured portfolio. Our equity risk portfolios (a group comprising client portfolios that we manage, with the highest levels of exposure to the equity market) are a good example of this and your Investment Manager would be delighted to share the independent Asset Risk Consultants (ARC) data with you.

Meanwhile, we would also be happy to show you the performance data from our Global Equity Model over the last one, three and five years. This is made up, as I described above, of 30 thematically focused holdings selected from our Research Covered List. Once again, I would encourage those clients who would like to, to have a more detailed discussion around this aspect

We are therefore pleased to be able to offer a range of portfolio management services that follow the structured investment process I have outlined. If you would like to find out more, your Investment Manager will be very happy to discuss them with you. ●

Online events – 2021 During 2020, we were delighted that so many of you decided to join our investment webinars (“Where to Invest?”) featuring our Research experts. We will be running more of these in 2021. Please also keep an eye out for the launch of our Young Investors’ Club and a new series of Planning webinars. For further information, or to register your interest in a specific online event, please email events@killik.com.

Killik Explains Anyone brand new to equity investing might like to try Tim’s short, educational guide, “How to Invest in Equities”, which is available either via an Adviser or by emailing editor@killik.com.

Please note that these Guides are also available on a range of other saving, planning and investing topics.

Winter 2020/21 — 5

THE BIG PICTURE

Combining forces Mark Nelson Senior Analyst

Speaking the right language So, what are these two schools of thought? Value investing is grounded in the work of Professors Benjamin Graham and David Dodd at the Columbia Business School – their 1934 book, Security Analysis, is the subject’s seminal text. In short, their approach focuses on shares trading on valuation metrics, such as price to earnings and price to book ratios, that are low compared to peers and the wider market. Such shares also tend to offer higher dividend yields.

Growth investing, by contrast, prioritises the search for growth in earnings over relatively low valuation multiples. Many companies that fall most naturally into this category do not pay a dividend, preferring to reinvest excess cash flows back into their businesses.

6 — Winter 2020/21

Chart 1 – MSCI AC World Growth vs.

Value, indexed 300 250 200 150 100 50 0 Dec 2013

Dec 2014

Dec 2015

Dec 2016

Dec 2017

Dec 2018

Dec 2019

Dec 2020

MSCI AC World Large Cap Value Index MSCI AC World Large Cap Growth Index

Gross data to 18th December 2020. Past performance does not guarantee future results.

Source: Factset.

Explaining the difference The factors that underpin the sustained superiority of growth stock performance in recent years are important to consider. One is the strength of technology stocks, a sector comprised, on average, of faster growing companies, trading on higher valuation multiples. This outperformance has been justified in our opinion, as these companies have displayed much stronger earnings growth than those in other sectors (chart 2).

Chart 2 – Last 12 months earnings per share growth since 2013 100

50

0

Information Technology

Utilities

Health Care

Consumer Staples

Materials

Financials

Industrials

Consumer Discretionary

Real Estate

-100

Energy

-50

Communication Services

Following the announcement in November of positive late-stage COVID-19 vaccine trial results from Pfizer and BioNTech, we have seen a notable style rotation in global equity markets, marked by the resurgence of “value” stocks. As measured by the MSCI All Country World Large Cap Indices (chart 1), these types of stocks have outperformed their “growth” peers significantly since then, as some of the sectors and companies hardest hit by the pandemic rallied in anticipation of a normalisation of economic conditions. This sudden change in fortunes has reignited a decades-old debate over the relative merits of value and growth investing.

The recent rally in value stocks should be considered in the context of an extremely strong run for growth stocks over the last seven years.

Since the end of 2013, the MSCI All Country World Large Cap Growth Index has produced over 100 percentage points of outperformance on a total return basis compared to the MSCI All Country World Large Cap Value Index.

Even after November’s style rotation, growth stocks have still outperformed value stocks by over 30 percentage points year to date.

%

Mark addresses the ongoing tug of war between growth and value investing and explains how portfolios can capture the best of both.

Gross data to 18th December 2020. Past performance does not guarantee future results.

Source: Factset.

Another important factor is that interest rates have remained extremely low during this period. Indeed, easy monetary policies have been a constant feature of the years since the global financial crisis. These reflect the fact that inflation has remained subdued and central banks have been reluctant to derail what has been a long, but at times fragile, economic recovery. This matters because of the differing impact of changes in interest rates on growth and value stocks, which is a product of their relative “duration”.

Although often used in fixed income markets, this term can be applied to equities as well. At a very basic level, duration is the expected sensitivity of a security’s price to changes in interest rates. Growth stocks tend to have higher durations, as expected cash flows are more heavily weighted towards the future, relative to value stocks. As such, declines in interest rates have a greater positive impact on them, in price terms, than is the case with their value peers.

The more recent rally in value stocks has led some to argue that the period

of sustained outperformance for growth stocks has come to an end.

We are not convinced of this, and besides, we would caution against investing purely on the basis of style.

Doing so threatens to distract an investor from considering what we believe to be the most important aspects of financial analysis.

In fact, we share the opinion of Warren Buffett who once said that growth and value investing are “joined at the hip”.

Many of the tenets considered central to value investing should be used by almost any investor in our view, including those with a preference for growth stocks. For example, at the heart of value investing is the principal of seeking out undervalued securities; something every investor should have in mind. Furthermore, much of the specific technical advice offered in Security Analysis is universally useful, whether assessing the strength of a company’s balance sheet, the track record of a business, the quality of management, or the historic stability of earnings and cash flow.

Staying relevant There are, nonetheless, some significant differences in the investing landscape as it exists today compared to that of the 1930s, when Security Analysis was published. Even allowing for the ongoing COVID-19 pandemic, today’s economic environment is more stable. However, technological change, while a constant through history, is arguably accelerating at a greater speed than ever before. Perhaps the best-known example of the non-linear pace of its progress is Moore’s Law. First put forward in the 1960s, it predicted an exponential growth in computing power through the increase in the number of transistors that could be squeezed onto microchips. Another example is the estimate that 90% of the data that exists in the world today has been created in the last two years.

There are plenty of examples outside of computing too, including the recent advancements made in renewable

THE BIG PICTURE

energy technologies, which have brought about a significant reduction in the cost of producing power using wind.

Averaging up Indeed, the sheer pace of technological change poses a significant challenge for value investors in terms of how it may be impacting the financial theory of mean reversion. This phenomenon suggests that asset prices and historical returns ultimately revert to the long-term average of a given dataset. It is often cited as a reason to avoid companies with above-market earnings growth, in favour of those whose earnings may be temporarily depressed. However, we believe that a number of sectors where earnings have failed to grow – or even declined – in recent years, may have suffered structural impairment at the hands of technological progress. They may, therefore, trade on low valuation multiples for valid reasons. As such, the risk of falling into a “value trap” is arguably greater than it has ever been.

On the other hand, we believe that technological leaders, and also the non-tech businesses that are able to harness the power of technology and successfully digitalise, can benefit from sustainable competitive advantages. These should support superior earnings growth and profitability over the long term.

Finding winners We therefore reiterate that our focus is ultimately on the fundamentals, rather than the categorisation of a stock.

However, our preference for highquality companies with competitive advantages, that play to long-term secular trends, means that “growth” stocks are well represented within our portfolios. Further, valuation will always therefore be considered alongside an analysis of a business’ growth prospects. Should the two conflict, we will usually defer to Warren Buffett once more – “it is far better to buy a wonderful company at a fair price, than a fair company at a wonderful price.” ●

Killik & Co Security Risk Ratings All research recommendations are issued with a security-specific risk rating, represented by a number between 1 and 9. Assessing the relative risk of any security (specific risk) is highly subjective and may change over time. The Killik & Co Risk Rating system uses categories which are intended as guidelines to the specific risks involved, as follows: 1. Restricted Lower Risk Securities in this category are what we believe to be lower risk investments such as cash, cash equivalents and short dated gilts, and the collective investment vehicles that invest in those instruments.

