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HL Select UK Income Shares – Q1 2022 Review


HL Select UK Income Shares – Q1 2022 Review

Managers' thoughts

Important information - The value of this fund can still fall so you could get back less than you invested, especially over the short term. The information shown is not personal advice and the information about individual companies represents our view as managers of the fund. It is not a personal recommendation to invest in a particular company. If you are at all unsure of the suitability of an investment for your circumstances please contact us for personal advice. The HL Select Funds are managed by our sister company HL Fund Managers Ltd.
Steve Clayton

Steve Clayton - Fund Manager

29 April 2022

Market review

The first quarter of 2022 witnessed the return of war to Europe, surging inflation, led by rocketing energy prices, and ongoing economic disruption linked to the pandemic. There are relatively few significant restrictions left in place in Europe and the UK. However, supply chains remain under pressure and shortages of goods, such as automotive semiconductors are still impacting on output.

The pace of inflation and its duration has exceeded expectations and prices are still rising at pace. Economic debate has swung from wondering when interest rates would eventually rise to speculating about how many times central banks in the major nations will hike rates this year.

The pressure on consumer incomes will only intensify as higher utility bills and rising mortgage rates kick in. Ultimately though, we believe the primary driver of the inflation has been the aftermath of the pandemic and supply chains, shipping arrangements and labour shortages will be navigated. Once these pinch-points are sorted we would expect the pace of inflation to decline. The digital economy continues to grow and as it does, it tends to drive costs down through greater transparency and automation. These forces will reassert themselves once the pandemic’s impacts have subsided.

Despite all that went on in the quarter, the market managed to eke out a modest gain of 0.5%, but beneath that small number were a number of substantial shifts. Energy and Industrial Metals were the top performing major sectors, in response to the surge in the price of metals, gas and oil. Rising bond yields raised discount rates, punishing highly rated stocks and the technology sector in particular. Fears over the coming squeeze on consumer disposable incomes led the consumer discretionary sector lower.

HL Select UK Income shares - Fund Performance Review

The fund delivered a return of -1.2%* for the quarter, lagging the market (+0.5%) and UK Equity Income peer returns (-0.1%). Our returns were driven on the downside by our holdings in Consumer Discretionary stocks, with the sector dragging performance down by 2.0% in the quarter. Our Information Technology holdings cost a further 1.2% of performance. On the positive side, our positions in Energy added 1.6%, whilst both the Healthcare and Materials sectors added 0.8% each to the fund’s value.

We were broadly reassured by the performance of the underlying businesses in the portfolio, even if sometimes their share prices were not matching the progress on the ground. We tend not to worry overmuch what a share is doing day to day, so long as the business is grinding out the profits and progress we were expecting.

Annual percentage growth % Growth % Growth % Growth % Growth % Growth
31/03/2017 To 31/03/2018 31/03/2018 To 31/03/2019 31/03/2019 To 31/03/2020 31/03/2020 To 31/03/2021 31/03/2021 To 31/03/2022
HL Select UK Income Shares -6.5 9.7 -12.3 18.3 11.3
IA UK Equity Income 0.4 3.5 -20.8 32.7 10.9

Past performance is not a guide to the future. Source: *Lipper IM to 31/03/2022

Significant winners and losers


Stock Gain/Loss (%) Contribution to Fund (%)
Shell plc 27.6 +1.2
Rio Tinto plc 32.3 +0.8
AstraZeneca plc 18.8 +0.7
British American Tobacco plc 18.8 +0.7
Sabre Insurance Group plc 26.2 +0.7

Past performance is not a guide to the future. Source: Bloomberg to 31/3/2022

Shell plc was our strongest position, gaining 27.6% over the quarter. We would ascribe this almost entirely to the impact of the surge in energy prices. Shell should be a particular beneficiary of the current high gas price because its Integrated Gas division is one of the largest producers of Liquefied Natural Gas (LNG) worldwide. LNG is loaded onto tankers and can be delivered to any receiving terminal. Most of Shell’s production will be sold under long term contracts, but some cargoes will be available to the highest bidder, allowing Shell to capture some of the extraordinary surplus returns currently available. Shell also announced a share buyback of some $8.5bn during the quarter.

BP did not make the leader board, due to its Russian exposure, but it still delivered a return of 14.7% in the quarter.

Rio Tinto was buoyed by its exposure to buoyant commodity prices. If Iron Ore prices remain elevated through the year than the group’s dividend policy of paying out a substantial proportion of free cash flow over the cycle should bode well for the income we receive from the stock.

Sabre Insurance enjoyed a strong quarter, with a 26.2% gain, aided both by well received full year results in March and also the announcement of an underwriting deal that should lead to them becoming a major player in the taxi insurance market. The company see insurance rates hardening as the year progresses, which should lead to rising cash and profit generation. The group’s capital position is strong, leaving them with good potential for dividends this year and beyond. We like Sabre because they focus solely on the profitability of the business they write, not the volume. This matters, because in insurance it is easy to write large volumes of cheap policies. But the only certainty that brings is large volumes of claims with only modest premium income from which to pay the claims. Sabre’s approach is we feel, far better suited to generating reliable cash flows.

