HL Select UK Growth Shares fund – Q1 2021 Review

Steve Clayton - Fund Manager

28 April 2021

UK Equity Market Review

The stock market rallied through the first quarter, with the UK market delivering a total return of 5.2%. Investor confidence has been driven by hopes of a re-opening of economies worldwide as vaccinations flatten the magnitude of future waves of the coronavirus disease.

Investors chose to ignore rising corporate taxation when the Chancellor announced increases in the years ahead, focusing instead on his ongoing largesse in the near term. The economy has proven more robust than feared and whilst growth was sharply negative in 2020, a recovery from the depths of recession appears well underway. Capital Economics predict that the UK economy will expand by 5.5% this year and recover to its pre-pandemic level during 2022.

Vaccine-driven optimism has had a significant impact on the relative performance of market sectors. Market leadership has generally fallen to Growth sectors in recent years and during the pandemic this was particularly true. With news of effective vaccines, sentiment changed dramatically. Previously unloved industries like airlines, banks and leisure, severely impacted by lockdowns, began to rally, whilst “safe havens” such as technology and digital services stepped out of the spotlight.

Fund performance review

The HL Select UK Growth Shares fund’s investment style is to invest into companies capable of delivering long term earnings growth. We look for quality, in terms of wide competitive moats, robust financial health and we hugely prefer businesses with a natural tendency for income to recur. That positioned the fund well during the pandemic, but less so during a wave of optimism when investors were focused on where recovery may be felt first and strongest.

So the fund has not kept up with the market during the quarter, losing 2.56%* in value. We remain very confident in the prospects of the companies in which the fund is invested. Indeed, we have been pleased with the results reported by our portfolio members so far this year. Only one, London Stock Exchange Group plc has reported any meaningful negative news (and even that looks more like a teething pain, rather than a matter of real concern).

We talk as usual about the winners and losers in the portfolio in the upcoming section but feel it worthwhile taking the time to discuss our broad intentions for the quarters ahead. We will not change our investment style. We believe that holding fantastic businesses for the long term is the best and most assured route to stock market success. When economies make significant changes in direction, the spotlight inevitably swings around the stage. Great businesses carry on building value, even when they are out of the spotlight. When we look at our portfolio we see some fabulous stocks, like Experian or Adobe which have not kept pace with the market in recent months, but where organic growth has continued robustly and will, we believe, continue to do so for a long time to come. “Value” stocks are enjoying their moment in the spotlight, but we doubt they will deliver returns comparable to those accruing to high quality growth businesses in the long run.

Past performance is not a guide to the future. Source: * Lipper IM to 31/03/2021

N/A = data for this time period is not available.

Significant Winners and Losers

Winners

Past performance is not a guide to the future. Source: Bloomberg (31/12/2020 – 31/3/2021)

Close Brothers was our strongest performer in the quarter. We are impressed but not surprised with how Close has managed this crisis so far. Of course, it remains to be seen what happens when government stimulus is withdrawn, but we do not worry about the health of the business given the very strong capital position and the group’s ‘protect first and then grow’ philosophy.

Ongoing investments, in areas like technology and its retail deposit platform, have enabled Close to navigate this crisis better than many of its peers. This has allowed it to re-start dividend payments with the group announcing an 18p interim dividend. Overall, Close Brothers looks well placed to emerge from this pandemic stronger and we would expect the banking division to gain share through this environment.

NEXT plc saw its shares jump when it reported robust Xmas trading. The company continues to benefit from its stronger online positioning than most of its High Street rivals. Indeed many of its rivals have failed in recent years and the group is facing fewer competitors in the physical world. The group’s strategy of offering both NEXT branded items and third-party brands online ensures that consumers have a multitude of reasons to visit the NEXT website compared to the sites run by single brand operators. With trading remaining robust through lockdowns because of that online strength, we expect NEXT plc to resume dividend payments later this year.

