Equity market volatility

The failure of Silicon Valley Bank catalysed a return to equity market volatility which had been more muted since the start of the year.

The equity market volatility is a reprise of the experience we had for much of 2022 but with a key difference; sector leadership has switched from cyclical value sectors such as Energy, Materials and Banks which drove the market in 2022, to broader sectors such as Industrials, Consumer Discretionary, Financials and TMT which have been the relative winners so far this year.

Our fundamentals-focused private equity approach to public markets means that we avoid more cyclical sectors such as Banks, Mining and Oil & Gas. We avoid cyclical sectors because large external factors such as commodity prices and interest rates drive profitability and, ultimately, share price performance rather than fundamentals making them unpredictable and volatile. As such, 2022 proved to be a tough environment for us to outperform peers who had exposure to these areas. We prefer to focus on businesses that we view as having resilient, strong balance sheets, where the fundamentals are robust. We prioritise operational visibility and look for situations with characteristically strong management teams which can be the key determinant of business success and shareholder returns.

In 2020 those cyclical sectors, as previously highlighted, demonstrated significant volatility. The volatility led to large dividend cuts driven by factors completely outside of the control of management teams. Factors included the dramatic fall in the oil price and increased political pressure on banks to halt pay-outs to shareholders. Fast forward to 2022, the Ukraine conflict pushed energy and commodity prices higher while central bank tightening drove up interest rates. In turn these factors drove the profitability and share prices of the same sectors giving our strategies a relative performance headwind as we missed out on the short-term upside.

In contrast today, materials has been the worst performing sector in the year to date as recessionary fears have resulted in a reduced demand for commodities. Energy stocks have suffered as oil and gas prices have sharply moderated. Recent concerns about liquidity in the Banking sector has led to a sharp de-rating of these shares and shone a light on the inherent volatility and risks for equity shareholders in this sector once again.

Our funds provide investors with the potential for return streams that are largely uncorrelated to the wider market and peers¹. In times of heightened uncertainty diversification can be beneficial for portfolio composition. We seek to deliver attractive long-term returns but we also value consistency and lower volatility. We believe greater transparency in the underlying fundamentals of the companies we invest in could have the potential to deliver greater predictability in dividends and total shareholder returns for our investors. This is the key reason why we avoid Energy, Materials and Banks, as well as loss makers and early-stage binary opportunities no matter how tempting the short-term outlook may seem.

1. Source FE fundinfo, March 2023

Ken Wotton
Managing Director, Public Equity

All opinions expressed are the authors own and not necessarily those of Gresham House.

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Key risks

• Past performance is not a reliable indicator of future performance
• Capital at risk
• Funds investing in smaller companies may carry a higher degree of risk than funds investing in larger companies. The shares of smaller companies may be less liquid than securities in larger companies
• The opinions expressed are those of the investment team, are correct at the time of writing and are not to be construed as investment advice

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