HL Select UK Income Shares - Portfolio changes

Steve Clayton - Fund Manager

20 November 2017

We have made a few adjustments to the portfolio. Here is what we have done, and why.

Sold - WPP

We have sold out of our position in WPP in its entirety. More and more evidence is emerging to suggest that the larger advertising groups are struggling to hold their positions in an increasingly digital world. The giant internet companies, from Google to Facebook and Amazon are offering services to brand owners that would historically have been seen as advertising agencies’ territory.

At the same time, there is a growing distrust between the agencies and brand owners, who fear the agencies have been over-charging them for advertising slots they have bought for them. It is showing up in a deceleration in the pace of growth for advertising business globally. At the moment, for all their undoubted creativity, it does not seem that the industry has an answer to the problems.

If the trend continues, then the scope of downgrades in the media sector could become distinctly uncomfortable and as the world’s leading media agency, WPP is in the firing line. The company has also been busily acquiring rivals and buying back stock in an attempt to accelerate a shift toward developing nations and digital services, whilst rewarding shareholders with cash returns.

These deals and buy-backs have taken the balance sheet to a position that whilst not over-stretched, could easily become so if earnings were to suffer a significant further setback. That combination of deteriorating trading and rising debts is riskier than we are comfortable with, leading us to exit the position. Overall, WPP cost the fund 0.9% during the time it was held.

New Holding – HSBC

Pivot to China is HSBC’s strategy. The bank has spent the last few years busily restructuring its operations in the US and preparing for the UK ring fence. Having fixed the broken stuff the bank is now targeting growth as it seeks to become the leading player in global trade finance. HSBC describes it as a pivot to Asia, especially China’s Pearl River delta, where so much of the world’s manufacturing activity now takes place.

HSBC’s Hong Kong roots have long given it strength in financing cross-border trade and facilitating payments between the trading parties. This leaves it well placed to grow in China. Recent results have shown signs that the strategy is working.

Costs are being tightly controlled, with the group having taken over $5bn out of its cost base so far. Capital is strong, with a core Tier One* ratio approaching 15% and an advances to deposits ratio* of 71%, leaving the balance sheet well-funded and liquid. The group’s exposure to investment banking is quite low, at around a quarter of revenues, reducing the potential for volatility. Most of HSBC’s income comes from its global retail banking, wealth management and commercial banking divisions.

The bank was not blameless through the financial crisis, but we believe most of the dirty laundry has now had a public airing and restitution paid. The strength of the balance sheet leaves them well placed to absorb any further impacts.

HSBC’s focus on retail and commercial banking should lower its risk profile, whilst the pivot to Asia ought to raise its growth potential. The bank pays quarterly dividends and offers a yield of over 5% although of course this is not guaranteed. We have begun a position in the stock, and expect to add to it further when trading opportunities arise.

*Bank jargon explained

Core Tier One capital – this is basically the banks own funds, money available to cover bad debts and it protects depositors against the risk of the bank failing if the banks loans start turning bad. The higher the ratio, the more protection. We consider a number greater than 10% to be sensible for a major bank to operate with.

The advances to deposits ratio is a measure of liquidity, or how easily a bank will be able to meet any unexpected demands by clients to take their deposits out. The lower the percentage of deposits that have been lent out, the safer the bank is typically judged to be. This is because loans are typically hard to call in on demand, whereas depositors can withdraw at will, often without penalty. HSBC’s ratio is well below that of peers like Barclays, Lloyds or RBS.

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