2-3. Restricted Medium Risk Securities in this category are what we believe to be medium and lower risk investments including medium and long-dated gilts, investment grade bonds and certain collective investment vehicles investing predominantly in these securities.

4-9. Unrestricted Securities in this category are what we believe to be higher risk and are drawn from across the United Kingdom and international markets. These are normally direct equity investment and collective investment vehicles which predominantly hold securities other than investment grade bonds and money market instruments.

The vast majority of the Killik & Co Research recommendations are likely to fall in the unrestricted/ higher risk category (4-9) above.

For further details on the Killik & Co Risk Rating system please see the Killik & Co terms and conditions.

Winter 2020/21 — 7

EQUITY RESEARCH

Growing ideas Andrew Duncan Senior Equity Analyst Andrew highlights three stocks that play to Killik & Co’s core growth categories. For more information about any of the companies mentioned here, please contact your Investment Manager As my colleague, Simon, notes on page 4 of this issue, at Killik & Co we classify our Equity Growth stocks into three distinct groups, Fast Growth, Cyclical Growth and Defensive Growth. This quarter’s article therefore takes a closer look at what these classifications mean (starting here with Defensive Growth) using individual stocks that showcase our approach.

All three companies share certain things in common. They are all high-quality businesses with leading positions in their respective industries and, what we believe to be, enduring competitive advantages. In addition, they are exposed to secular growth trends, by which we mean forces that are driving their underlying sectors, rather than being solely related to the economic cycle. This gives us confidence in the long-term opportunity in each case.

Defensive Growth These are businesses whose underlying operations are likely to be relatively unaffected by changes in the broader economic cycle.

The search for firms that meet our Defensive Growth criteria encompasses those where revenues, and to a lesser extent earnings and cash flows, are resilient to an economic downturn, or even recession. Demand for such a firm’s products should not be driven, in the main, by the prevailing economic 8 — Winter 2020/21

backdrop, or specific related factors such as weaker consumer spending.

Historically, companies in sectors such as Healthcare, Telecommunications and Consumer Staples typically fall into this category.

A great example is Danaher. Now a collection of 22 distinct operating companies, the business has reinvented itself over the last half century, evolving from real estate and various industrial assets to its latest iteration as a healthcarefocused conglomerate. Supporting its overall operations is the Danaher Business System. This borrows from the Japanese business philosophy of kaizen (meaning continuous improvement) to enhance profit margins, increase spending on research and development, and drive faster revenue growth.

Danaher meets our Defensive Growth criteria thanks to its exposure to healthcare, which is a relatively predictable industry. Demand for the related services should remain robust – the world’s population is rising and growing older, overall wealth is increasing and access to care in emerging markets is improving.

A key feature of Danaher’s business is that is does not sell drugs or devices directly to patients. Rather, it supports the healthcare industry through its leading life science tools

and services that help companies to research and produce treatments.

This means that the firm is exposed to overall healthcare spending and is not unduly reliant on identifying and commercialising successful products. Further, roughly 70% of annual revenues are recurring, which provides investors with good visibility and predictability.

The company is currently experiencing strong growth from demand related to COVID-19, thanks to its expertise in drug development and production, plus diagnostics (i.e. testing).

However, this is no short-term blip, as Danaher believes the healthcare spending environment is likely to remain strong over the longer term.

That is why it expects to increase its long-term organic growth rates by 1%, to 6%-7% annually.

Cyclical Growth These are businesses whose revenues and profits are more highly correlated with that of the wider economy, at least in the short term.

Companies in sectors such as Financials, Consumer Discretionary and Industrials typically fall into this category. That is why Disney is an excellent example of a Cyclical Growth company, with its broad portfolio of consumer assets that include movie studios, TV channels and theme parks.

EQUITY RESEARCH

2020’s COVID-19 pandemic, and its associated lockdowns, sharply curtailed consumer spending and manifested in lower attendance at the firm’s famous parks and cinemas. However, whilst theme park attendance might be considered cyclical, we believe that Disney stands out from its peer group thanks to an incredible brand and the unique proposition it offers the whole family.

Its venues play a hugely valuable part in creating tangible experiences for customers, through Disney’s brands and franchises, in the form of rides, characters, and merchandise. The most recent bookings data, coupled with the firm’s historical success, suggest an underlying appetite for all of these. With increasingly positive news emerging on coronavirus vaccines, we therefore expect to see the release of strong pent-up demand in 2021 and beyond for its “once-in-alifetime” family experiences.

In addition, the company is reinventing itself in other key areas to “futureproof” its overall business model. A prime example is video streaming, a market it successfully entered via the launch of Disney+ last year.

Seismic changes are occurring in video media content creation and consumption, which we believe are transforming the ways in which content is created, distributed and paid for.

This shift is being driven by a move away from traditional “linear” television programs to the consumption of video via direct streaming over the internet.

We see content creators and owners as the relative winners because they benefit from having additional distribution channels through which to reach consumers.

In this context, Disney is well positioned over the long-term thanks to its unrivalled library of content and creative capabilities. Disney+ represents the company’s entry into the mainstream direct-to-consumer video streaming market. The service reached 85 million paid subscribers in

its first year of launch, far surpassing initial expectations. By harnessing such a strong secular tailwind, the firm has successfully reduced its cyclical exposure.

Fast Growth These are businesses whose revenues and profits are increasing at a significantly faster rate than the wider economy, on the back of secular growth and the proliferation of new business models.

Historically, companies in the Technology sector typically fall into this category.

One of the key driving forces for growth here is the enormous speed with which data has proliferated since the advent of the digital age.

Recent advances in computer technology and data science are enabling huge quantities to be processed and analysed with ever-increasing efficiency. These trends have combined to create a fast-growing market for data, used to inform profitable decision-making in countless fields of commerce. We believe businesses that can satisfy the demand for this information – i.e. those which control large quantities of proprietary data, and have the technology to interrogate it – have a compelling business model that is difficult to replicate.

Experian is just such a business, in our view. It has access to credit history data encompassing 1.3 billion people and 163 million enterprises, combined with a growing suite of leading analytical technologies.

At the core of this business is one of the world’s largest credit bureaux,

which produces reports that are used by lenders to assess the credit worthiness of customers. This business model carries significant competitive advantages. Firstly, credit reports are ‘must-have’ products, which are integral to the operation of credit markets and, by extension, the functioning of the wider economy.

Secondly, anyone wanting access to these reports will find it hard to avoid using credit bureaux. That is because they are neutral parties compared with the credit institutions, which cannot share commercially sensitive data among themselves. Thirdly, there is a powerful “network effect”: the more customers a credit bureau attracts, the more desirable its data becomes to those customers. This, in turn, increases the barriers to entry.

However, there is more to Experian than this. Over the past 20 years, much of the company’s growth has come from exploiting its advantage in proprietary data by expanding into analytical software and platforms, as well as consumer services. It has also diversified beyond its traditional financial sector customers, into industries such as healthcare and automobiles. Constant product innovation in these areas has counterbalanced the more cyclical parts of the business. That helps to explain why there has never been a year during which the company has not grown organically, even during the financial crisis. Innovation continues apace today, via rapidly growing new offerings such as Experian Boost – an ‘Open Banking’ service that allows users to increase their credit score for free by submitting data.

With a powerful competitive position, an abundance of structural growth opportunities, high and growing profit margins, and consistent cash generation, we feel Experian is well positioned to compound shareholder returns at an attractive rate over the medium- to long-term. ● Winter 2020/21 — 9

FUND RESEARCH

Emerging opportunities Gordon Smith Head of Fund Research Gordon discusses why he remains keen on emerging and frontier markets as investors leave behind a challenging year.

