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HL Select UK Growth Shares – Q1 2022 Review

HL SELECT UK GROWTH SHARES

HL Select UK Growth Shares – Q1 2022 Review

Managers' thoughts

Important information - The value of this fund can still fall so you could get back less than you invested, especially over the short term. The information shown is not personal advice and the information about individual companies represents our view as managers of the fund. It is not a personal recommendation to invest in a particular company. If you are at all unsure of the suitability of an investment for your circumstances please contact us for personal advice. The HL Select Funds are managed by our sister company HL Fund Managers Ltd.
Steve Clayton

Steve Clayton - Fund Manager

29 April 2022

Market review

The first quarter of 2022 witnessed the return of war to Europe, surging inflation, led by rocketing energy prices, and ongoing economic disruption linked to the pandemic. There are relatively few significant restrictions left in place in Europe and the UK. However, supply chains remain under pressure and shortages of goods, such as automotive semiconductors are still impacting on output.

The pace of inflation and its duration has exceeded expectations and prices are still rising at pace. Economic debate has swung from wondering when interest rates would eventually rise to speculating about how many times central banks in the major nations will hike rates this year.

The pressure on consumer incomes will only intensify as higher utility bills and rising mortgage rates kick in. Ultimately though, we believe the primary driver of the inflation has been the aftermath of the pandemic and supply chains, shipping arrangements and labour shortages will be navigated. Once these pinch-points are sorted we would expect the pace of inflation to decline. The digital economy continues to grow and as it does, it tends to drive costs down through greater transparency and automation. These forces will reassert themselves once the pandemic’s impacts have subsided.

Despite all that went on in the quarter, the market managed to eke out a modest gain of 0.5%, but beneath that small number were a number of substantial shifts. Energy and Industrial Metals were the top performing major sectors, in response to the surge in the price of metals, gas and oil. Rising bond yields raised discount rates, punishing highly rated stocks and the technology sector in particular. Fears over the coming squeeze on consumer disposable incomes led the consumer discretionary sector lower.

HL Select UK Growth shares - Fund Performance Review

Q1 was perhaps the most challenging period in the fund’s history to date. Our investment style of focusing on high quality stocks, often with leading positions in the digital economy was distinctly out of favour and the fund lagged both the market and less growth-oriented peers. The loss for the quarter was -7.3%*, which compared to an average loss by sector peers in the UK All Companies sector of -4.9%, both far behind the market’s gain of 0.5%.

The greatest impact came from the fund’s substantial position in the Information Technology sector, which cost the fund 4.0% in value, whilst our Industrial sector holdings cost a further 2.3%. Between them, Communications and Consumer Discretionary sectors subtracted 2.4% from the fund’s value. Our Energy sector position added 1.2%.

Looking at the stocks we hold, there were obviously some significant moves, mainly downward, but the underlying businesses generally gave a strong performance. We go on to discuss the stories behind the major movers in the next section.

Annual percentage growth % Growth % Growth % Growth % Growth % Growth
31/03/2017 To 31/03/2018 31/03/2018 To 31/03/2019 31/03/2019 To 31/03/2020 31/03/2020 To 31/03/2021 31/03/2021 To 31/03/2022
HL Select UK Growth Shares 6.1 8.8 -6.2 22.9 3.3
FTSE All-Share 1.3 6.4 -18.5 26.7 13.0
IA UK All Companies 2.7 2.9 -19.4 38.2 5.2

Past performance is not a guide to the future. Source: *Lipper IM to 31/03/2022

Significant winners and losers

Winners

Stock Gain/Loss (%) Contribution to Fund (%)
Shell plc 27.6 +1.2
Sabre Insurance 26.2 +0.7
London Stock Exchange 15.0 +0.5
British American Tobacco 18.8 +0.4

Past performance is not a guide to the future. Source: Bloomberg to 31/3/2022

Shell plc was our strongest position, gaining 27.6% over the quarter. We would ascribe this almost entirely to the impact of the surge in energy prices. Shell should be a particular beneficiary of the current high gas price because its Integrated Gas division is one of the largest producers of Liquefied Natural Gas (LNG) worldwide. LNG is loaded onto tankers and can be delivered to any receiving terminal. Most of Shell’s production will be sold under long term contracts, but some cargoes will be available to the highest bidder, allowing Shell to capture some of the extraordinary surplus returns currently available. Shell also announced a share buyback of some $8.5bn during the quarter.

