HL Select UK Income Shares - January Review

Charlie Huggins (CFA) - Fund Manager

5 February 2018

The UK stock market gave up some of the ground it had won in December, with a total return of minus 1.9% in January. For us, two market themes stuck out as the month went on.

The first is the poor performance of the UK outsourcing sector, following the collapse of Carillion and an ugly profit warning from Capita at the end of the month.

We do not own any construction or public sector out-sourcing companies in the portfolios. These companies tend to exhibit low profit margins, since there is little to differentiate one firm from another, the accounting is complex and cash flows are volatile. This is not a combination we favour.

The other theme which continues to dominate is digital disruption. Many traditional retailers, including M&S, Debenhams and Card Factory, endured Christmas trading that was patchy at best. Consumers continued to click away from the comfort of the sofa, instead of venturing out into the wintery cold of the High Street.

E-commerce continues to gain market share and there seems little reason to expect this trend to reverse when the sun does finally emerge. We are seeking to position ourselves on the right side of these shifting sands and do not own any traditional retailers within the funds.

Despite dodging these bullets, January was a relatively difficult month for the fund. The Consumer Staples and Utilities sectors, where we are strongly represented, had a weak month as bond yields rose, while Materials (where we are absent) was again the strongest-performing sector.

We believe these sector moves can partly be explained by rising global growth expectations after President Trump successfully pushed ahead his tax cuts. This has led to more economically-sensitive sectors outperforming more defensive areas of the market which has tended to be a headwind for our strategy and the income fund in particular.

We discuss a number of these developments below while highlighting the biggest positive and negative contributors to the HL Select UK Income Shares fund performance in January. However this is over a very short period and past performance is not a guide to future returns.

Biggest positive contributors

Past performance is not a guide to the future. Source: Bloomberg 01/01/2018 – 31/01/2018

Close Brothers rose after saying that it has seen a strong start to the financial year, with all parts of the business performing well.

Some parts of the banking division, such as motor finance, are currently experiencing greater competition and here Close Brothers is maintaining discipline, refusing to chase business. However, the group continues to see opportunities in other areas, such as Property Finance, which enabled the division as a whole to grow its loan book by 2.6% in the 5 months to 31 December.

The rise in Lloyds Banking Group can probably be explained by an increase in bond yields and rising interest rate expectations. As interest rates rise, the difference between what banks can charge borrowers and what they pay for funding widens, potentially leading to higher profits.

Biggest negative contributors

Past performance is not a guide to the future. Source: Bloomberg 01/01/2018 – 31/01/2018

Britvic fell after saying that sales were modestly below analysts’ forecasts, with organic growth a lacklustre 0.7%. While its largest division, GB Carbonates, reported much better than expected growth, this was offset by weaker performances in GB Stills and the overseas operations.

The shares trade on a price to earnings ratio of less than 14x and offer a prospective yield of 3.7% which we think looks good value.

We put weakness in Imperial Brands, Relx and Diageo down to a weaker dollar, with all three companies generating a significant proportion of their sales in the USA. The latter released a very solid set of interim results during the month and raised its dividend by 5%.

There was no news from Sanne or BCA. Both are relatively illiquid meaning their shares can move around more than might otherwise be expected. We focus on business results not share prices, with the former the biggest driver of the latter in the longer term.

Please note the author or his connected parties own shares in Imperial Brands and Sanne and invests in the HL Select UK Income Shares fund.

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