2020’s pandemic rapidly accelerated some long-term economic trends at the expense of others. The news flow from emerging market economies was particularly brisk, not least because of the unique nature of the economic slowdown and the huge differences in the way that individual countries chose to tackle the crisis. However, we believe that there is much to look forward to in 2021 from an investment perspective.

Stratifying performance The emerging and frontier market region is still viewed too often through a single lens. Concerns surrounding its sensitivity to global trade, reliance on commodity markets, dependence on US dollar funding and the fragility of individual financial systems often seem to overshadow every economy in the region. This is despite the very significant differences that exist between their growth drivers and the rapid evolution of many of the fastest developing markets over recent years.

The performance of the broad MSCI Emerging Market (EM) Index this year demonstrates the point. As has been the case in developed markets, investors have experienced a big divergence in returns from a sector and geographic perspective. Some individual EMs suffered a big capital deterioration, notably the more fragile Latin American economies, as well as heavily oil-biased Russia. Yet overall, the group produced a low teens total return from the start of 2020, 10 — Winter 2020/21

broadly keeping pace with the MSCI Developed Market (DM) Index.

Investors have also witnessed something of an overlap with developed markets, in so far as both were led by a relatively small group of companies that were well-positioned to gain market share as the year’s challenges unfolded. The broader EM index was supported by strong returns from China, Taiwan, and Korea in particular, generated by a small group of businesses within these markets. The common thread that connects those countries is their recent focus on building their own sizeable technology sectors. It has been the companies in that area that have pushed markets higher over the last twelve months.

Building global brands Indeed, the rise of businesses offering truly world-leading products and services has been a key feature of recent years. Examples include the Taiwan Semiconductor Manufacturing Company (TSMC), whose dedicated chip foundry plays a critical role in

memory and processing technology around the world. Then there are Tencent and Alibaba, the Chinese internet, smartphone and ecommerce platforms. Meanwhile, Reliance Industries, the mobile service provider, is now partnering with many of the largest western technology businesses to develop the Indian market. Given the challenges faced

by US and European technology and retail businesses, when it comes to capturing the commercial opportunities presented by large Asian populations, we believe the emergence of this type of large and successful business, built within domestic markets, will continue over the next decade. Investors who exclude direct investment in the emerging regions from their portfolios therefore risk missing out.

Overall, our long-held view remains that Asian markets, which make up a considerable portion of the emerging bloc, will continue to be a very significant driver of total global growth over the next decade. The increasing interconnectedness of the underlying economies is likely to be a very

FUND RESEARCH

Data to 18th December 2020. Past performance does not guarantee future results. Source: Factset.

Schroder ISF Asian Total Return

Fund Type

Investment Trust

Fund Type

Luxembourg SICAV

Manager(s)

S Vecht, E Fletcher

Manager(s)

K F Lee, R Parbrook

Market Cap

£282m

Fund Size

$5.51bn

KID Impact on Return

1.50%

KIID Ongoing Charges

1.30%

Historic Yield

5.0%

Historic Yield

2.0%

This UK investment trust seeks long-term capital growth. It invests in companies from lessdeveloped countries, including frontier markets and smaller emerging markets, whilst excluding markets such as China, Korea, Taiwan, India, and Brazil. The resulting universe comprises countries that typically offer a favourable backdrop of demographics and economic growth, alongside a more diverse set of return drivers, relative to developed and larger emerging markets peers. Risk Rating: 7

This fund aims to provide total returns from investing in companies across the Asia Pacific region, excluding Japan. The fund further seeks to mitigate losses in falling markets by using derivatives such as index put options, which rise in value as market indices fall. In recent years, it has benefited from a significant allocation to Chinese technology stocks such as Tencent and Alibaba, which have contributed a large portion of the region’s equity market returns.

Risk Rating: 6

Share price, total return (last five years)

NAV, total return (last five years)

Growth

Dec-20

Dec-19

Dec-18

Dec-17

Dec-16

240 220 200 180 160 140 120 100 80 Dec-15

Dec-20

Dec-19

Dec-18

Dec-17

200 180 160 140 120 100 80

Growth

Newton Global Emerging Markets

Stewart Investors Asia Pacific Leaders

Fund Type

Dublin UCITS OEIC

Fund Type

UK OEIC

Manager

S Whitbread

Manager

D Gait, S Reddy

Fund Size

£256m

Fund Size

£6.31bn

KIID Ongoing Charges

0.74%

KIID Ongoing Charges

0.88%

Historic Yield

0.0%

Historic Yield

0.7%

Dec-20

Dec-19

Dec-18

Dec-17

Dec-16

200 180 160 140 120 100 80 Dec-15

NAV, total return (last five years)

260 240 220 200 180 160 140 120 100 80 Dec-20

NAV, total return (last five years)

Dec-19

This fund seeks to provide capital growth by investing in Asia Pacific equities, excluding Japan. A “quality” style bias means that it seeks well-run companies managed in the interests of all shareholders. Consideration is also given to businesses which contribute to, and benefit from, sustainable economic development. The team have historically uncovered numerous ideas in India, which offers many strong companies and relatively few state-owned enterprises. Risk Rating: 5

Dec-18

This fund targets capital growth via a portfolio of emerging market equities. The Newton team use a thematic investment approach to identify areas of future growth and those companies that are set to profit from it. Current themes include climate change, and China’s growing influence in the world, as well as increasing automation and digitisation. The portfolio is built from companies offering exposure to these themes and the ability to compound growth over a number of years. Risk Rating: 6

Dec-17

2019

2021

2017

2015

2011

2013

2007

2009

2005

2001

380 360 340 320 300 280 260 240 220 200 180 160 140 120 100 80

2003

Relative performance of MSCI Emerging Market Index compared to MSCI Developed Market Index.

Growth

BlackRock Frontiers Inv. Trust (BRFI-LON)

Dec-16

When it comes to the performance of emerging markets, relative to developed markets, we have seen something of a game of two halves over the last 20 years. Since the end of 2010, the developed market bloc, led largely by the US, has persistently clawed back the outperformance achieved by EMs through the 2000’s (see chart). Nonetheless, there are many reasons why this trend could reverse once more over the coming years. That is why we continue to believe that investors should incorporate some exposure to the EM regions within their portfolios. Four funds that we currently favour are highlighted in the table opposite. ●

Income & Growth

Dec-16

Capturing returns

This quarter we highlight four differentiated funds focusing on the Emerging and Frontier regions. Please speak to your Investment Manager for more details on any of these strategies.

Dec-15

From a foreign policy standpoint, we anticipate little change from a Biden administration that is likely to maintain tough US rhetoric in its dealings with China, both when it comes to general trade terms and the intellectual property rights linked to technology.

However, we also expect the political backdrop under the Democrats to be more predictable, less confrontational, and ultimately better aligned with other major trading partners than it has been under Donald Trump.

Key fund data and charts

Dec-15

important feature of the forthcoming phase of growth from the region.

Meanwhile, supply chain analysis by the multi-national corporations will inevitably be a rising factor too.

All chart data source: Bloomberg. Chart data to 18th December 2020. For details of the Killik & Co risk rating system, please refer to page 7. Figures stated gross. Past performance does not guarantee future results.

Winter 2020/21 — 11

W E A LT H P L A N N I N G

Saving for life after work Svenja Keller Head of Wealth Planning To kick off 2021, Svenja answers nine commonly asked questions on pensions.

How much can I pay into a private pension this tax year?

I wish the answer could be as simple as ‘£40,000’ per annum, which is the standard annual allowance. However, this is only the headline figure. In reality, there is a lot more complexity to working out how much someone can, let alone should, pay into their pension.

For example, one thing to consider is whether a client is talking about a company contribution or a personal one. Company contributions can qualify for corporation tax relief.

However, there are qualifying conditions, the main one being that any contribution is made “wholly and exclusively” for the purposes of running the business.

