HL Select UK Income Shares fund - Two Years In

Steve Clayton - Fund Manager

14 March 2019

The HL Select UK Income Shares fund has just passed its second anniversary, so we thought that this blog should focus on how the fund has fared.

Investors will be aware that the fund didn’t have a strong start, suffering from one stock, Provident Financial that suffered a major trading problem and, more generally, a lack of exposure to commodity producer stocks which came into vogue. The result was a weak first year.

Regular readers will know that we have been focused on turning performance around. Weak stock markets have not helped here. But we are pleased to report that in its second year of existence, the HL Select UK Income Shares Fund was the top performing fund out of all the 86 members of the IA UK Equity Income sector, beating the All Share index in the process by 3.7%. Past performance is not a guide to the future.

That is perhaps a cause for relief, but not celebration, for the fund has only generated very modest total returns to date, and remains behind both the median fund and the market for the full length of its existence. Charlie and I remain very much focused on trying to boost your returns.

Past performance is not a guide to the future. Source: Lipper IM, correct to 02/03/19.

Past performance is not a guide to the future. Source: Lipper IM. *Data not available prior to launch on 2 March 2017.

What drove the improved performance?

We sold the Provident Financial holding after it recovered some of its losses and have not been exposed to any of its subsequent problems as a result. So no further impact there. We have also taken advantage of some weakness in the oil price to add BP and Shell to the portfolio. We’ve been impressed by the efforts they’ve made to improve their cash flows, even at lower oil prices, and their commitment to pay dividends to shareholders through thick and thin. As with any dividends there are of course no guarantees.

Perhaps more importantly though, we’ve seen some really strong performances from some of our holdings, both old and new. All of the comments below refer to how much the stocks mentioned have contributed to the value of the fund over its full life.

Fidessa, a specialist technology stock serving the financial services sectors received takeover offers that led to us realising a big gain on the position, which added 2.2% to the fund’s value.

Ascential, a digital media services company has been a big winner for the fund, adding over 0.7% to the value of the portfolio.

Britvic was a strong performer, adding 1.5% to the fund’s value before we took profits and sold the position. Car Auctioneer BCA Marketplace attracted a potential takeover offer, but in the end it rebuffed the approach. Either way, the gain on the stock has so far added almost 0.8% to the fund’s value and we remain invested.

Financial Services has been a curate’s egg for the fund. Our investment into Provident Financial cost 3.2% of the fund’s value. But investments into Burford Capital and Legal & General have been successful, so far each adding a little over 0.8% to the value of the fund.

Backing AstraZeneca, even after a drug trial failed to deliver, proved worthwhile because the stock appreciated strongly after other trials were more encouraging. The stock has added almost 1.2% to the fund’s value. Our investment in Primary Health Properties, which owns a portfolio of Doctor’s Surgeries and Health Centres - 90% let to government backed clients - has added 0.7% to the fund’s value.

GB Group, an IT company specialising in ID and Location verification services to the e-commerce sector added over 0.5% to the fund, whilst business information group Relx added over 0.6%.

And which holdings held it back?

We had some other notable misses beyond Provident Financial along the way too. Domino’s Pizza has so far delivered only disappointments, with the position costing the fund over 1.1%. Advertising giant WPP was floored by the rapid shift to online advertising and a vicious margin squeeze on traditional agencies and the position cost the fund 0.9%.

Tobacco stocks were hit by moves to regulate the industry more aggressively in the USA and our holdings lost a total of 2.8% of value for the fund. The boss of the US regulatory agency involved has just resigned, leading to something of a bounce in recent days.

We sold WPP but continue to hold and believe in the long-term potential in Domino’s Pizza, Imperial Brands and British American Tobacco.

What can we expect going forward?

Brexit is unfolding, or unravelling, as we write, depending on your viewpoint. Hopefully you’ll have seen Charlie’s piece covering our view on Brexit with regard to your fund. In the long term, we think that its impact on your fund’s value is unlikely to be significant but you can read why, in more detail, there.

More generally we should stress that with the fund only holding around 30 holdings at any one time, its performance is often likely to diverge from that of the wider market, in both positive and negative fashion. We believe that our focus on investing in businesses that offer attractive dividend growth prospects and strong finances will deliver attractive returns in the long run.

The fund has good exposure to technology and e-commerce through positions like GB Group, Rightmove, Ascential and Just Eat. It owns some of the world’s leading consumer brands through its holdings in Unilever, Diageo and Reckitt Benckiser. Burford Capital is the global leader in financing corporate litigation and is growing rapidly as this new asset class takes off. We see plenty of growth potential in the portfolio and expect it to continue to generate an attractive income return. Over the long run, we believe that income growth will translate through to capital values, although of course this is not guaranteed.

The fund will continue to pay dividends each month and we currently expect to pay at least as much in the current financial year as we did in the last. So far holders of income units have seen dividends of 7.9p declared (with February’s 0.3p payment to be received later in March) whilst Accumulation unit holders have had the equivalent yield reinvested back into the value of their units. This should not be seen as a guide to future returns.