HL Select UK Income 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 fund delivered a return of 2.67%* during the first quarter. Dividends of 0.25p per Income unit were declared for each month. Holders of Income units will receive these payments into their designated accounts toward the end of the following month. Accumulation unit holders see the equivalent sum rolled up into the value of their units. This is why over time the Accumulation units become progressively more expensive than Income units. The difference being the dividends that were paid out to the Income unit holders.

We run the fund with the aim of delivering income growth over time by investing in high quality, cash generative stocks. That helped us to limit the impact of the pandemic upon the fund, and the fund’s overall income held up better than the wider market’s. The flipside of this is that with the market anticipating an economic recovery as we emerge from the pandemic, higher quality, more dependable companies have dropped out of the spotlight somewhat.

We are not inclined to change course. Over the long run, we believe quality businesses deliver more dependable growth and dividend paying capabilities. The global economy was interrupted by Covid-19’s arrival, but the trends toward digital commerce have accelerated as a result. Huge stimulus programmes by governments have enabled a recovery to begin, but we prefer businesses that can make their own growth, rather than those that need to benefit from a helping hand.

On our current projections we expect to be able to continue to declare dividends each month at the current rate, with a larger final dividend in September, although this is not guaranteed.

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.

We’re glad to reveal a new holding, Fuller Smith & Turner plc, one of the leading pub companies in the UK. You can learn more about it in the rationale posted in the Portfolio Breakdown page here.

We started building the position a while ago and are glad to say it has performed very well so far. Fuller is a high quality pubco with strong freehold backing to its estate. We expect trading to be strong as restrictions ease and the group’s bias to London and Southern locations to position it well longer term.

Lloyds Banking Group has come through the pandemic relatively unscathed and the strength of its mortgage book remains a compelling investment attraction. The support offered to the UK economy by the UK Government has prevented bad debts escalating out of control and Lloyds has continued to manage its own costs well. Dividend controls remain in place and Lloyds paid out the largest amount that the regulator would permit with its final results. We expect restrictions on payouts to ease and for Lloyds to be capable of offering a very attractive level of dividends in future, given its strong capital ratios.

Our two property holdings recorded very different performances, with Tritax rising by 8% and Primary Health Properties falling 2%. Tritax was helped by a cracking portfolio valuation, usefully ahead of most analysts’ expectations and reflecting the strength of demand for large scale warehouses capable of hosting e-commerce infrastructure. For its part, PHP did nothing wrong, but in a risk-seeking market, a portfolio of doctors’ surgeries is unlikely to be Top of the Pops. In the longer term we expect both stocks to continue to generate steadily rising dividend streams and those will surely come back into fashion soon enough.

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.

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.

An extension of the Stamp Duty holiday helped house building shares to perform well and Persimmon participated with a gain of almost 11%. The company has resumed dividend payments and its ongoing capital management policy, coupled with high ongoing returns on capital bode well for future income levels. At some point the industry will have to cope without state support for the sector, but underlying demand for new homes seems solid and interest rates set to stay low for the foreseeable, which should be a pretty supportive environment. Persimmon’s substantial net cash balances leave it well placed to ride out any bumps along the way.

Losers

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

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 GB Group reflects a general market rotation from ‘Growth’ (particularly tech) into ‘Value’ names seen as beneficiaries of vaccines and stimulus packages. Likewise, we cannot find much to explain Paypoint's weakness. The company released a trading update in January which was in-line with expectations, evidencing further progress in re-positioning the business towards faster growth areas like cards and parcels, while reducing reliance on cash payments.

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 an indicator of future income.

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%.