Where someone makes a personal contribution on the other hand, income tax relief can only be given up to the amount of their “relevant earnings”, which broadly means income from employment or selfemployment. If this number is, say, £20,000 then that is the limit on their pension contribution for that tax year, which puts a lower ceiling on the annual allowance.

It is possible to boost it by bringing forward the previous three years’ worth of unused allowances. In theory, this could add up to £120,000 to the maximum annual allowance in 2020/21. However, the additional rules on tax relief for company and personal contributions remain in place and need to be considered alongside 12 — Winter 2020/21

the carry forward amount for the annual allowance.

This allowance could also be tapered via some separate, complex rules.

The bare bones of them is that if you have high total “taxable income” (this is different to the “earnings” limit for personal contributions – total taxable income includes things like rental income and dividends, whereas earnings only includes income from employment and self-employment), the £40,000 contribution limit may be reduced by £2 for every £1 that your “adjusted income” exceeds £240,000, subject to a separate check that your “threshold income” is above £200,000. If that last sentence sounds fiddly, that is because it is! I would recommend anyone with total taxable income at this sort of level to seek professional advice, because the financial consequences of getting this wrong can be severe.

Another restriction to consider is the Money Purchase Annual Allowance.

This kicks in when someone starts

withdrawing taxable income from a pension under the new pension freedoms rules. To stop the same money being recycled back into their pension to achieve further tax relief, the allowance is reduced down to £4,000. In addition, carry forward of annual allowances is then no longer possible.

The final sting in the tail is the lifetime allowance, which caps the total value of a pension fund when it comes to tax-efficient drawdown. I will return to this one later.

Should I prioritise saving into an ISA or a SIPP? The right choice will depend on someone’s circumstances. A Self Invested Personal Pension (SIPP) is, in most cases, more tax-efficient when it comes to saving for life after work because of the upfront relief on the way in (20% is given automatically, with the scope to claim more for higher and additional rate taxpayers).

Set against that, although an Individual Savings Account (ISA) may not attract the same up front tax relief, it is more flexible because it can be accessed at any time and there are no complicated rules to worry about on the way out.

As such, it may suit someone who is looking for a tax efficient tax wrapper to fund a less distant goal.

Confusingly, there is then the lifetime ISA, which sits somewhere in the middle – it pays a capped bonus to a saver aiming to fund a first property purchase, or their retirement. However, it also comes with strings attached, the biggest one being that you must be under 40 to open one and under 50 to save into it. Even then, whilst the

PERSONAL VIEW

bonus is attractive, it will not match the higher or additional rate tax relief available through a conventional pension. You are also unlikely to receive any employer contribution.

Another twist comes later when people who have been fortunate enough to be able to use up all their various allowances, try to work out which wrapper to draw money from first. For example, whilst pensions can be inheritance tax-efficient, in so far as they are normally excluded from a death estate, ISAs are generally not, unless someone has opted to invest in something like AIM shares. It is important to realise that the various taxes that might have to be juggled work differently, whether related to income, the lifetime allowance, capital gains, or an eventual death estate.

There are often compromises to be struck when it comes to plotting the most tax-efficient path.

levied by a pension provider. There are other risks too, such as ending up overexposed to an asset that is relatively illiquid and can be difficult to subdivide without the right ownership structure. In short, this is an area that needs some careful thought.

Is it a good idea to transfer a defined benefit (DB) pension into a SIPP? I get asked this one a lot, especially when companies that are keen to offload the unknown liability associated with DB schemes make generous offers to their employees to encourage them to transfer out.

However, that does not mean that they should.

of the way they manage tax going forward and plan how they want to live. Then there are estate planning considerations – a lifetime income stream will die with the recipient (or their spouse) unlike a lump sum invested via a SIPP which can be passed to any beneficiary, normally free of Inheritance Tax. Before giving any advice, we investigate whether a transfer will enable someone to meet all their essential, committed expenditure and live the life that they envisage. There is no point in even starting the process if the answer is “no” or the risks are too high. If, on the other hand, they have other wealth available to them then it might make more sense to look at transferring their pension.

How can I boost my pension pot?

The simplest answer is “by saving more”. Most of the older adults I meet regret not putting more money into their pensions at an earlier age.

Is property a good asset to hold within a SIPP? Much as though some people might love to put a residential asset, such as a buy-to-let property, into their SIPP, the rules forbid it. Commercial property, on the other hand, is allowed, whether it is a simple office building or something more esoteric, such as a river with fishing rights. The benefits can be significant – rent is received into the SIPP tax-free and any rise in the value of the property will not attract capital gains tax (although Lifetime Allowance charges could become an issue if the value rises significantly). Moreover, the rent paid to the SIPP by the occupying business is corporation tax deductible.

Final, or average, salary pensions offer a guaranteed income for life, which is usually inflation-linked. Not only is that promise financially valuable, but it also offers psychological certainty.

There are risks, such as the pension fund running up a huge deficit or a sponsoring employer going bust, however, safety nets such as the Pension Protection Fund, help to offset these.

Unfortunately, all this tax efficiency comes at a price in terms of the associated costs and potential complexity of the necessary trust arrangement. As well as the usual legal hoops when it comes to buying and managing the property, there are other hidden fees attached to possible VAT registration and the charges

If you transfer to a SIPP, there is no similar guarantee, either in terms of how much income you may receive or how long it will last. That said, what someone gets, in return for giving up that certainty, is a lump sum to do with as they wish. The relative degree of control this brings with it may be attractive to some people in terms

W E A LT H P L A N N I N G

Another component of successful pension saving is to take whatever help is available from an employer.

People who opt out of company pensions usually forgo a valuable contribution which is not matched by any alternative.

For those who can afford it, salary sacrifice is something worth investigating. This exchanges salary for a higher pension contribution from an employer. In effect it offers a pretax benefit at a post-tax cost, and if an employer will share their National Insurance saving on top, so much the better.

What can I do about the lifetime allowance?

A good starting point is to know about the risks it presents. A lot of people get caught out, mainly due to the complexity of the rules, especially when it comes to “protection”. Over the years, the lifetime allowance (the maximum amount that can be taken Winter 2020/21 — 13

W E A LT H P L A N N I N G

as a pension benefit, penalty-free) has been reduced to just over £1m.

Every time it has changed, pension savers have been allowed to apply for protection at previous, higher levels.

Breach the relevant limit and sizeable tax penalties can kick in.

The challenge is therefore saving enough to fund a decent retirement whilst not exceeding the ceiling. Once someone crosses this line, it becomes harder to mitigate unless the value of their investments starts falling, which is not ideal either. Monitoring this is therefore critical as people approach the point when they might want to start drawing down their pension, as that is when the limit is usually tested.

A second valuation test that kicks in aged 75 should also not be overlooked.

It is worth remembering that defined benefit pensions count towards the total too. The test takes the expected annual income and multiplies it by 20 to give a lifetime allowance value. So, for example, someone who is fortunate enough to have a £50,000 final salary pension would be close to the current limit (£1,073,100) before considering any other pensions they may have.

What happens if I start drawing from my SIPP?

the money is taken from, based on which taxes we have been tasked with minimising. So, whilst it often makes sense to draw from an ISA first, because a SIPP is more inheritance taxefficient, this is not an iron rule.

When looking at income tax, for example, it makes sense to use up the personal allowance to absorb some, or all, of the tax impact of drawing down more than the tax-free amount allowed under the pension rules. We also need to keep an eye on the lifetime allowance. We may advise drawing from a pension to stay below it, rather than risk a tax penalty.

A cash flow model can help to make the overall tax picture a lot clearer and highlight the trade-offs between different strategies.

Is a junior SIPP a good way to help children or grandchildren?

It certainly can be, provided parents or grandparents do not mind locking away their contribution for the very long-term and can live with the risk that the rules might change. Since grandchildren are unlikely to have any income in their own name, the contribution limit is usually £2,880, which the government then tops up to £3,600. This is a welcome bonus.