British American Tobacco shares, in common with other tobacco firms have been weak in recent years. The company has continued to run its operations efficiently and grow its dividend to shareholders to the point where during late 2021 the stock was flirting with a double digit yield. Having deleveraged significantly since the Reynolds deal the attractions of a share buyback, which would enhance earnings per share and improve dividend cover had become compelling and the group duly obliged by announcing an intention to commence repurchasing stock in the market. The group has announced its exit from Russian operations, since the Russian invasion of Ukraine.

AstraZeneca had a good quarter, rising 18.8% as investors anticipated a period of strong new drug launches ahead. With AstraZeneca’s increasingly significant oncology treatments commanding high prices and margins to match, the potential for growth and cash flow looks good. Analysts are increasingly looking at Enhertu, a drug/adjuvant combination as being capable of achieving over $10bn a year in revenues, given large potentially addressable markets for breast cancers and other clinical settings.


Stock Gain/Loss (%) Contribution to Fund (%)
NEXT plc -24.4 -1.1
GB Group -25.5 -0.8
Close Brothers Group plc -13.6 -0.6
Persimmon plc -20.2 -0.6
Ascential plc -13.9 -0.5

Past performance is not a guide to the future. Source: Bloomberg to 31/3/2022

Three of our top losers in the quarter are digitally led businesses. GB Group is a software business, playing a key role in helping companies identify their clients online and protecting against fraud. The sell-off in tech stocks worldwide was undoubtedly a factor in their weakness. But GB also suffered from having issued stock in a discounted placing late last year, leading to a case of market indigestion. We still regard GB as one of the most exciting businesses we hold in the portfolio. Their markets are growing, and their products embed deeply into their customers’ day to day processes making their revenues highly likely to recur.

The Consumer Discretionary sector was weak and NEXT plc was caught up in the concerns over the impact of inflation upon consumers’ spending power. But the group has been trading strongly. Bears would say that at the moment, outperformance on sales is simply compensating for higher costs, leaving profit expectations little moved but margins pressured. Whilst there is truth in that, it’s also true that Next has navigated these challenges before. And with most of its income earned online it’s far better placed than its rivals in our opinion.

Ascential is building an increasingly impressive portfolio of digital businesses that help brands to boost their performance in the online world. We think Duncan Painter is doing a great job in creating a unique gem, but when technology stocks are out of favour it is hard to swim against the tide. The lifting of covid restrictions will help the group’s remaining conference and corporate festivals to perform to potential and we expect a strong outcome from the key Cannes Lions event this year.

Persimmon produced strong results, but have been drawn into the furore around cladding compensation, despite having little exposure. The sector as a whole has been impacted by fears too around the squeeze on consumer incomes and the potential for inflation to push interest rates higher. For now though the housing market remains firm and Persimmon is generating lots of free cash flow.

Close Bros. lends to the UK corporate sector and concerns over the pending consumer squeeze have hurt sentiment toward Close. Recent results were fine, but the slowdown in their Winterflood market making business was quite marked. That belies the fact that it had exceptional growth when pandemic struck and day trading became the national hobby on both sides of the pond. The slowdown was more about people going back to work and generally having better things to do than day trade meme stocks, than any structural weakening of the franchise. With the dividend growing nicely we think the stock’s 5.6% yield deserves more attention. Yields are however not guaranteed, nor a reliable indicator of future income.

Dividend Outlook

At the moment our projections for the fund’s income this year are encouraging and barring the unexpected we hope to be able to raise the monthly dividend by 20% to 0.3p per income share per month, with effect from the payment declared at end-April and paid to investors toward the end of May. This will leave the regular payment back within 10% of its pre-pandemic level. The final dividend will as always be the residual of the income received during the financial year, but not already paid out. At this stage we expect it to be broadly similar, or a little better than the previous year’s level.

Team Changes

We are delighted to welcome a new UK Equity Analyst to the Select Team. Matt Gregg has joined, supporting Steve in running the funds. Matt has been with HL for 10 years. He is a CFA Charterholder and has a BSc in Economics from the University of Bristol. Prior to joining Select, Matt headed up HL’s Quantitative Investment Research team.

Charlie Huggins has decided to move on to a new venture and leaves with our thanks and best wishes. We have been fortunate enough to recruit a highly experienced Fund Manager who will be joining the team shortly. We’ll introduce them in our Q2 blog.

Important - This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information. Unless otherwise stated performance figures are from Bloomberg and estimates, including prospective yields, are a consensus of analyst forecasts from Bloomberg. They are not a reliable indicator of future performance. Yields are variable and not guaranteed.