Diploma is a recent addition to the fund, so it is nice to see it make an early positive contribution. We’ve followed Diploma very closely for the best part of a decade and regard it as one of the highest quality businesses in the UK market. It is a classic HL Select business with high margins, returns on capital and prodigious cash generation; operating in resilient, high-growth end markets with ample reinvestment opportunities. The business has a small share of its markets and significant opportunity to grow this share both organically and through acquisitions. A trading statement towards the end of March confirmed the business is recovering strongly from the effects of the pandemic and recent acquisitions are performing well. A full rationale for this holding is available on the portfolio breakdown page.

Schroders performed well following a robust set of full year results. The group has benefitted from buoyant stock markets, and a re-positioning into higher growth areas of Solutions, Private Asset and Wealth, which now account for 43% of revenues. The fourth quarter saw inflows into the group’s mutual fund business which is particularly encouraging as this business is higher margin and has been seeing outflows in recent years.

With the price of oil continuing to recover after its pandemic-induced slump, it was no surprise to see the price of major energy companies recovering too. Royal Dutch Shell was no exception and the rising crude oil price helped provide credibility to the group’s dividend policy of aiming for growth of around 4% in the annual payment to investors.

Losers

Past performance is not a guide to the future. Source: Bloomberg (31/12/2020 – 31/3/2021)

The London Stock Exchange was our largest negative contributor over the quarter. The negative performance was due to an increase in operating and capital costs related to the acquisition of Refintiv. The challenge of integrating these two large businesses is significant and investors were rightly concerned with the news that costs involved would increase. What hasn't changed is the value of the data both businesses supply to their customers, the reduction in operating expenses from the merger and the potential new opportunities from their combined resources. Given our confidence in the businesses’ longer-term potential we continue to hold the shares.

2020 was a tough year for Ascential as neither of its physical events – Cannes Lions or Money 20/20 - could run. The group also recently confirmed that the Cannes Lions event scheduled for June 2021, will now run as a digital-only event with no physical attendance. This is unfortunate but isn’t a surprise given that France has recently gone into new lockdowns. While physical attendance is an important part of Cannes Lions’ revenue stream, it isn’t the only one. Ascential will earn revenue from award entries, digital subscriptions and digital sponsorships this year, which will help soften the blow. Outside of events, Ascential’s digital commerce business had an exceptional year with revenue rising by a quarter and profit almost doubling. With the pandemic having accelerated eCommerce adoption, we think the prospects for this division are very bright.

The weak performance of Autodesk, Experian and GB Group reflects a general market rotation from ‘Growth’ (particularly tech) into ‘Value’ names seen as beneficiaries of vaccines and stimulus packages. We don’t attempt market timing and have avoided the temptation to take profits; indeed, we used the volatility to add further to our position in Experian. We are sticking to our knitting – long-term ownership of great companies that are largely in charge of their own destiny. We think all three of these companies fit the bill and we view them as key beneficiaries of accelerating digitisation.

Sabre Insurance, the motor insurer, had a weaker 2020 than we would have anticipated at the start of the pandemic. While the company has benefitted from lower claims frequency, as a result of fewer cars on the road and fewer accidents, premium levels declined. The lockdowns impacted Sabre in several ways - some competitors offered big price discounts so Sabre became less competitive, there was less shopping around for insurance, fewer new car purchases and fewer new drivers due to delays to driving tests (new drivers is a key market segment for Sabre). We expect these headwinds to start to abate as the UK emerges from lockdowns allowing premiums to recover. At some point competitors will also have to start increasing prices, which should see Sabre’s competitive position improve. In the meantime, the shares offer a prospective yield of 5.5%, variable and not guaranteed.

With markets focusing on recovery, the dependability of Unilever’s portfolio of foods, personal care and household products was firmly out of fashion. Full year results were met with disappointment in February when the company revealed a slowdown in growth during the final quarter of 2020. However the group remains robustly cash generative and we continue to believe their top quality brands portfolio is capable of generating substantial value over the long term, with an attractive and growing dividend along the way. The company maintained its payout throughout the depths of the pandemic and grew the final payment by 4%.