Once someone reaches the minimum age (55, although this will increase to 57 in 2028) they can access their pension very flexibly. Options include taking out a tax-free lump sum, a taxable income, or both.

Some thought needs to be given to the Money Purchase Annual Allowance I mentioned earlier. Interestingly, anyone with an older style “capped drawdown” arrangement is not caught by these rules so we always need to establish the type of drawdown arrangement someone is in before reaching a conclusion.

When it comes to designing a drawdown strategy, we need to be able to see all the investments someone holds and not just those within a SIPP. That way we can prioritise where 14 — Winter 2020/21

contribution made into a junior SIPP on behalf of a new-born child and invested until retirement age can lead to a higher pension figure than a SIPP funded by contributions of the same amount over a ten year period between the ages of 40 and 50, assuming the same annual growth rate for both pensions.

What can we expect from a future Budget?

Given the UK’s huge deficit, it is not surprising that people are speculating about what a future Budget might do to the pension rules. One potential target is the amount of tax-free cash that can be withdrawn. However, I suspect that the retrospective element of such a move may see this escape again in 2021.

Another rumour, which has emerged before every recent Budget, is a move to restrict upfront tax relief to the basic rate or even a flat rate of, say, 30%.

However, it is not yet clear whether this is in the government’s eyeline.

Another problem, albeit a nice one to have, is that if parents and grandparents are too generous, they may create a future lifetime allowance headache, thanks to the sheer power of compounding over very long periods. For example, a single

My view is that clients can only plan based on what they know now and not what may, or may not, come to pass in the future. Otherwise there is a danger that they start to make expensive plans that may have to be unwound later. Besides, past changes have usually come with transitional rules that are designed soften the immediate blow. As such, I think it is better to watch and wait, rather than try to second-guess the Treasury. ●

BOND RESEARCH

Going green Mateusz Malek Head of Bond Research Mat explains the recent surge in sustainable (“green”) bond issuance.

Increasing numbers of investors now incorporate environmental, social, and corporate governance (ESG) factors within portfolios. Bond markets have duly responded. Here is a snapshot of a rapidly developing space.

Defining terms Sustainable bonds, as they are known, are issued by the same entities as other bonds and they therefore carry similar credit risks. Provided any proceeds raised are exclusively used to finance green, or social, projects these bonds can be of any type or maturity, whether secured or unsecured, senior, or subordinated, fixed or floating coupon and rated investment-grade through to ‘junk’.

Generally, they are categorised in three ways. The first is pure “green”, where the funds raised finance projects usually linked to renewable energy, clean transportation, or environmentally friendly buildings. “Social bonds”, meanwhile, pay for projects that may include affordable housing, food security, employment generation or socioeconomic advancement.

The third sustainability category encompasses a combination of both.

Rising issuance To date, most bonds issues have fallen into the ‘green’ category. The first were issued in 2007 by the European Investment Bank (EIB). Supra-nationals and other organisations, such as the World Bank and African and Asian development banks, were also early adopters. The pace of issuance picked-up from 2013, as non-financial corporates, governments, and financial companies joined the market. More

recently, as more market participants have spotted the potential to use these bonds to fund climate change related projects, market issuance has grown exponentially – as at the end of June 2020, it had reached $868bn, according to Climate Bonds Initiative.

The first corporates to issue green bonds were Swedish housing company Vasakronan and French utility Electricite de France (EDF) in 2013. Since then, hundreds of others have followed suit. Most issues have been in euros or dollars – according to Bloomberg, there are only 44 sterling denominated green bonds (issued by 22 entities) from a total of over 1,000 globally.

Green bond issuance is picking-up amongst sovereign states too, including France, Ireland, Belgium, Netherlands, and Germany. These bonds are also popular amongst city councils and regional governments, as they often provide a cheap source of funding for climate friendly infrastructure.

Although the UK is yet to issue its first green sovereign bond, in November the Chancellor announced plans to launch a series of ‘green gilts’ from 2021. These could be used to support an economic recovery plan which includes a £3bn investment package for jobs, buildings upgrades and greenhouse gas emission reductions.

Balancing goals So, who buys these bonds? Some investors do so to balance financial returns with social, or environmental, objectives. For others, however, the rationale may be that firms which proactively adopt ESG principles are likely to be ahead of their peers in managing regulatory, legal, and

reputational risk. A third group buys them purely because they believe that strong demand should see them outperform their non-green peers.

Critics of this young market, meanwhile, point to a lack of transparency around the use of proceeds and insufficient accountability when it comes to monitoring how and where funds are applied. There are also some concerns about relatively low levels of issuer, currency, and structure diversity, albeit these are inevitable features of a relatively new asset class.

Investing responsibly Sadly, existing regulations limit direct access to green bonds to institutional and professional investors. Future exceptions may include those issued by supra-nationals, such as the EIB, and some governments, however the yields will probably be abysmal.

Within the Killik & Co discretionary, managed Fixed Income Service, we have been buying bonds offering higher yields issued by UK registered charities. The money raised helps them to accelerate specific objectives, such as providing housing for people with learning disabilities (Golden Lane), preventing homelessness (Hightown) and helping the elderly to combat isolation (Alnwick Garden).

When sustainable investing like this can offer solid returns, whilst tackling the world’s environmental and societal challenges, it’s a win-win. ● Winter 2020/21 — 15

BUSINESS PLANNING

Protecting small businesses James Bowman Wealth Planner James highlights some of the key risks that business owners may miss and explains what they could do to mitigate them.

How big a problem is a lack of small business protection?

Research from insurer Legal & General suggests that there are 5.7 million private sector businesses in the UK, the vast majority of which have fewer than 10 employees. Typically, they are owner-managed, with about 90% of them having fewer than five shareholders. Whether they are wellestablished, or brand new, the majority are being run to support the lifestyles of their owners and their families.

Many will rely heavily on one person, or a small group of people, to provide everything from the strategic direction, to sales account management and technical expertise. So far so good – many successful entrepreneurs and businesses thrive that way.

However, some consideration also needs to be given to what protection these small organisations have in place should something suddenly go wrong. In a worst case, a business that depends on just a few people, or perhaps only one, could quickly fail, leaving its owners and their families stranded financially. And whilst some people might argue that this is no different to a key family member losing a full-time job, it is often more serious. Finding another role, or setting up something else to replace a business that has hit problems, takes time, motivation, sacrifice, and effort. That is why having the right level of protection in place, based on proper analysis of all the “what can go wrong?” scenarios, is vital.

16 — Winter 2020/21

What sorts of risk can get missed?

Identifying and mitigating risk is all about achieving one goal – to keep a firm in business should something go wrong. With that in mind, there are four significant areas that need to be discussed.

Firstly, protecting profits. Most entrepreneurs, whether working solo or in combination, are understandably focused on growing a business and making money. They are the type of people who may not think too hard about what would happen to profits and cash flow were a key link in their management team to die, or fall very ill. A typical response is “we would just have to respond quickly”. However, they could also put some protection in place that might give them a cash injection designed to cushion the business. This could be vital in a situation where someone may be thinking about selling an enterprise – the last thing they want is a competitor taking advantage of a risk management gap by marking down their valuation.

A second potential problem is a sudden call on outstanding debt obligations. Most small businesses take on loans of some sort, whether direct from a bank, or via the directors as personal loans. The question is whether the business has the funds available to clear such debts. A capital call may get triggered via, say, the death, or illness, of a key individual who has offered personal guarantees.

Business protection in this instance is about making sure that a lump sum is available to clear the relevant loans and allow the business to continue.

Then there is ownership risk. Business owners are often well organised when it comes to thinking about what will happen to their own personal estate and assets should they die. However, they often leave a gap when it comes to thinking about what will happen to their firm if another key individual dies.

