March review

Steve Clayton - Fund Manager

7 April 2017

March was a quiet month for the market as a whole, with little movement in the major market indices. Overall, the FTSE All Share index managed a 1.2% total return for the month. You may have noticed in past monthly reviews that we haven’t compared fund performance to that of the market’s. We don’t here, either, and it’s worth explaining why.

Firstly our regulator, the Financial Conduct Authority, understandably discourages such comparisons until a fund has built a bit of a track record – minimum 12 months to be precise. Secondly, and more importantly, shorter term movements of the funds relative to the market can simply be reflective of near term volatility that we have no say over.

So a longer view is necessary, and we’ll carry on focusing on what matters most; results from our companies and their managements’ confidence, or otherwise, in the direction of their businesses.

HL Select UK Shares fund

The fund holds no bank shares and this proved a good decision in March as banking names came under some pressure. Burford Capital, the litigation funder we wrote about recently, had an excellent month, registering a double-digit increase after issuing excellent financial results. Just Eat too delivered a double-digit increase, offsetting some earlier weakness. It too had released well received financial results. Intertek, our quality assurance specialist also performed strongly in March. Please note however that past performance is not a guide to the future.

Our weakest performer was Domino’s Pizza, where recent like for like sales were revealed to have slowed somewhat. The shares fell sharply, losing almost 20% in the month, neatly illustrating the benefits of not having all the eggs in one basket. As we explained here when they reported results, we have added to the Domino’s Pizza position because we believe the price drop is not matched by any underlying deterioration in the prospects for the business.

HL Select UK Income Shares fund

We were able to invest the monies raised without encountering any real difficulties, reflecting a fairly active but largely directionless period of trading across the wider market.

The fund’s total return for the month was inevitably impacted by the need to pay stamp duty on the shares we purchased. This costs 0.5% each time a share is bought, underlying the importance of investing for the long term, because frequent trading would see the tax levied repeatedly.

Our strongest performances came from names like Paypoint, British American Tobacco, AstraZeneca and Ascential, all up by mid-single digit percentages although these are not a guide to the future.

The stand-out weak performer was Domino’s Pizza, here a near term slowing of like for like sales appears to have spooked a few investors into selling. We paid more attention to the 15% dividend increase (variable and not guaranteed) and added to the position.

At the end of the month we declared the first dividend for the fund, of 0.3p per unit. We intend to maintain this level of payment per month through until August and then pay a final dividend in September of 0.3p plus all other income not already paid out. We will announce the new level of "regular" monthly dividends in October. Four companies, BAT, Domino’s Pizza and WPP have already paid dividends, and all of them have announced increases to their payments. Although, until received, these are not guaranteed.

Horrors Imagined

A salutary lesson in the markets this month came from Imagination Technologies, who perfectly illustrated the dangers of having too much reliance on a single customer. Lest anyone get alarmed by what follows, neither of the HL Select funds has ever had any exposure to Imagination Technologies shares.

Customer concentration is something we always monitor, for even the best of customers can be lost. For many years, Apple had used the Graphics Processor Unit designs that Imagination create to power everything from iPods to iPhones. Revenues from Apple were about half of the group’s total and so close was the relationship, Apple even had a large stake in Imagination.

But money talks. Apple clearly now believes it has a better option, for it has informed Imagination that it intends to drop them in the next couple of years, using an in-house design instead. To make matters worse, because Imagination designs chips then sells licences to use the designs and earns royalties each time their designs are used, once a new customer is signed up, virtually all of the revenue is profit, for nothing extra has to be made by Imagination.

Imagination’s future profit forecasts were a lot lower than the revenues Apple were paying them. In other words, not only was Apple far and away the largest customer, their income was needed to offset substantial losses made elsewhere in the group. No surprise then that Imagination’s shares promptly fell as much as 70% on the news.

We prefer businesses without this sort of dependency. The answer to the question “Will your largest customer still be with you in two years’ time?” is ideally “Doesn’t really matter, we’ve got lots more to trade with”. Our holdings in names like Unilever, Diageo, British American Tobacco, or even Domino’s Pizza and Auto Trader all have thousands or millions of customers, making them far more resilient over the long run. No business is immune to everything, but we try to find those with better than average inoculation. Our most exposed investment is Playtech, which provides systems and services to gaming companies around the world. Their top five customers account for 36% of sales.