HL Select UK Growth Shares - December Review

Charlie Huggins (CFA) - Fund Manager

10 January 2019

December was a difficult month for stock markets around the world. In the UK the FTSE All Share index delivered a total return of -3.75% for the month, to leave the market’s outcome for the year at -9.47%.

The list of investors’ worries is familiar; trade wars between the US and China, a capricious President in the States, all playing out alongside central banks backing away from longstanding easy money policies. And Brexit.

Having been the standard bearer for global equity market strength in the early part of the year, Wall Street led the retreat in the dying weeks of December, with the S&P 500 index threatening to enter bear market territory (20% down from its highs) at one point late in the month.

Uncertainties about the economic outlook abound, with China seemingly decelerating, the US losing the stimulus from President Trump’s early tax cuts and Europe riven by budgetary squabbles. Back home we are approaching a politically volatile period, with a minority government that lacks even much of its own party’s support, trying to push through a controversial Brexit deal package.

Everywhere we look, we can see risks and downsides. History tells us that this is often the time of greatest opportunity.

Fund performance

In a challenging month, the fund delivered a total return of -2.61% during the month, ahead of the market return of -3.75%. For the fourth quarter the fund’s total return was -9.84% compared to the market’s return of -10.25%. And over the full year, the fund finished comfortably ahead of the market, returning -3.24% compared to the market return of -9.47%.

Below we review the biggest positive and negative contributors to the fund’s performance in December. Remember, these details are over a short period of time and past performance is not a guide to future returns.

If you haven’t seen it already, you can read our longer summary of 2018 here.

Biggest Positive Contributors

Past performance is not a guide to the future. Bloomberg 30/11/2018 – 31/12/2018

Once again, Burford Capital delivered a strong return for the portfolio, after the group announced it has secured funding for $1.6bn in new litigation investments. $1bn will be provided by a new partnership with a sovereign wealth fund. Under the terms agreed, Burford will fund one third of any investment (with the remainder coming from the sovereign wealth fund), but it will receive 60% of the investment profits plus expenses.

We view this as a very positive development for Burford, cementing its market-leadership position. Burford is rather unusual amongst our holdings in that it operates in a very capital-intensive industry. Each case requires up-front funding, while the size and timing of pay-offs from these investments is highly uncertain. On average, it takes about two years for a legal case to conclude but some cases can rumble on for years, and even if the case goes Burford’s way it can be some time before the monies are recovered.

The ability to compete in this industry therefore depends, to a large extent, on how deep your pockets are. This new funding will provide Burford with major firepower, allowing it to fund expansion for several years without having to resort to excessive leverage.

Biggest Negative Contributors

Past performance is not a guide to the future. Bloomberg 30/11/2018 – 31/12/2018

Ideagen and GB Group were our biggest negative contributors in December. A notable feature of this market correction is that many companies trading on higher than average valuations have been indiscriminately sold-off, leading to a rather savage de-rating in some cases.

The chart below shows the price to earnings ratio (P/E) of GB and Ideagen over the last five years. In the last few months, both stocks have seen their P/E fall by around a third from their peak despite these businesses continuing to trade well. We took advantage of these lower valuations to add to both holdings during the month.

P/E over last five years

Past performance is not a guide to future returns. Source: Bloomberg. Correct as at 03/01/2019.

We attended GB’s Capital Markets Day in London on 13 December. The event involved a series of presentations focused on the group’s address verification division (Loqate) and provided an opportunity to meet with members of GB’s wider management team.

The event reinforced our positive view of the business, and gave us a greater appreciation for the international opportunity. Loqate’s international expansion plans are at a very early stage and it is enjoying encouraging early success, mainly owing to GB’s superior data and technology. This, combined with a large and growing market for address verification solutions, means the long-term opportunity for GB looks very promising indeed, although of course there are no guarantees.

Past performance is not a guide to the future. Source: Lipper IM to 31/12/2018. *Full year data prior to December 2016 is not available.