This is where a “business will” is very useful. Should an entrepreneur lose a partner, member or shareholder, the policy proceeds from the resulting protection arrangement can be used to ensure that the business has the funds available to buy out a deceased owner’s share. This helps to avoid a potentially tricky situation that arises when other family members, or relatives, of the deceased, may have little interest in or loyalty to, a business. They then look to raise capital via the sale of a stake in it to a third party, or even a competitor.

This may be anathema to a business founder, but if those people may need the money to meet their own obligations they will not necessarily view a valuable stake the same way.

The fourth risk relates to the direct impact of losing key people to death

PERSONAL VIEW

BUSINESS PLANNING

People often forget that whilst business relationships can work fine when things are going well, they can sour when they are not. For example, a small business might find itself taken off standard payment terms and moved to cash-on-delivery instead.

That could have a dramatic, or in some cases terminal, impact on cash flow.

How does business protection cover work?

or illness. A small business can quickly grow to the point where it may rely not just on its founder and CEO but also on other individuals, whether their expertise lies in sales, IT or legal.

Having a capital injection available at the point one of them is affected by a serious illness, or even dies, can mitigate the considerable stress, time and cost involved in replacing them.

All four protection scenarios ultimately share a common aim – to take the pressure off a firm’s management team at what could be a businesscritical moment.

Has the pandemic changed the way small businesses think about this?

I think it has focused many more people on their own mortality and what could go wrong were something to happen to them. Many of the entrepreneurs I encounter are well prepared on the personal side – they may have rainy day funds set aside and life assurance cover in place already. Plenty will also have thought through everything else from mobile phone cover to pet insurance.

Where I find gaps is in relation to their business, often because they have been too busy to give protection much thought or do not see the need for it. An example of a hidden challenge, that is all too easily missed, is where multiple business owners have different expectations and timescales, something that

may only become apparent when things go wrong and a stake in the business is in play. Another risk people miss is in understanding quite how unsympathetic lenders can get when a small company starts to struggle – to keep a lending arrangement, or overdraft facility with the business in place, for example, they may suddenly start asking for personal guarantees.

Business protection is about putting a policy in place that can offer some breathing space.

How should a business owner start this process?

By being honest about where the potential weakest links in their business are and then undertaking a formal risk audit. Once a founder understands, for example, that they are not the only critical business resource, we can start to identify their other risk exposures and quantify the potential cost of covering them.

Some of this is straightforward – we can work with a firm’s accountants to identify the value of business loans or overdrafts. However, things get more complicated when it comes to putting a value on a key individual’s contribution, which may equate to a multiple of annual profits.

We also need to go through other “what if?” commercial scenarios and weigh up the probability of them occurring and estimate how long it might take for a business to recover.

Whilst every case is different, in most we are talking about a form of life assurance that provides a lump sum, under certain specified scenarios, in return for a premium. The cost will vary according to factors such as the number and type of risks to be insured and the size of any potential losses.

Why would someone need an Adviser?

Entrepreneurs tend, by their nature, to be confident, optimistic and above all, busy people. They may not give much thought to downside risk or see the need to do so. Or, they may have started the process but not considered one, or more, of the four risk areas I mentioned earlier. In effect, they “don’t know what they don’t know”.

That’s where we come in. Having established the full extent of the various threats that a business could face, we can then review any protection that might already be in place. Whilst the chances of one policy covering off everything are slim, a good Adviser will aim to ensure that a business is neither under, nor over, insured. Unfortunately, busy people are sometimes sold policies that are not fit for purpose – they pay a lot of money for a plan that will never protect them properly. We can help to ensure that the right level of cover is put in place as early as possible, leaving our client safe in the knowledge that their worst-case scenarios have been identified and mitigated. ● Winter 2020/21 — 17

S P E C I A L S I T U AT I O N S

Moving on Peter Bate Portfolio Manager Peter highlights four stocks that should see further upside once the threat from the pandemic fades.

Many of the more cyclically exposed sectors have already rallied strongly in the wake of widespread COVID-19 vaccine optimism. However, we believe that some companies – in particular, those with exposure to transportation and the automotive sector – continue to trade on ratings that fail to price in the recovery we think may unfold in 2021. Here are four names to keep an eye on. Please note that none of them are covered by Killik & Co Research.

Redde Northgate – delivering value

achieving greater fleet utilisation and significant operational synergies.

In common with other companies exposed to transportation, the firm’s operations have been adversely impacted by the UK lockdowns.

On the Redde side of the business in particular, lower levels of traffic generated fewer incidents of accident damage needing repair. We expect a return to normal volume levels to take some time. However, we also believe that the recent acquisition of Nationwide Accident Repair Services, with the significant scope it brings for vertical integration, could offer synergies that are not fully priced into earnings expectations.

ratios, at around 75% of wholesale and 63% of retail, limiting the downside risk), for which it charges multiple fees which are paid off when the vehicle is sold. In aggregate, the gross yield on these assets is around 8%, with an average loan term of 130 days. DFCH’s lending product is in high demand; as at June 2020 the group had requests from existing dealer relationships for credit lines worth more than £1bn (of which £362m were approved and £165m utilised).

Recent trading at the Northgate division, on the other hand, is already strong. Indeed, the business has recovered to a point where it is operating above pre-COVID levels, with support coming from strong vehicle residual values and profit from disposals.

Redde Northgate is a mobility services business. It was created through the all-share merger of Northgate, a light commercial vehicle hire business that accounts for around 65% of combined group profit, and Redde, a vehicle credit hire and repair business, that contributes the rest. The rationale was that these two businesses, each with large vehicle fleets offering multiple touch points into the transportation industry, could together unlock better buying power with original equipment manufacturers (OEMs), whilst

18 — Winter 2020/21

Overall, with the shares trading below 8 times April 2022 expected earnings, and yielding around 7% (as at 18th December 2020) we see significant value and the scope for earnings upgrades as the recovery progresses.

DFCH – lending support DFCH provides “supply chain” finance to dealers in capital assets, ranging from motorcycles through to caravans and agricultural equipment.

In essence, the firm helps them to fund their forecourt inventory. It does this by buying vehicles from an OEM at a value that represents a discount to the wholesale price (with loan to value

Whilst the company has been constrained in the past by a lack of access to capital, this issue is now being addressed following the recent award of a banking licence. As a result, we see the firm benefiting from being able to extend more loans to its existing customers (as well as taking an enhanced interest margin) with its cost of capital now closer to 2%, having been as high as 6%. In short, DFCH is a very interesting lender. It has a low rating, in the context of its high growth and high returns potential, holds a strong position within its niche market and has an attractive funding solution in place.

We believe a key cause of the current valuation anomaly is down to the existence of a specific shareholder, Arrowgrass, with a 47% holding.

Having already had its life extended, this fund is, nonetheless, currently set to close on 31st December 2021.

Whilst we do not doubt that its life could be extended again, until the holding finds a long-term home we would expect some of the uncertainty hanging over the shares to linger.

Halfords – pedalling into profit

Halfords is a UK retailer with a focus on motoring and cycling products and services, which contribute about 66% and 34% of revenue respectively.

These are available through a portfolio of 451 stores. The group also operates 317 Halford Autocentres, which make it a notable independent operator in the highly fragmented vehicle servicing, maintenance, and repair category.

The key strategic focus of the group is to become more service-led. From a financial point of view, this route offers higher margin revenue streams that are more recurring in nature.

It also reduces the firm’s foreign exchange exposure, given that it currently buys significant amounts of the products it sells across its various retail categories in dollars from China. From a customer experience perspective, the strategy provides a clear differentiator over pure online retailers and non-specialists, which

PERSONAL VIEW

generally operate a transaction-led model and engage in a “race to the bottom” on price.

