HL Select UK Income Shares - December Review

Steve Clayton - Fund Manager

8 January 2018

The stock market in December

The UK stock market enjoyed a strong performance in December 2017, delivering a total return of 4.8%. This was driven by strength in commodity producers, pharmaceuticals, tobacco producers and housing stocks, offset by weakness in utilities. Optimism in the strength of the global economy and perhaps a sense of relief that some sort of a Brexit divorce had been agreed.

The December rally topped off a year of positive returns for the market, with the All Share index rising by 12.9% with dividends reinvested. With returns from bonds and cash remaining at very low levels, investors have been prepared to turn a blind eye to risks ranging from political upheavals to nuclear tensions. With higher interest rates expected on both sides of the Atlantic before too long, we believe this preference for yield in the face of risk could be tested in 2018.

The HL Select UK Income Shares fund in December

With a portfolio heavily exposed to yield-heavy utilities and no positions in mining and energy stocks, a month like we saw this December inevitably poses challenges. Nonetheless, the HL UK Income Shares fund still benefited from the market rally with a significantly greater positive contribution from our top five performers than the drag created by the bottom five, as shown in the tables below.

Biggest positive contributors

Past performance is not a guide to the future. Source: Bloomberg 01/12/2017 - 31/12/2017.

The total return column represents the stock’s return over the month, whilst the contribution column reflects how much that added or subtracted from the fund’s value. Thus Sanne Group rose by 11.1% in December, which added almost a half of a percent to the value of a unit in the fund.

With a limited number of trading days in the month and few scheduled trading updates from companies in December, the market tends to be driven at least as much by sentiment as information in the run-up to year end.

The move in Sanne was welcome, but we cannot point to any new news that emerged in the month to drive it. But there had been some earlier weakness, which we attributed to a persistent seller in the market. Their apparent absence appears to have allowed the stock to claw back towards previous levels. We next expect news from Sanne towards the end of January when they issue a trading update.

Ascential had enjoyed a reasonable run-up to Christmas and then spiked towards the New Year after announcing the acquisition of Clavis, a specialist marketing consultancy. Clavis specialise in advising manufacturers how to position their brands and products across online platforms. It looks a good fit with Ascential’s One Click Retail business, which has grown like Topsy since it was bought a year or so ago. The market is hungry for online exposure and Ascential is fitting the bill nicely as it continues to position its portfolio further towards the digital economy.

British American Tobacco benefited from a solid pre-close trading update, with FX tailwinds and good volume performances from key brands helping to offset a weaker pricing environment in some markets. Reckitt Benckiser enjoyed a rally after a period of profit taking.

Domino's Pizza continues to recover from the weakness seen back in the spring. Recent trading updates have been good and the company recently announced plans to acquire a further stake in its Icelandic offshoot. We approve of the latter move; Icelanders are phenomenal consumers of pizza. For some reason they seem to prefer tucking in to a piping hot pizza delivery over traditional “delicacies” such as rotten shark meat. This could be a long term trend.

Biggest negative contributors

Past performance is not a guide to the future. Source: Bloomberg 01/12/2017 - 31/12/2017.

BCA Marketplace fell by 2.1% in December, which subtracted just almost one tenth of a percent from the value of a unit in the fund.

BCA Marketplace entered the FTSE Mid 250 index during the month, albeit with a whimper, rather than a bang. We met with management in November and came away confident in the strength of their position and their depth of knowledge across the motor industry.

National Grid and Unilever are both “safe haven” stocks and in the buoyant market conditions of December it was unsurprising to see them out of favour.

Portfolio change

We finished disposing of the position in Provident Financial during December. As previously discussed, the company has been the single biggest drag on the performance of the fund since launch as it revealed first the botched implementation of a restructuring in its Home Collected Credit business, then regulatory issues within its Vanquis credit card operations. More recent revelations have seen further regulatory difficulties at its Moneybarn car finance operation. Tragically, Chairman Manjit Wolstenholme who stepped up to an executive role after the departure of the former CEO died suddenly during the 4th quarter.

With all three main trading divisions under pressure, Provident now faces a management vacuum at the top. We also believe there is rising pressure on the balance sheet, heightened by regulatory restrictions on moving capital within the group. With no dividends likely until the Prudential Regulatory Authority permits the group to return to normal operations, we took the heavy decision to allocate the funds elsewhere. We are currently building a new position and will discuss its attractions once the fund’s dealings have completed.

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