Sabre Insurance enjoyed a strong quarter, with a 26.2% gain, aided both by well received full year results in March and also the announcement of an underwriting deal that should lead to them becoming a major player in the taxi insurance market. The company see insurance rates hardening as the year progresses, which should lead to rising cash and profit generation. The group’s capital position is strong, leaving them with good potential for dividends this year and beyond. We like Sabre because they focus solely on the profitability of the business they write, not the volume. This matters, because in insurance it is easy to write large volumes of cheap policies. But the only certainty that brings is large volumes of claims with only modest premium income from which to pay the claims. Sabre’s approach is we feel, far better suited to generating reliable cash flows.

London Stock Exchange Group saw investors reacting favourably to the group’s latest trading update which gave vital reassurance about their success to date in integrating the very large Refinitiv acquisition of recent years. Cash generation has already reduced their leverage to less than 2x, a year ahead of schedule. This progress is helping to de-risk our position which was first entered into before LSEG had announced the Refinitiv deal. We have always been attracted to the potential of the deal but recognised that during the period immediately after the deal, the leverage assumed was a risk if the group executed weakly.

British American Tobacco shares, in common with other tobacco firms have been weak in recent years. The company has continued to run its operations efficiently and grow its dividend to shareholders to the point where during late 2021 the stock was flirting with a double digit yield. Having deleveraged significantly since the Reynolds deal the attractions of a share buyback, which would enhance earnings per share and improve dividend cover had become compelling and the group duly obliged by announcing an intention to commence repurchasing stock in the market. The group has announced its exit from Russian operations, since the Russian invasion of Ukraine.

Losers

Stock Gain/Loss (%) Contribution to Fund (%)
Ideagen plc -20.7 -1.3
Experian plc -18.5 -1.2
GB Group plc -25.3 -0.9
Autodesk Inc -21.6 -0.9
NEXT plc -24.4 -0.9
Adobe Inc -17.3 -0.9

Past performance is not a guide to the future. Source: Bloomberg to 31/3/2022

Ideagen released decent enough trading results during the quarter, whilst GB Group unveiled an earnings enhancing acquisition, but both suffered the hangover of having issued new shares to fund acquisitions during the closing weeks of 2021. Having left the market amply supplied with stock, both then suffered from a huge shift in market appetite toward technology stocks. Indeed when we look at the list of significant losers above, every single name on the list derives all or the majority of their income from digital businesses.

After a long period when technology stocks and other digitally-driven businesses were in high demand, Q1 saw a sharp reversal.

Our strategy of eschewing Value has served us well over most of the last five years. Too often Value is synonymous with compromised. Businesses tend to be rated according to their capacity to deliver rising returns over time. By definition, those falling into the Value universe are those expected to be least able to generate superior returns over the long run. If you can spot Value stocks whose fortunes are improving, then money can be made, but we think that is a skill more often claimed than proven.

We stick with quality growth shares for the simple reason that even if we pay a relatively high multiple to buy in, the future growth of the business will catch up with the share price before too long.

Buy a Value stock that fails to deliver and you can find yourself locked into a long-term trend of declining returns. In the end, those can end up being the most expensive mistakes.

Team Changes

We are delighted to welcome a new UK Equity Analyst to the Select Team. Matt Gregg has joined, supporting Steve in running the funds. Matt has been with HL for 10 years. He is a CFA Charterholder and has a BSc in Economics from the University of Bristol. Prior to joining Select, Matt headed up HL’s Quantitative Investment Research team.

Charlie Huggins has decided to move on to a new venture and leaves with our thanks and best wishes. We have been fortunate enough to recruit a highly experienced Fund Manager who will be joining the team shortly. We will introduce them in our Q2 blog.

Important - This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information. Unless otherwise stated performance figures are from Bloomberg and estimates, including prospective yields, are a consensus of analyst forecasts from Bloomberg. They are not a reliable indicator of future performance. Yields are variable and not guaranteed.