Halfords has performed very well operationally over the coronavirus lockdown period thanks, in part, to a UK cycling boom. This was boosted by the widespread desire for a safe form of transport in the wake of the pandemic, plus some persistently good weather. Classified as an ‘essential’ retailer, the firm was able to keep around 70% of its shops and over 90% of its Autocentres open. And by effectively operating its shops as “dark stores” (i.e. “click and collect” hubs), they could be serviced with significantly less staff than usual.

We envisage the company employing the same model again, should there be another nationwide lockdown.

We still see significant value in Halfords at current levels, with the shares trading on a calendarised prospective price to earnings multiple of less than 10 x December 2021 earnings. This compares favourably to other specialist retailer “Category Killer” peers, such as Dunelm, Pets at Home and JD Sports, which trade on an average multiple of more than double this level. It is rare to see such a valuation anomaly associated with a larger company.

Cambria Automobiles – revving up Cambria Automobiles is a car retailer, which trades through 19 brands across 29 locations in the UK. The company was originally established to undertake a “buy and build” strategy, with the rationale being that, over time, the UK car retail market would consolidate down into a much smaller number of larger, professional and well-invested operators. We expect this theme to gain pace in the wake of the pandemic, as the larger, listed operators, with access to capital, accelerate their market share gains.

During the nationwide lockdown, the company’s entire estate was closed

S P E C I A L S I T U AT I O N S

for eight weeks. That equates to around 19% of the trading weeks available in the year, so it is not surprising that overall reported revenues dropped by 20%. However, whilst the timing of showroom openings was outside of the control of management, they were able to contain costs via a number of initiatives, such that operating profit only fell by 4.4% for the year.

The ratings of automotive retailers have always been limited by their perceived cyclicality. Yet, we would argue that Cambria’s proven ability to protect its profitability, during what will be viewed as one of the worst trading years ever seen across a number of consumer-facing sectors, supports a reappraisal (particularly given that around 80% of new and 60% of used cars are sold under finance agreements that typically have a 3.5 year lifespan). Aside from appearing very cheap on an earnings basis, the company also has significant asset backing in the form of freehold property – £81.3m worth equates to 81p per share, versus a current price of 62p. It is also interesting to note that the company is around 45% owned by insiders. Whilst we would argue that access to external capital is important, we also believe that a private equity backed management buyout (MBO) should not be ruled out, given the low valuations across the sector. ●

Winter 2020/21 — 19

GUEST INTERVIEW

Making the right choices John Grove Executive Head Teacher John shares his insights around developing young people, gleaned from a successful teaching career, and reflects on his long tenure at Belleville School SW11, close to the House of Killik on Northcote Road.

What first inspired you to go into teaching?

I was fortunate to grow up in a family that prioritised education. My father never got the chance to pursue his formal schooling beyond the age of 14, but that made my parents even more determined to support our education as children.

was always going to be a primary, rather than secondary, school.

Moreover, I wanted an environment where I would be challenged and could also make the biggest impact.

That philosophy has stuck with me throughout my career, which is probably why I have established my reputation as something of a turnaround specialist.

When I started at Belleville School in London’s Battersea area around 20 years ago, for example, about 90 children arrived in reception class, yet five or so years later up to half of them had left. Parents were actively choosing not to send their children to the school even though it was convenient, and the area was becoming gentrified. Fortunately, by then I had established my track record at other London schools as someone who could drive change and so I was entrusted with doing so here again.

His early experience influenced my subsequent decision to go into teaching, which was rooted in my already firm belief in social equality and every child’s right to succeed.

After all, we all only ever get one chance to be at school and teaching offered me the huge privilege of being able to help children to maximise that opportunity.

Do you have a recipe for success?

I was always sure that I did not want to specialise in one subject, such as English or Maths, so my natural home

Yes, I would say so. For me, three key ingredients go into making a good school. Firstly, there is the building,

over which I only have limited control.

Then there are the children, and their parents who choose whether to send them to you. Thirdly, you have the teachers and the educational process they can offer. It is this last ingredient that I have the most direct influence over. Get that right and the second one starts to take care of itself. As consultants McKinsey & Co put it in 2007, “the quality of an education system cannot exceed that of its teachers.”

I therefore see the most important job of a head teacher as overseeing the recruitment, development, and retention of excellent teachers.

At Belleville school, we now use a “three circles” model. The first one encompasses recruiting and retaining the right people, the second is all about getting the systems and structures right, so that the learning environment is as comfortable as possible, and the third is focused on training our staff. We pride ourselves on our professional development processes and I am always clear about what I expect from my teams and how I will help my staff to meet their objectives. A key component of this is an open two-way dialogue and continuous monitoring.

What sorts of people do you recruit?

It may sound simplistic, but I really do try to bring in the best teachers.

I am not looking for experience in a particular subject because advertising for, say, a maths teacher can knock other good candidates out of the process. Instead, I want people who can teach across the board. Having identified them, we then watch them 20 — Winter 2020/21

GUEST INTERVIEW

Parents also know who is doing a good job, or struggling, and will happily tell me. The upshot is that poor teachers cannot hide for long – they will be found out by the children, their parents, or their peers. On the flipside, get this job right and it is undoubtedly one of the most rewarding ones anyone could choose to do.

How do you judge a school’s success?

teach and give detailed feedback.

They are often surprised at how advanced our pupils are these days and sometimes pitch a trial-run at the wrong level as a result. That is fine, provided they are self-aware and honest enough to recognise it.

I do recruit quite a few young teachers because they are often the most willing to learn and happiest in this environment – my schools are not for jaded types who want to sit in a corner and be left alone!

As for what makes a great teacher, it often comes down to that intangible thing called “presence”. Some people just walk into a classroom and command attention and respect.

Others will plan incredibly hard and then vanish the moment they go through the door. It is relatively easy to tell the two apart – you simply watch the children while they are teaching.

The bottom line is this is a job that you have got to want to do. At the risk of offending people who do not teach, that is not the case in many other careers. I am sure that being a tax inspector, for example, is demanding, but I am equally certain that they can have an off-day without too many people noticing. That is not true when you are in front of 30 children.

Popularity is one metric – in short, do people want their children to come to my schools, or not? If I look at a typical year at Belleville, after sibling places and so on have been allocated, there might be 60 left for new children but a waiting list of over 300 applicants. It is a huge honour to have that sort of demand. Of course, for the parents who miss out on places, it can be hugely disappointing. That is why I have tried to expand capacity at the school whenever I can, with the caveat that we maintain standards.

We also monitor why children are leaving us. There are a host of reasons, apart from the obvious one when they reach secondary school age. It could be that their parents always wanted to send them to a private school from the age of 8 and are happy to save a few years of fees with us first. Or it could be that they are leaving the area and moving away, or abroad. What matters to me is that all children and their parents feel able to move on in complete confidence.

The subsequent success of our pupils at secondary school is, I think, testament to that.

What aspect of your role do you most enjoy?

Watching growth, both in terms of individual pupils and the overall popularity of the school. I have been in teaching long enough to have known some children before they were even born because I got to know their parents first, often via a sibling.

Some of the children I met when I first

arrived in this area are adults now.

That continuity of contact via their families is one of the biggest personal rewards of my job.

What do you like the least?

There is not much about the job that I actively dislike, nonetheless some aspects are more challenging than others. Although I have done it several times, improving a school that is struggling is always tough going in the early stages.

Another frustration is the staff retention barrier we hit quite often in Battersea. It is an area that few young teachers can easily afford to live in, once they decide to settle down and perhaps start a family, so inevitably that means our staff turnover is higher than I would ideally like. On the flipside, new teachers bring in a welcome stream of fresh ideas and energy and most rise quickly to the standard I expect.

How important are parents to the education process?

They are vital. Although we all try to give children choices, the reality is that decisions about schooling are usually taken by their parents. We are fortunate in that we have a highly motivated group of them here who know what they want and are prepared to support us in trying to provide it. For example, we are always grateful for the huge efforts made by the PTA, and local businesses such as Killik & Co, when it comes to supporting events and raising funds. Equally, if we do not provide a particular club or activity, a group of parents will typically try to get it started.

