2018 in review

Steve Clayton - Fund Manager

28 December 2018

2018 has not been a vintage year. The UK stock market looks set to end the year close to its low point, with a year to date decline of a little over 10% at the time of writing, before taking account of any income received. Both HL Select funds have produced returns for 2018 to date that are ahead of the market, but still in negative territory for the year to date.

This is not all about Brexit, (though that has hardly buoyed sentiment), for other markets around the world have also struggled. Indeed Bloomberg estimate that almost $15 trillion has been knocked off the value of shares worldwide in 2018 since a peak at $87 trillion on 28 January.

Trade wars between the US and China have sapped confidence. Europe’s problems extend far beyond Brexit; Italy, France and Germany all have issues of their own which have impacted at times during the year. Asian markets have been dogged by concerns over trade wars, with the Chinese market especially hard hit. Sterling has had a tough year too, losing ground against both the dollar and the euro. Markets have to contend with the notion that central banks globally are seeking to ease off, or even begin to reverse, the stimulus that was so assiduously pumped into economies when the financial crisis erupted a decade ago.

Digital disruption

The year has seen some extraordinary stories playing out amongst listed companies. The HL Select funds hold no mainstream traditional retailers for good reason. Shop rents are high and online sales are winning market share across the piste. 2018 has seen House of Fraser snapped up out of administration by Sports Direct, who then went on to warn of extraordinarily tough trading conditions. Debenhams has seen trading worsen and profit forecasts evaporate.

Christmas trading statements are scheduled to kick off in early January; few will be expecting any visible signs of Santa in them. Even online-only retailers are not immune; market darling ASOS has reported sharply reduced expectations after a tough November, sending the share tumbling.

Digital disruption is a recurring theme. We are seeing technology impinge on business models in almost every sector we look at. Retail is the obvious one and HL has its own indicator of the pace of change here. Staff who order parcels to be delivered to the office must collect them from outside the post room. The proportion of parcels sporting the Amazon logo is astonishing.

In food delivery, the original disruptors now find themselves at risk of disruption by newer players, and Just Eat is contending with sharp competition from Deliveroo and Uber Eats, having seemingly conquered the market for itself.

We hold Just Eat in both funds and are monitoring the position carefully. All three of those names are presenting challenges to restaurants that previously took care of the delivery service themselves. Domino’s Pizza now has to compete against restaurants that did not previously offer a delivery service, but can now deploy Deliveroo or Uber to do the job for them.

Data is being captured and analysed at ever greater scale. Businesses that do this better than their rivals can gain an edge, those that fail to do so can quickly founder. GB Group is one of our fastest growing holdings. It provides corporations and governments with electronic services that prove online clients’ identities, ages, locations and bona fides. The group spend big sums every year on R&D to keep their technologies at the cutting edge and also acquire smaller rivals to gain access to new technologies, markets and industries. With online transactions likely to continue rising, demand for GB’s services looks promising, although as always there’s no guarantees.

Home or away?

Internationally-oriented businesses have fared better than domestically focused stocks ever since the referendum result. Some of this is a reflection of currency movements, which have favoured overseas earnings, but there is also a judgement on the economic impact of Brexit. The valuation of UK-focused shares is attracting attention from value-seeking investors, but we must confess to being wary.

Many domestic names are in fact exposed to much bigger threats than Brexit poses. ITV has Netflix and Amazon Prime breathing down its neck, retailers must contend with Amazon and eBay, whilst extricating themselves from over-valued real estate. Much of the portfolios of UK property companies face tricky rental negotiations at the next review, whilst banks’ collateral held against real estate loans may prove less solid than required. Gambling companies face new regulatory threats that are decimating their earnings from fixed odds betting terminals. And then there is the risk of a general election, which could see a radical change to politics and taxation, unlike anything witnessed in the last forty years or more.

We see the international diversity of our portfolios’ holdings as a key support currently. Businesses like Unilever, Diageo or Relx earn the vast majority of their profits overseas. This income is pretty well insulated from whatever is going on in and around Westminster.

HL Select UK Income Shares

The HL Select UK Income Shares fund continues to pay monthly dividends. Consensus forecasts for the fund’s underlying holdings suggest that there could be scope to grow the dividend this year. We have taken advantage of recent turmoil in the markets to raise exposure to faster growing companies in the fund.

We sold the position in Britvic, which had served the fund well, growing in value and raising its dividend whilst we held it. But the valuation no longer looked as appealing to us. In its place we have introduced Burford Capital and raised our exposure to GB Group further. We have also taken a position in BP to keep the fund’s income level healthy.

Burford Capital will be familiar to holders of the HL Select UK Growth Shares fund, where it has long been a significant position. The company is the world’s leading provider of funding solutions to corporate litigants. Burford take on the cost of lawsuits in return for a share of the proceeds if the case succeeds in court or settles beforehand. The industry is relatively new and Burford are enjoying strong demand for their services. The stock had come rattling back in the market lately, despite exemplary results from the group. We have built up a position approaching 3% of the fund.

BP has shown real resilience following Gulf of Mexico tragedy in 2010 and the oil price collapse of 2014; the group recently raised its quarterly payout, signalling a return to health. The group has moved fast to bring data into the heart of the business, boosting efficiencies from drilling to rig construction. Capital expenditure levels have been reined back and project costs renegotiated. With a yield on purchase cost of circa 6% the holding boosts the fund’s income and makes it possible to accommodate faster growing, lower yielding names like GB Group and Burford Capital.

HL Select UK Growth Shares

The HL Select UK Growth Shares fund has also boosted its holding in GB Group recently. A feature of the market in recent months has been a rotation away from growth stocks and GB Group had come back a long way, despite solid progress in the business. Charlie came back from a meeting with the company recently, impressed by the potential for growth in the business.

The year ahead

As for 2019, it’s pretty clear that Brexit will dominate the early months and maybe beyond. We make no predictions here other than, whichever way you incline, you will find yourself shouting at the TV before the process is over.

Brexit aside, the digital revolution will march on. Cyber-criminals sadly, will march alongside it and we think that the quality of businesses’ digital defences will become an increasingly important differentiating factor for both customers and investors alike. New digital business models will continue to emerge and challenge incumbents. Subscription models are in vogue, for everything from movies (Netflix) to razor blades (Dollar Shave Club) and more and more businesses are seeking to sell to clients this way. A subscription can reduce sticker shock, and tie a client in for the long term. No surprise then to see cloud computing companies selling their services this way. We expect more of the same.

Geopolitics will do what it will. With President Trump in the White House, many things are possible, some of which could Make America Great Again, but many, we fear will not. The Middle East is as volatile as ever and China has issues with debts and growth that could be more significant than squabbles with the USA.

We can only suggest that you do what we do, and try to ignore it all. Quality companies grow and prosper despite, rather than because, of what goes on in the TV news. If Brexit looks too troublesome, businesses will work around it. Firms do not let go of their customers lightly and customers for their part tend to want their suppliers to keep supplying. So there is a commonality of purpose on both sides.

We find the greatest rewards come from trying to find those businesses strong enough not to bend in the wind, with products and services so good that customers will beat a path to their doors regardless. And we will spend 2019 trying to find more of them.

View HL Select UK Income Shares portfolio breakdown

More about HL Select UK Income Shares

View HL Select UK Growth Shares portfolio breakdown

More about HL Select UK Growth Shares

Read more blog articles