US Multi-Cap Income Investment update - Silicon Valley Bank Collapse

The collapse of Silicon Valley Bank (SVB) on Friday sent shockwaves through financial markets. The rapid decline of such a large financial institution, the 16th largest bank in the US at the time of its failure, raised questions about the causes of its insolvency and the implications for the wider banking system.

The unwinding of SVB

 SVB experienced very strong growth for more than a decade. A high proportion of SVB's customers were technology companies and this helped fuel this rapid growth, but ultimately played a significant role in the bank’s demise. After strong performance through the pandemic, the technology sector slowed in 2022 causing many firms to withdraw funds deposited with SVB. At the same time, SVB had invested a significant proportion of client deposits in bonds. When the Federal Reserve began increasing interest rates, this caused a sharp decline in the value of SVB’s bond portfolio. 

On Wednesday, SVB announced the sale of the bond portfolio, at a huge loss, to provide much-needed funds, and this was paired with a plan to raise capital through an equity sale. This announcement caused a stampede and by the end of Thursday SVB clients had tried to withdraw $42 billion. California’s banking regulator stepped in on Friday to shutter SVB. 

The importance of quality 

This incident reminds us of an axiom that we believe stands investors in good stead, ‘unexpected events occur frequently’. We believe the best defence to protect portfolios against these unexpected events is to focus on quality companies. 

We hold a conviction portfolio of 25-40 quality companies selected from an investable universe of around 4,000 US stocks. We look for well-managed businesses benefiting from stable demand for market-leading products and we want to see durable competitive advantages, pricing power and, very importantly, conservative balance sheets. 

I highlight the importance of a conservative balance sheet, because financial leverage played a large role in the demise of SVB. The mistakes made by the bank were magnified because like almost all banks they use significant financial leverage. This meant that when events turned against SVB, the bank did not have time on its side to manage a successful resolution. 

We look to invest in companies with manageable leverage for their business model, and in many cases this will be significantly lower than that of the average company. This helps to ensure that poor timing or management mistakes are not life threatening for the business. It should also lead to less volatile investment performance. 

We want to see a durable business model. Common attributes of companies we own are a ‘sticky’ customer base, a recurring revenue business model and replacement-driven demand. We look for ‘all-weather’ businesses that are not reliant on the economic cycle to drive growth. 

As recent events have demonstrated, while SVB was a fast-growing business it was very far from a durable, high-quality one. The bank relied on the perception of stability, and when confidence wavered among its customers, the business proved very fragile indeed. 

Looking ahead, US economic growth has slowed and conditions are challenging for many companies. In the absence of a rising tide that will lift all boats, we believe a highly selective approach to stock-picking offers the most attractive opportunity for investors. And, since we may see more unexpected events, we believe a focus on durable, high-quality companies is more important than ever. 

Brad Weafer - Fund Manager US Multi-Cap Income

14/03/2023

Sources: Marlborough Investment Management

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Capital is at risk. The value and income from investments can go down as well as up and are not guaranteed. An investor may get back significantly less than they invest. Past performance is not a reliable indicator of current or future performance and should not be the sole factor considered when selecting funds. Our funds invest for the long-term and may not be appropriate for investors who plan to take money out within five years. The fund will be exposed to stock markets and market conditions can change rapidly. Prices can move irrationally and be affected unpredictably by diverse factors, including political and economic events. The fund invests in other currencies. Changes in exchange rates will therefore affect the value of your investment. The fund invests mainly in North America therefore investments will be vulnerable to sentiment in that market which may strongly affect the value of the fund. In certain market conditions some assets may be less predicatable than usual. This may make it harder to sell at a desired price and/or in a timely manner. In extreme market conditions redemptions In the underlying funds or the Fund itself may be deferred or suspended. All or part of the fees and expenses may be charged to the capital of the fund rather than being deducted from income. Future capital growth may be constrained as a result of this. Dividends paid by companies are not guaranteed and can be cancelled, which may impact the fund’s ability to deliver an income to investors.

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Issued by Marlborough Investment Management Limited, authorised and regulated by the Financial Conduct Authority (reference number 115231). Registered office: PO BOX 1852 Lichfield, Staffordshire, England, WS13 8XU. Registered in England No. 01947598. Investment Fund Services Limited (IFSL) is the Authorised Fund Manager of the Fund. IFSL is registered in England No. 06110770 and is authorised and regulated by the Financial Conduct Authority. Registered office: Marlborough House, 59 Chorley New Road, Bolton, BL1 4QP. Copies of the Prospectus and Key Investor Information Documents are available from www.ifslfunds.com or can be requested as a paper copy by calling 0808 178 9321 or writing to IFSL, Marlborough House, 59 Chorley New Road, Bolton, BL1 4QP.