John Armitage reflects on Q1

John Armitage’s Egerton Long-Short Fund reported gains of 6.3% in Q1 bringing it’s long term net annualized return since 1994 to 14.0%. These numbers compare favorably to respectively 5.4% and 6.9% for the MSCI World TR index. The quarter’s result has been achieved with a net exposure to equity markets of only 58%.

Armitage is ‘moderately satisfied’ with the Q1 result which was driven by the relative outperformance of the fund’s long positions. While shorts were loss-making, they appreciated markedly less than their longs.

Armitage expects the muted US economic revival to continue with, perhaps at some stage, some modestly stimulative policies boosting prospects. He expects the Dollar to remain relatively firm as inflation is trending a little higher and the Fed’s anticipated rate rises are likely to sustain. If the US can remain on its modest growth track, economies worldwide can continue to heal.
The problem Armitage faces is that this benign scenario seems embedded in today’s markets with its high valuations. And there are some real risks. The emergence from historical lows in interest rates may not be benign and steady but volatile. And the French elections and populism produce low probability but very negative outcomes.

So whilst the economic backdrop is reasonable, Armitage is struck by how many mediocre business, with poor quality earnings and limited revenue growth, trade a historically high multiples. It explains the fund’s short exposure of c. 45% which for their standards is high and around its historical maximum.

Armitage points to the fact that a key cause of low nominal growth rates worldwide is the pervasive and deflationary/disruptive impact of technology on many sectors and business models. Stimulus cannot change this. The team therefore favors businesses with revenue visibility and growth drivers which are independent of stimulus or a cyclical upturn.

Armitage describes several individual investments in his Q1 letter, one of which is the newly initiated position in Applied Materials, a worldwide semiconductor capex industry leader. He also writes about the position in AIA Group, which he started buying in Q1 2016 and has been increasing since. The letter finally discusses the fund’s US Packaged Food shorts. It is a category of companies that hitherto generated resilient compound growth, but in Armitage’s view is facing a variety of structural challenges. Consumer preferences are shifting towards healthy, fresh and natural food and digital marketing, social media and e-commerce have eroded the scale-related barriers to entry. An increase in the availability of third party manufacturing and distribution has also worked to help new entrants. These developments have caused a persistent decline in volumes for the US packaged food companies. Valuations, in Armitage view, have decoupled form these deteriorating fundamentals. As a result of QE investors were led to favor yield and ‘defensive’ long duration assets driving these companies’ share prices up regardless.