HL Select UK Income Shares - September Review

Steve Clayton - Fund Manager

19 October 2018

Talking about the market’s movements in September seems rather academic, given the rather more dramatic moves that have erupted around the world in October.

The market’s total return of 0.7%  in September was driven by strength in commodity stocks, and partly offset by weakness in areas ranging from tobacco to pharmaceutical and banking names.  

Before we recap performance in September, we’ll share a quick update on what we’ve seen so far this month. While at the end of the blog, we discuss dividends – what we’ve paid this year and what we project to pay next year.

Early October has seen markets across the world fall quite sharply, with the FTSE 100 having dropped almost 500 points, circa 7% at the time of writing (Oct 11th 10:00 hrs).

Bull markets they say, climb a wall of worry. At the moment the worries have the upper hand and these  range from rising interest rates, especially in the USA to fast-developing trade wars between the USA and whosoever President Trump chooses. Meanwhile there is still no clarity on where Brexit is headed, nor what it will look like when we get there. Ongoing US rate increases seem likely, in our view. All of the other factors can spin on a sixpence.

Within the overall movement of the market, there has been a pretty marked rotation from growth toward value. Stocks that had been leading the way have been punished for high valuations and investors have been turning toward (often lower quality) businesses trading on lower multiples of earnings.

Some of the moves have been dramatic, many growth stocks that have not delivered any bad news have still seen double digit price falls. We don’t know how long this bout of nerves will go on for, but we do see it as an opportunity to add to some of our favourite companies at more attractive valuations than we have seen for some time.

Fund performance in September

The fund declined by 1.60% in September, underperforming the wider stock market, which rose by 0.70%. Just under half of this underperformance was caused by the fund’s zero exposure to Materials and limited exposure to Energy, the two strongest performing sectors this month, with individual stock declines accounting for the remainder. 

Below, we list performance of the biggest positive and negative stocks by their contribution to the fund’s return. As always, remember these details are over a short period of time and past performance is not a guide to future returns.

Biggest positive contributors

Past Performance is not a guide to the future. Bloomberg 01/09/2018 – 30/09/2018.

Sanne’s share price rose following the release of interim results which were in line with analysts’ expectations. The fund administrator reported revenue growth of almost 20% in the first half and increased its dividend by 9.5%, although profit fell slightly.

Sanne’s focus over the last year has been on integrating acquired businesses. As part of this process it has invested heavily in areas such as compliance, IT systems and new management which has inevitably weighed on margins.

However, we believe these investments should position the business strongly for the future. The acquisitions have transformed Sanne from an industry minnow into a business of scale, with a network of offices across the globe. This global platform is particularly attractive to larger fund groups looking to launch funds in multiple jurisdictions, and is allowing Sanne to bid for work they didn’t previously have access to. With the ground work having been laid in the first half of the year, management expect both stronger growth and higher margins in the second half.  

Biggest negative contributors

Past Performance is not a guide to the future. Bloomberg 01/09/2018 – 30/09/2018.

BCA Marketplace shares weakened despite issuing a brief trading statement confirming that the year has started strongly, with the Board remaining confident in future prospects.

There is plenty of nervousness around car markets at the moment, due to things like Brexit and new emissions standards weighing on car manufacturers. However, BCA has a strong, resilient and diversified business model which is allowing it to make progress at a time when many other businesses in this sector are struggling.  

 Rumours during the month that Uber Eats is in talks to buy Deliveroo caused sentiment towards Just Eat to weaken. Both Uber and Deliveroo compete with Just Eat in the food delivery market and the worry is that a single, deep-pocketed competitor could pose a greater threat to Just Eat.

Maybe, but it doesn’t change the fact that both Deliveroo and Uber Eats are burning through cash at a rate of knots, while Just Eat generates cash in spades. We would rather be in Just Eat’s position – funding investment into delivery from internally generated cash flow, rather than relying on the goodwill of debt and equity investors to fund expansion plans (as in the case of Uber and Deliveroo).  

 Nevertheless, with the competitive dynamics of the industry evolving quickly, we are monitoring the situation closely.

Pennon declined despite issuing a first half trading update confirming that the business is on track to meet management expectations. We expect the company to raise its dividend when it reports first half results on 27 November underpinning a current yield of almost 6% - remember though, dividends are variable and not guaranteed.  

Your dividend

The fund pays dividends monthly, and we aim to pay out eleven even payments each year, with the final dividend a variable payment that takes account of any exceptional income received during the year.

For the financial year to end September 2018 we have paid a level 0.3p per income unit for the first eleven months and subject to the annual audit sign-off, expect to declare a final dividend of circa 0.59p per income unit, which will be paid in late October to investors who were on the register of unit holders at the end of September.

Looking ahead to next year, current projections suggest the fund will enjoy a higher level of income in the year ahead, though of course none of the dividends that the fund will receive, or pay to investors are guaranteed.

Both the path of the wider economy and our own actions can impact the level of dividends. Recessions are rarely positive for dividend payments, booms can lead to rapid growth. If we buy or sell shares with higher or lower levels of yield than the current portfolio average that will impact the future level of income too.

With this in mind, and given the current level of volatility in markets, we feel the most appropriate course of action is to leave the regular monthly rate at 0.3p. If the current projections do indeed prove accurate we will have the option to raise the monthly rate later on, or return the higher level of income via next year’s variable final payment.

Holding the payment steady for now also gives us more flexibility to pick up bargains that may appear in the current volatile conditions.