Most importantly, happiness and success for all children starts at home.

As a state school, Belleville is not run as a crammer for purely academic success – we like to think that all children here are given the opportunity to make the most of their time with us.

Without love, engagement and support from their parents, that would be much harder to achieve. ● Winter 2020/21 — 21

OPINION

Settling the bill Matthew Lynn Columnist and Author Matthew discusses the best way to tackle the huge cost of dealing with coronavirus.

2020 will be remembered, amongst many other things, for being eye-wateringly expensive for the government. According to the Office for Budget Responsibility (OBR) the furlough scheme used up £73 billion.

Another £66 billion went on grants and loans to businesses that were locked down. Meanwhile, the NHS and other public services needed an extra £127 billion to cope with the pandemic.

Even the summer’s half-price pizza deal – otherwise known as ‘Eat Out to Help Out’ – ended up costing £849 million. In short, over the last ten months the government has spent money on a scale unprecedented in peacetime, just as the deepest recession in a century created a shortfall of around £100 billion in tax revenue. The obvious conundrum, as we head into 2021, is how the Treasury will pay for all this economic support.

deliver higher rates. Some business owners, landlords and second homeowners are starting to take action as a result. Rumours have also emerged that the self-employed, many of whom already feel they were left out in the cold during the crisis, may find themselves paying the same tax rates as employees. The perennial pensions debate, around whether higher earners should receive extra tax relief on their contributions, has resurfaced too. Then there are the many possible direct tax increases connected to delivering climate change reforms. I could continue to speculate, but one thing is clear – the Treasury seems intent on squeezing more cash out of a shrinking economy.

This, however, is the wrong approach because tax rises could crush any recovery. Many businesses that have struggled their way through lockdowns and social distancing restrictions, cannot afford to pay more. Meanwhile, consumers who are already worried about losing their jobs will simply tighten their belts further.

Besides, the UK already collects almost 37% of its GDP in tax, close to a record high – if the government tries to levy yet more, we may hit the point where higher tax rates result in lower overall revenues. That is why I think the Chancellor should make two very different moves.

Gearing up

Taxing times Plenty of hints are being dropped about tax increases, once the COVID-19 epidemic is finally over. For example, a review of Capital Gains Tax is already on the way, which is likely to 22 — Winter 2020/21

Firstly, he should re-define how much debt we can afford to carry as a nation. We live in a world where interest rates are close to zero, and are likely to stay that way for a generation or more. Any country with its own currency can therefore carry a lot more debt, as a percentage of GDP, than was perhaps previously thought possible. Japan, for example, has already gone past the 200% debt-to-

GDP mark, and yet its financial system has not collapsed. A rise in the UK’s national debt to 110%, or even 120%, of GDP should not therefore spell the end of the world. That said, for this reset to work, the Chancellor needs to set out a clear borrowing framework.

He must explain where the new upper limits are, and how they have changed, so that the ratings agencies and the wider markets are not thrown into panic mode. Given that every other developed country will be doing a version of the same thing, the risk of a flight from sterling should be small – there are increasingly few places left for it to go.

Boosting growth Secondly, he must aggressively support growth. To stand any chance of recovering quickly from this crisis and bringing unemployment back to normal levels within a few years, the UK economy needs to expand a lot faster than it has done over the last decade. How? Cutting Corporation Tax, to the point where it is at the most competitive level in the developed world, would be a good start. That will encourage a wave of inward investment and give some respite to beaten-down firms here.

The UK also needs to launch an aggressive round of deregulation.

Outgoing US President Donald Trump had the right idea when he stipulated that two rules had to be repealed for every new one introduced. He grasped that the liberalisation of domestic markets lies at the heart of driving growth. Our own departure from the European Union may offer the UK just such an opportunity to make radical changes to our regulatory landscape, provided the government can seize it. If they do, Brexit Britain could be well placed to bounce back from COVID-19. ●

Q U A R T E R LY R O U N D U P

Looking forward Rachel Winter Associate Investment Director Rachel sums up the key takeaways from an eventful final quarter of 2020, as we start a new year.

Biden time Markets entered the last three months of 2020 on a jittery footing. As the US presidential election loomed, the polls showed a tightening margin between the two candidates. Sure enough, following a record voting turnout, Donald Trump fared far better than predicted, achieving the second highest number of votes ever received in a US presidential election after the winner, Joe Biden. A disappointed Trump has been questioning the result ever since.

Nonetheless, in broad terms, markets reacted well, largely because the Democratic Party failed to secure control of both the House of Representatives and the Senate.

That will make major changes to legislation tricky. Biden may struggle, for example, to roll back Trump’s tax cuts. Sanguine investors were therefore reassured by the prospect of “business as usual”. They may, however, note that two Senate seats will be contested in Georgia during January. Whilst the Democrats are unlikely to win them both, should they do so, they would effectively gain control over both houses.

Reacting to vaccines Markets were given another reason to rally sharply when pharmaceuticals firms Pfizer and BioNTech announced positive clinical trial results for their coronavirus vaccine in November.

Further good news followed from Moderna and AstraZeneca. As a result, some of the previously hardest-hit areas of the stock market, such as the travel and leisure sectors, have rallied, albeit they remained down heavily in December on an annual basis.

Conversely, some of the biggest beneficiaries of lockdown, including Zoom Video Communications, Ocado, and a host of DIY firms, lost ground on the back of the vaccine news as investors mulled the possibility of a return to some sort of normalcy.

Newsworthy as the fourth quarter was, markets were less volatile than they were earlier in the year and December’s FTSE reshuffle triggered just two changes: the relegation of Homeserve and the promotion of Pershing Square Holdings. This was a far cry from June’s which featured eight changes.

Reducing pollution The fact that the global transition towards renewable power is likely to accelerate with the election of Joe Biden provides a fillip to Prime Minister Boris Johnson’s recent announcements on the subject. He wants the UK to generate enough wind power to service all our homes - which account for around one third of national power consumption - by 2030. The construction of the world’s largest wind farm has now started at Dogger Bank, just off the east coast of England, as a joint venture partnership between Norway’s Equinor (formerly Statoil) and UK utility SSE. Johnson’s 2030 vision also includes a ban on sales of new petrol and diesel vehicles, a target that will necessitate huge upgrades to our electricity grid and charging networks. As such, this is another space we are watching closely.

Keeping ahead 2020 has been a year of great change.

As thematic investors, we strive to pinpoint the big trends that will define the next decade and to identify the potential beneficiaries early. However, we also never lose sight of the firms that have survived for decades and continue to flourish by demonstrating extraordinary levels of innovation and a willingness to change.

The dangers that lurk for the unprepared were made all too clear by the demise of Arcadia at the start of December. The company began the millennium riding high on the wave of fast fashion but has now fallen into administration. That is down, in no small part, to a failure to invest in its online infrastructure.

By contrast, several constituents of the US S&P 500 index are thriving, having been in existence for over 100 years. Investment bank JP Morgan, for example, can trace its roots back to Alexander Hamilton, and is now the biggest bank on Wall Street.

Meanwhile, FMCG stalwart Procter and Gamble was founded by a candlemaker and soap manufacturer in 1837 and is now the largest consumer goods company in the world. Similarly, Abbott Laboratories began life in 1888, as a producer of plant-based painkillers, and has since grown into an international medical device manufacturer and major producer of coronavirus testing kits.

Entertainment giant Disney deserves a mention too (see also page 9). At the grand old age of 95, it heads into 2021 with over 85 million subscribers to its new Disney+ streaming service.

In summary, 2020 demonstrated that massive disruption often also creates opportunity, in the old investing world and the new. This year, we will continue to seek out the best of both. ● Winter 2020/21 — 23

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