- NAV down 28% and shares down 35% in 2022
- Most of the damage caused by rising rates
- Pledge to stick with quality despite short-term pain
Simon Barnard, the manager of Smithson Investment Trust (SSON), began his 2022 shareholder letter by holding up his hand and admitting that while it is impossible to outperform the market every year ‘the extent of the poor performance this year was particularly painful’.
Smithson shares gave up 35.2% in 2022, even more than the 28.1% decline in NAV (net asset value) and a significantly worse return than that on UK bonds, which lost 15%, and global small and mid-cap equities, which lost 8.7% over the same period.
WHY DID THE TRUST UNDERPERFORM?
Last year was characterised by the acceleration of inflation and the realisation by central banks that price pressures were no longer ‘transitory’ but constituted a threat to the global economy.
This in turn led to aggressive interest rate rises - spurred by the invasion of Ukraine which added to upward pressure on energy prices - which had a ‘profound’ effect on future interest rate expectations.
Barnard borrows from Warren Buffett in stressing the significance of rising rates on stocks and bonds: ‘Interest rates are to asset prices like gravity is to the apple.’
Higher rates mean the present value of future cash flows falls, causing a reciprocal fall in the value of long-dated assets, and given the trust’s focus on high-quality companies - which grow their earnings faster than the market and whose value is mostly linked to their future cash flows - the value of its holdings fell further than the market.
However, not all the underperformance was caused by external factors, admits Barnard, with the failure to exit overvalued stocks such as Australian fast-food operator Domino’s Pizza Enterprises (DMP:ASX) and US cybersecurity firm Fortinet (FTNT:NASDAQ) also partly to blame.
WHAT ABOUT THE OUTLOOK FOR 2023?
‘While recession holds some trepidation for us, the quality of the companies held in the portfolio, including their lower level of cyclicality and generally strong balance sheets, should enable them to weather the storm better than other companies in the market,’ says Barnard.
Moreover, due to their high gross margins, low capital requirements and strong competitive positions, the trust’s portfolio holdings should be less negatively impacted by high inflation than other companies if price pressures persist.
‘So, what next? While we would like to say that all the poor performance is behind us, there is no guaranteed way to tell what is ahead,’ says Barnard.
‘We continue undiscouraged with our strategy of buying high quality, growing companies. Although style drift - the act of becoming less disciplined in the execution of your original strategy in an attempt to make money in all periods - may sound attractive after a year like 2022, it’s only a short while before your North Star becomes so clouded by opportunism that you end up far away from a cohesive strategy and no longer know what type of investments you are looking for. Be assured, this will never happen at Smithson.’
Smithson shares traded 1% lower at £13.86 at midday.
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Disclaimer: The author (Ian Conway) and article editor (Daniel Coatsworth) own shares in Smithson Investment Trust
