HL Select UK Income Shares - December Review

Steve Clayton - 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

The fund delivered a total return of -2.41% during the month, bettering the market return of -3.75%. For the fourth quarter the fund’s total return was -5.64% compared to the market’s return of -10.25%. And over the full year, the fund also fared better than the market, returning -5.84% compared to the market return of -9.47%.

We have previously written about trading activity in our recent blog reviewing the markets in 2018. If you haven’t already seen the blog, you can read it here.

In the rest of this blog, we review the biggest positive and negative contributors to the fund’s performance in December. As ever, remember these details are over a short period of time and past performance is not a guide to future returns.

Biggest Positive Contributors

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

New addition to the fund, Burford Capital made a sparkling entry, rising by over 20% in its first few weeks. Shortly after we had built a position, 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

There was no news from Domino’s Pizza themselves during the period, but press reports revealed that some of the group’s larger franchisees have formed an alliance to press for better trading terms with the group. If the reports are indeed accurate, then this could prove something of a headache for Domino’s.

But the company has always had to balance the interests of itself and the franchisees. So we see this as an old hand being re-played. At the end of the day, both groups are dependent upon the other and their customers’ desires for hot pizza, delivered to the door is unchanged.

GlaxoSmithKline had a very eventful month with three noteworthy announcements. On 3 December it announced the sale of Horlicks and other Consumer Healthcare nutrition products to Unilever for an estimated £2.4 billion. Later that day, GSK announced a £4bn agreement to acquire oncology specialist TESARO, which was met with scepticism by investors, reflecting concerns over the balance sheet and dividend.

However, these concerns were eased by news on 19 December that GSK intends to form a new consumer healthcare joint venture (JV) with Pfizer. The JV will have £9.8bn in annual sales, with GSK having a controlling 68% equity stake. The deal is expected to generate annual savings of £500m by 2022, with total costs of £1.2bn.

GSK said it will pursue a separate listing for the consumer JV within the next three years and said it plans to hold the dividend steady at 80p per share in 2019. We welcome the extra cash flow provided by the consumer JV along with the dividend commitment, and think that splitting the pharmaceutical and consumer businesses makes sense. However, the medium term dividend implications of doing the splits are unclear and will need to be re-assessed closer to the time. All dividends are variable and not guaranteed.

Past performance is not a guide to the future. Source: Lipper IM to 31/12/2018. *Full year data prior to December 2017 is not available.