March saw a continuation of the market trends in February, with attention focused on the prospects for economic recovery, as COVID-19 vaccinations gathered pace. In the UK, 50% of the adult population has now received a first dose. In the US there was also a lot of attention on the large stimulus package signed by President Biden. US bond yields rose again, taking bond prices down, and delivering their worst quarterly performance in decades, whilst most equity markets posted further gains.

The FTSE All-Share Index gained 4%, including dividends, cementing a 40% rally from the trough a year earlier. In general, companies on lower valuations outperformed those on higher valuations, as the “value” style outperformed the “growth” style. The strongest performing sectors included cyclicals like housebuilders and construction, but also defensives like tobacco and telecommunications. The worst performing sectors included financial services, mining and oil & gas.

Portfolio performance was significantly above the benchmark’s 4% return and the Trust’s NAV total return over the month was 9.4%. The biggest contributions to outperformance came from IG Group, DFS Furniture and Imperial Brands, which were three of several investments which produced double-digit total returns. The portfolio also benefitted from not owning London Stock Exchange plc, which fell by 28%, holding back the index return. There were few significant negative contributors to performance, but Diversified Gas & Oil and Conduit Re both fell back, and not owning Unilever made the biggest single impact, as that share rallied by 9%.

The Merchants Trust was originally established, in 1889, to invest in North American railroads and other international opportunities. In recent years, however, it has invested exclusively in companies listed on the UK stock market, although many UK-listed companies are multinational enterprises with a large proportion of their underlying sales and profits coming from overseas. In March, the board decided to allow the Trust to invest up to 10% of the portfolio in companies listed overseas, as mentioned in the latest annual report. The opportunity set of large, high yielding companies has become more concentrated in the UK in recent years. Introducing a limited amount of international investments will enable us to diversify the risk profile of the portfolio and, in particular, to diversify the income profile. This will help us aim to continue meeting the key objective of providing a rising income stream to shareholders, without taking excessive risk, and without compromising the fundamental qualities of the companies we seek to invest in.

We made the first overseas investments in March adding four new companies representing just under 4% of the portfolio. All four companies pay high dividends. Two of these, Scor and Swiss Re are insurance companies with a bias towards reinsurance.We believe that this could be a good time to invest in the reinsurance sector, as prices are rising and profitability is expected to recover following several difficult years in the industry. Sanofi is a diversified pharmaceutical company which also owns vaccine and consumer health businesses. The sector has de-rated in recent months and Sanofi is very modestly valued. Finally, we added a small position in Total. This energy company has announced a clear plan to transition the business towards a net zero emissions company, including building a large renewable generation portfolio, and will soon change its name to TotalEnergies to mark this transition. The company has been well managed in recent years and has not cut its dividend during the pandemic.

These purchases were funded by taking money out of shares that had performed well in recent months, moving closer to fair value. Some of these are businesses where share prices had more than doubled from depressed levels during the pandemic, including Barclays, Kin & Carta, ITV and Entain. Others are more defensive businesses that had delivered solid operating performance, such as PZ Cussons, Stock Spirits and Tate & Lyle. We sold the remaining position in the shopping centre owner Hammerson. Whilst this has been a disappointing investment overall as the company has been hit hard by the pandemic, the shares have performed well since we supported the rights issue last summer. We also sold most of the BT shareholding, for a decent profit, reflecting the company’s higher valuation and a moderation in our investment view.

We added one other company to the portfolio, Relx; a provider of science, medical, legal, risk and other information and services to professional and business customers. Relx has strong market positions and has made high returns. The company has a good record of growth across its operations, which could accelerate as the business mix improves, and it also stands to benefit from a recovery in the exhibitions business, which was heavily impacted last year.

Despite the recent recovery in the UK stock market, valuations are reasonable compared to history and cheap compared to global markets. There remains a high level of dispersion in valuations, creating opportunities to buy strong businesses at attractive prices. Whilst we retain a bias towards lowly valued shares, the recent strong market rotation towards many “value” stocks is creating opportunities to switch money, selectively, into higher growth or better quality companies at sensible valuations.