HL Select UK Income Shares - Q1 2025 Review

James Jamieson - Fund Manager

21 May 2025

Market review

The UK market was one of the stronger markets in Q1, delivering a return of 4.5%. UK investors benefited from being relatively insulated from the concerns around the sustainability of the extraordinary performance of AI-related stocks on Wall Street, where meaningful profit-taking held shares back in the quarter. UK investors appeared relaxed about the potential impact of possible US trade tariffs, which were only announced after the quarter’s end. Instead investors seemed more pre-occupied with the positive impacts that might come from Europe’s pressing need to raise defence spending.

The UK market was led higher by mining stocks and banks, within the major sectors, while Leisure and Luxury Goods stocks featured prominently among the losers.

The Bank of England made a single quarter point reduction to interest rates during the period, which was widely anticipated. Expectations remained very much that future rate reductions would be modest and further out. Whether the fast-shifting global trade environment will impact the course of rates remains to be seen.

Fund performance

The fund delivered a return of 4.75%, slightly outpacing the market’s 4.5% gain. Our energy exposures delivered some of the strongest returns, with a 14.3% gain. But the biggest driver of relative returns versus the market was our Financials sector position, which delivered a 16.6% return over the quarter.

Stocks review

The winners

Lloyds Banking Group plc

Banks enjoyed a solid quarter in general and Lloyds was no exception. The strength came despite no easing of the tensions surrounding the Motor Finance Review, which could lead to significant compensation costs for Lloyds and other leading players. The FCA’s intervention on behalf of the industry was insufficient to stop the courts from proceeding and a key trial is due to kick off imminently with a judgement expected toward late summer. Lloyds’ underlying business performance seems strong enough, judging by their latest figures, but reported profits were held back by provisions relating to potential Motor Finance charge-offs.

HSBC

The banks sector was a strong performer in the quarter. Like major energy companies, the larger banks fall into the “Large Cap Value” bucket, which has been in vogue of late. HSBC recently reshuffled its top team and they have begun to restructure the business, exiting from some underperforming units. So far, the market is on HSBC’s side and duly upgraded expectations after the Group’s results were published.

Shell

The return of President Trump to office heralded a more positive backdrop for traditional energy producers, helping sentiment toward major oil and gas producers. The Group’s results helped underline Shell’s cash-generative qualities. We believe these could be sufficiently strong to enable Shell to repurchase as much as 40% of its equity over time, which should provide a strong underpin to the company’s dividend paying ability.

AstraZeneca

The UK’s largest pharmaceutical business took a knock toward the end of 2024 when it revealed regulatory investigations into its practices within the Group’s Chinese business. A strong set of quarterly results allayed fears over the impact of the investigation and the announcement of a $2.5bn investment by AstraZeneca into a new Chinese research facility suggested that relations were back on nodding terms at least.

RELX

RELX’s business is remarkably stable, with a series of divisions that each have good track records of steady growth in most environments. But Q1 saw anything but a stable performance by the stock, which went on a sentiment-driven rollercoaster ride. Fears over the impact of Elon Musk’s Department of Government Efficiency hit confidence in the Academic Journals division, pushing the stock lower. Brokers then stepped into the fray with upgraded recommendations that steadied confidence, allowing the stock to recover. A classic example of how so often, near term market movements are entirely about what people think, not what companies have actually done.

The losers

Greggs

Greggs had a terrible quarter. A Q4 trading statement in January revealed unexpectedly weak trading toward year end. Full year results released later in March confirmed that weak trading was still ongoing. We were surprised by the degree of weakness in revenue from what has traditionally been a very defensively positioned consumer business. Official data have suggested that UK consumers have been acting cautiously, that this should extend to Gregg’s inexpensive range of pastries and sandwiches suggests that reticence to spend is strong. We are trying to better understand the causes of the malaise. The Steak Bake has long been the dirty secret of many a shopper and the Greggs sausage roll, vegan, or preferably not, holds cult status. Until we can figure the underlying drivers of Greggs’ struggles, our conviction in the stock is at risk.

Diageo

The US is talking of mandatory health warnings on alcohol packaging and Scotch Whisky is an obvious product whose relative attractions can be impacted by tariffs. For their sake, Diageo’s latest figures provided some reassurance but there is now a bigger debate going on. Will imported spirits be able to hold onto their share of the key US market and if so, at what impact to profit margins? And has the recent reduction in consumption of alcohol by younger generations been a fashion swing or is it a structural shift downward in demand? Without clear answers, Diageo feels a little rudderless.

Fuller Smith & Turner

This is a unique holding in the portfolio given its especially small size and affiliated liquidity, both attributes that penalize such stocks when risk appetite is falling, and elevate volatility in general. These dynamics are entirely responsible for the recent weakness. Results scheduling saw both a Q3 and Q4 update in the three month period, both of which revealed solid trading, despite a generally softer consumer and budgetary cost pressure, as well as initiatives adding to the strength of the business. We continue to see significant value.

GB Group and Kainos

Technology stocks were under pressure in the quarter as profit taking and scepticism about the reliability of AI-driven growth broke out. When confidence in growth prospects slips, the market places a greater discount on future profits and this appears to have been a bigger factor impacting GB in the quarter than anything they disclosed with their latest results, which were broadly fine.

Kainos Group, however, have definitely given the market reasons not to be cheerful in recent quarters. Kainos are seeing order slippage in their division that serves the UK public sector, as well as in parts of their Workday business that sells into the private sector. Part can be attributed to UK political uncertainties and part to a wider drop in commercial confidence but the combination of the two issues has led to big cuts to forecasts. We await their next trading update somewhat trepidatiously.

Holdings changes

During the quarter we exited from our small position in Pennon Group while adding new holdings in BAE Systems (the UK’s leading defence contractor), Irish food technology business Kerry Group and Flutter Entertainment.

Outlook

The world is very uncertain at present. The post-war consensus over international trade and relations is being redrawn by the USA. Their assertive stance threatens to disrupt established trade patterns and pricing structures in both at home and abroad.

Pricing power becomes ever more important in such a world. Weak operators cannot pass tariffs on and must either lose customers or swallow the tariff cost, hitting profitability. Our portfolio is already diversified across many industries and contains companies that operate locally in the States as well as those that export to it.

We see risks of recession, both in the US and its trading partners. We expect overall economic activity to reduce as a result of the erection of commercial hurdles to trade.

President Trump obviously believes that the US will emerge the winner. He has some grounds for optimism; the US is a far less open economy than many. Quite simply the US has domestic solutions to more trading issues than most of its competitors and should feel the pain less accordingly. But many would argue that job losses should be measured in absolute, not relative terms and the electoral impact of winning a trade war may not be as the president might hope.

Tariffs may prove to be both deflationary and inflationary. Initially they raise the cost of goods that cross borders. As buying patterns adjust and tariff-free products gain market share, firms that used to export to the US will seek new markets, creating excess supply in those territories. Economists do not possess the tools to accurately predict how this all plays out. Investors must simply be alert to elevated risks and position themselves for this.

Focusing on companies with must-have products and services and robust balance sheets is the best strategy in these times. Events also call for more diversification. Predicting precise outcomes when large scale change is being unleashed risks stretching bravery into foolhardy territory. We expect to continue adding gently to the number of portfolio positions accordingly, whilst also seeking to limit the concentration of risks.