A year after the coronavirus pandemic first rocked markets, there was a clear change in market sentiment in February. With evidence mounting that vaccines are proving effective at reducing the spread of the virus and the rate of hospital admissions, there was rising optimism about the economic outlook. Bond markets reacted to improving prospects and the risk that higher commodity prices would stoke inflation. Bond prices fell sharply, as yields rose, with the US ten-year bond yield hitting 1.5%, before pulling back on the last day of the month. In the UK 10-year gilt yields more than doubled to 0.82%.

Equity prices moved in the opposite direction to bonds, with the FTSE All-Share index giving a total return of 2%, with small and mid-cap companies rising more than larger companies. Within the stock market, there was a definite pro-cyclical bias. Banks, which benefit from higher interest rates, led the market. The banks sector, along with travel & leisure, life insurance, mining and oil & gas producers, all made double digit gains, whilst defensive sectors like food retail, personal goods, electricity and pharmaceuticals fell between 7-10%.

The portfolio outperformed the stock market, with stock contributions mirroring this theme. Barclays shares were up over 20%, and the portfolio also benefitted from not owning Unilever or AstraZeneca, which both underperformed. On the other hand, the biggest negative contributions came from the defensive stocks SSE, Imperial Brands and GlaxoSmithKline, which all underperformed. Against this strong background the Trust’s NAV total return over the month was 5.5%, well ahead of the 2% return from the index.

There were no new investments or complete sales. We took profits in shares that had appreciated significantly in recent months, and were less attractively priced, such as Stock Spirits, PZ Cussons and Barclays. This money was recycled into shares that remained very attractively valued, such as the housebuilders Redrow and Bellway and the asset manager Man Group.

The UK stock market is one of the cheapest major markets and remains highly polarised. As a generalisation, companies offering higher growth and those often referred to as higher quality - making high and more stable returns on capital - trade at a substantial premium to the rest of the stock market. This creates excellent stock picking opportunities, as many perfectly sound companies are significantly under-priced.

The portfolio is invested in a collection of modestly priced yet fundamentally strong companies, exposed to supportive end market themes. It is diversified across industries, geographic exposures and economic cyclicality. We believe that this portfolio is well positioned to deliver a combination of above average income and total returns.

Active Engagement

We believe in active engagement with companies on environmental, social and governance (ESG) issues, on behalf of shareholders. Not only do we want to understand how businesses assess risks, such as climate change, we want to encourage them to reposition their businesses to address this, and other issues. A recent meeting with the management of Shell highlights the complexities of the issue of climate change, and how the big energy companies can be important, probably essential, players in the transition to a zero-emission future, whilst driving profitable business opportunities.

Shell markets approximately 5% of the world’s energy, almost three times the energy it actually produces. Over 90% of related greenhouse gas emissions comes from their customers’ use of this energy, not their own. Shell has many of the vital capabilities to help those customers cut or offset their emissions and is committed to achieving a net-zero emission business by 2050. Consider a couple of examples. To transition trucks to “green” (zero emission) hydrogen power, assuming the technology can be developed, requires a massive expansion of hydrogen production and scale businesses, that can distribute huge quantities of gas, and supply it at thousands of convenient locations around the world. But it also requires the balance sheet and capability to manage and hedge commodity risk and negotiate contracts with large users, not to mention working with governments to promote appropriate regulatory and taxation policies.

Another example to consider, is large industrial users that need huge amounts of heat and power. It may not be realistic or even possible to supply them with totally renewable power. There may need to be “offsets”, where carbon dioxide is pumped into underground caverns to neutralise the greenhouse impacts. The energy companies are in an almost unique position of having many of the technical capabilities, capital, people and underground storage locations to perform these tasks.

If the large energy companies, like Shell, are not involved in these activities, the energy transition will likely take longer and be harder to achieve. Just as the electricity utility SSE has transitioned from running coal fired power stations, to operating one of the UK’s largest wind and hydro powered generation businesses, we think the big energy companies will move, in time, from being seen as part of the problem to an essential part of the solution to climate change.