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The growing threat from disruptors in this traditional market

24 May 2017

David Jane, manager of Miton’s multi-asset fund range, explains how disruptors are affecting the structure of the retail market, creating worries around traditional investment destinations.

A lot of successful fund management is about avoiding or minimising the downside, rather than picking winners. In our view this is a critical part of being genuinely active.

Internet disruption is having a major impact on traditional consumer sectors. Retailing is an industry which is losing share of wallet not just to online retail, but to other activities such as gaming and social networking.

We have seen in the past how tricky ‘brick and mortar’ retail can be when sales start to fall. The combination of high fixed costs and unsold stock leads to rapid margin declines and, when combined with high debt levels, the rapid demise of what seemed like large and successful businesses.

In the US, J C Penney and Macy’s are clearly under pressure and in the UK the strain is being felt by Matalan and Debenhams. This is despite an otherwise healthy state of the consumer. So, we would avoid these types of retailers and only have exposure to specific niches or beneficiaries, such as Home Depot, Amazon and Netflix. Our positive view of the UK and US consumer can readily be expressed through exposure to leisure or homebuilding, without the need to look at retail.

In corporate bonds, retail is an area where we only have very limited exposure as the risk seems all to the downside. This is despite the fact that some of the big US retailers still cling, albeit tenuously, to an investment grade rating. We see no need to be exposed, whatever their weight in a benchmark.

The risk of disruption in retail goes beyond the most immediate risk to the big traditional retailers however, as much of US retail is mall based and these malls tend to be anchored around one of the struggling large department stores. As these close, the mall can quickly cease to be viable as footfall declines and other retailers leave.

We have therefore avoided retail exposure when we have invested in US REITS, The US has many times the amount of retail space per capita compared with other developed markets as it has traditionally been a mall based culture. Malls have been the meeting place of choice in the States, acting as more than shopping centres, providing a leisure and broader community function. The sheer scale of the industry and the negative economies of scale might lead to a huge potential for lost capital both in the debt and equity markets.

A further risk from disruption in retail is the amount of people employed in the industry, where rapid declines are unlikely to be absorbed quickly elsewhere. Roughly 11 percent of the US workforce works in the retail industry. Walmart employs 1.5 million Americans alone. So, despite the news flow from Ford and the coal industry, Macy’s and its peers might be a bigger worry if they are forced to reduce their workforce materially.

 

 

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