CITS Investment Update | Russia/Ukraine

CITS Investment Update | Russia/Ukraine
  • Investment Insights
  • 6 minute read

The impact of the Russia-Ukraine crisis

Russia’s invasion of Ukraine has added another troubling dimension to markets already grappling with the prospect of higher interest rates to tackle surging inflation in many Western economies. The conflict has provoked volatile trading as investors take stock.

The humanitarian crisis is heart-breaking and our thoughts are with those affected by recent events.

It is still too early to predict with any clarity how the war will affect the global economy. Equity markets, somewhat counterintuitively, have seen limited impact from conflicts since World War II, recovering early losses in short order. To date, we have seen a similar story play out.

Insignificant portfolio exposure to Russia-Ukraine

Within the Close Inheritance Tax Service (CITS), we own no companies domiciled in Russia or Ukraine, or which conduct significant business there. That said, many companies have supply chains that span the world or a global sales presence, and it is therefore impractical to have zero exposure to these economies. Within the largest 20 portfolio companies (representing 65% of the assets in the CITS), we estimate that our exposure to the crisis is de minimis, with approximately £2m (or 0.03%) of turnover being directly derived from the region.

Has the war changed our outlook?

The invasion has decreased risk appetite and we would expect more volatile equity markets as a result. Inflation is set to push higher than originally forecast and persist for longer. This is unlikely to alter central banks’ intention to continue raising interest rates. The pace and scale of rate hikes still look set to be the defining forces in financial markets this year.

We must also acknowledge that by invading Ukraine, Russia has crossed the Rubicon and the current economic confrontation with the West could broaden into a range of potential outcomes. In the short term, the consequences of further supply chain shocks (particularly in oil, gas and agricultural commodities) are yet to be fully seen. Looking further out, the effect of the conflict on consumer and corporate confidence, and therefore demand, represents a further unknown, as does the impact on the wider geopolitical landscape. We will remain vigilant and continue to draw on the wider expertise of our sizeable investment team here at Close Brothers Asset Management.

Quality on sale

Over the first two months of the year, the performance of the average CITS portfolio has been resilient.

Indiscriminate sell-offs frequently ignore company fundamentals, creating opportunities for us. Our proprietary financial models allow us to quickly identify stocks which we feel have fallen too far in panicked markets. Many companies, hitherto trading on price to earnings multiples that in our view were unjustifiably high, have de-rated and are back within reach on valuation grounds. RWS Holdings, a global leader in technical and intellectual property translation services, is a good example: until last week, we had not bought it for new clients for over a decade. We have also been buying core holdings - perhaps more familiar in clients’ portfolios - at levels we feel offer prospects of growth at a reasonable price. Next Fifteen Communications (a PR consultancy to blue chip clients including Apple, Microsoft and Google), Strix (safety controls for kettles and water purification technology) and Alliance Pharma (consumer healthcare) come to mind. Elsewhere, during better trading days, we have taken the chance to prune those smaller holdings in which we have lost conviction, selling Joules after spiralling supply chain problems led to a profit warning.

Left behind by the pandemic

Beyond the immediate horror of war, we should not forget that there are pockets of the UK economy that have yet to fully bounce back from the pandemic. As governments’ efforts to contain COVID-19 come to an end, reflective that the virus is now endemic in the global population, investors’ focus will shift to those companies whose earnings have been slower to recover. We feel well positioned to benefit from this change in sentiment. The re-opening of more leisure venues should be positive for Johnson Service Group, the UK’s leading supplier of workwear and linens for the hospitality, retail and catering industry. The severity of the real-income squeeze during a period of high inflation should benefit H&T Pawnbrokers, asset-backed by a large pledge book of gold. The withdrawal of Government support schemes and tougher trading conditions ought to boost demand for Begbies Traynor, the insolvency practitioner. Both are counter-cyclical stocks, providing a hedge against worsening economic conditions. Elsewhere, Ramsdens’ travel FX business should revive as pent up demand for holidays is satisfied.

Slowly does it

In our experience, it pays to have a disciplined investment process with a long-term investment horizon. This is particularly true in times of market stress, where share prices react more aggressively to news flow from companies. We are investing clients’ capital at a more measured rate, cognisant of the heightened stock specific risk while balancing the aim of achieving Business Property Relief as quickly as possible. We are confident that this will serve investors well as we build diversified portfolios with around 30 holdings.

As ever, March represents a very busy reporting period for companies. We look forward to a continuation of the positive updates that contributed to a strong performance from the Service last year. Reflective of market conditions, this may not lead to immediate responses in terms of share price movement. That said, it does mean that we are seeing a wider opportunity set of quality companies, trading at attractive valuations, for consideration in portfolios. In spite of the current backdrop, we are cautiously optimistic of achieving good returns over the coming years.


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