HL Select UK Growth Shares fund - May review

Steve Clayton - Fund Manager

8 June 2018

UK Equity Market - May 2018

May was a strong month for equities, with the market delivering a total return of 2.8% over the month, as measured by the FTSE All Share index. The move was led by energy and mining sectors, accompanied by healthcare, industrial and technology stocks. Each of these sectors made gains of between five and seven and a half percent. The only sector to generate significant negative returns was telecoms, which dropped by over eleven percent, with both BT and Vodafone contributing to the drop.

The market’s move was driven by early strength in commodities and a sense of relief that interest rate increases, widely expected to be imminent until quite recently, might not come before the late summer. As always in the stock market, nothing is guaranteed and we feel compelled to point out that oil prices have already retreated by 10% from their May peak and that sentiment toward the course of interest rate increases is turning a shade hawkish once more.

HL Select UK Growth Shares fund - May 2018

The fund enjoyed a successful month, delivering an underlying return of 5.4%, usefully ahead of the broader market’s 2.8% total return. This was all the more pleasing given that it was achieved despite having zero exposure to commodity producing sectors which were particularly strong during the month.

Performance was driven by our Consumer Discretionary, Financial, Industrial and Technology positions, which all delivered returns well ahead of the market, more than enough to offset the drag caused by zero commodity exposure. Please remember this is over a very short period and past performance is not a guide to the future.

Biggest Positive and Negative Contributors:

Positive contributors

Negative contributors

Relative contribution refers to how much the value of the fund was improved or worsened by holding the stock, compared to the outcome that would have been earned had the monies invested moved in line with the FTSE All Share index.

Past performance is not a guide to the future. Source: Bloomberg 30/04/2018 - 31/05/2018

As we've said before, Burford can do no wrong, it seems. It would be foolish to think so, however, because as we all know, courtroom dramas can and do happen. Burford of course spends too much time in courtrooms for comfort on that front. But presently, the market is increasingly appreciating Burford’s leading position in the fast growing world of litigation finance. We continue to monitor the size of the position, which has grown to become the largest single company holding in the fund, at over 5% weighting.

Burberry gave a convincing performance under the new management team when they reported results. Sentiment has swung 180 degrees from last year. Then, Mario Gobbetti’s plans to restrain sales whilst pushing the brand upmarket in search of wealthier clients and fatter margins were seen as a risky strategy. Today, the market cannot get enough of Burberry and the stock has hit new highs in recent trading. Whilst we support Mario Gobbetti’s aims, we do not consider the process risk-free. But with newly appointed Creative Director, Riccardo Tisci set to revitalise the range over the next twelve to eighteen months, there should be much to keep investors engaged.

GB Group continued running after a trading update in April sent the stock skywards. Results announced in early June confirmed the progress reported in April but were not enough to propel the stock yet further. We met with GB management after the results and came away encouraged by the ongoing growth potential and the stewardship displayed by the top team. GB Group remains a vital cog in the ecommerce ecosystem, if such things have cogs, and with online transactions constituting an ever rising share of overall commerce, GB’s position looks solid.

Ideagen updated on trading which was strong, as previously guided and the group reiterated their aim to double revenues and adjusted EBITDA every three years. If they achieve this, the outlook for the stock should be promising, but of course the bigger you get, the harder the trick becomes. A restructuring of Board roles sees the CEO move up to Executive Chairman, with a focus on the M&A necessary to supplement organic growth, en route to the group’s ambitious targets.

Ending on a low note...

We will gloss over Close Bros.whose negative contribution was not that significant in the scheme of things, in order to focus on Alfa Financial Software, a recent addition to the portfolio. Alfa create software that allows firms to run asset leasing businesses. These firms could be banks, vehicle manufacturers or specialist lease providers. Alfa have a global leading position, serving the most sophisticated clients in the industry with highly complex and customisable software that goes right to the heart of their organisations.

We bought after a relatively minor miss against broker forecasts earlier this year sent the stock down 40%. The number shown for Alfa above is performance to end May. The first of June saw the group issue a full-on profit warning. Alfa’s product is costly and expensive to install. They have a little over 30 clients, and only one client has ever dropped them. Each year they aim to win a handful of new clients and last year around half their income came from the fees generated from installing the Alfa System into new clients’ operations, a process that takes between nine months to five years to complete.

Three of the clients where new installations were underway or currently planned have seen plans change. Two have asked Alfa to quote for a larger installation, covering more territories, delaying project start. A third, already well underway with their implementation, discovered data problems in their own legacy systems which must be fixed before the installation can proceed further. This is the first time in the company’s history that such an issue has occurred. The client will not be ready to resume the project for several quarters, but with £30m already spent, they seem unlikely to cancel.

The impact on Alfa’s 2018 revenues and profit is severe, and profit forecasts have roughly halved, as did the share price before staging a degree of recovery. We spoke to the chief executive and finance director, who were somewhat taken aback by the turn of events, but remain confident in Alfa’s longer term prospects. On the plus side, the group’s pipeline of strong sales leads, those that they expect will most likely convert to new implementations, has grown in recent months. But it will be early to mid 2019 before the company has full visibility of these revenues and the recovery or otherwise of the three delayed/stalled implementations.

The company released the news rapidly when the clients announced their delayed plans and the situation must be seen as evolving rather than completed. The company must plan to redeploy staff onto other clients or product development and calculate the full costs. Our focus on financial strength has helped here; Alfa sit on tens of millions of net cash, so despite the sudden blow, the business remains healthy and can re-build. It retains its market position and even now has good profit margins. But it could get worse before it gets better.

Regrettably the loss on Alfa has cost the fund around 0.9% so far in June. Other positions have done rather better, so the overall underlying move in the portfolio’s value in June at the time of writing is a small gain of around +0.2%, which is behind the market’s return, month to date of around 0.7%.

Past performance is not a guide to the future. Source: Lipper IM to 31/05/2018.

n/a* - full year performance data unavailable.

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