Two years in

By Steve Clayton & Charlie Huggins

The HL Select UK Growth Shares fund is now two years old. Back in December 2016, we said we wanted to invest in a virtuous circle of growth. We were going to back financially robust businesses, with great products and services, strong profit margins and cash flows, capable of compounding years out into the future.

It’s early days but, so far, we are pleased with how that strategy is working out. Investors who bought in at launch have seen returns of almost 25% compared to a market return of 12%. Of course, past performance is not a guide to the future and all investments fall as well as rise in value, so you could get back less than you invest.

HL Select UK Growth Shares - two years in

What’s changed?

At launch we said few companies would meet our high quality criteria, so the fund would be a concentrated mix of large, medium and higher-risk smaller companies we thought had the best potential. Only holding around 30 stocks does increase risk, but crucially it allows each company to have a real impact on performance and, today, we still hold most of the positions we started with.

But not everything went the way we would have wished, and a few positions have had to be sold. We exited Intercontinental Hotels Group when it became clear that online travel agents were making it easier for prospective guests to find alternatives to the big branded chains, putting future pricing power at risk.

WPP left the portfolio because the incumbent advertising agencies found themselves facing an ever increasing challenge from digital businesses, like Facebook, Google and Amazon which looks unlikely to get any easier, any time soon. Similarly we sold out of Playtech when it became clear to us that their competitive position was weakening.

We made money on the position in IHG, but WPP was a losing bet and Playtech broke even, considering the dividends we received whilst we held it.

What’s pushed the fund forwards?

A frequent theme amongst our investments has been to seek out businesses that were well set to exploit the digital opportunities in their industries. This has proven a sound strategy so far, generating some of the biggest contributions to the fund.

Fidessa provided the electronic links between brokers and their markets and held strong positions in their niche markets, which eventually led to multiple takeover offers being made for the group and a contribution of 2.4% to the growth of the fund.

GB Group was a smaller company when we bought it, and now it is a medium-sized one. The group provides electronic ID and location verification services to businesses around the world. They help banks satisfy themselves of customer bona fides and retailers identify e-commerce customers as trustworthy and prove their age if regulation requires. We still hold GB and so far it has added 2.3% to the value of the fund.

Ascential has been another winner so far. This business data services group has been transforming itself into a company focused on enabling successful e-commerce strategies and effective communications. Assets that served non-digital markets have been sold and young, fast growing businesses serving the e-commerce ecosystems acquired. So far, the shares have added 1.7% to the value of the fund and we remain invested.

Stand-out performer

But our stand-out success story has been Burford Capital, a business almost unique amongst quoted equities. Burford provide capital to companies that wish to pursue commercial lawsuits, but do not want to pay up front, in return for a share of the proceeds if the case wins. This is a fast-growing industry and Burford lead it. So far the shares have produced a gain of over 230%*, adding 5.4% to the value of the fund. Past performance is not a guide to the future.

Waiting for delivery

We have some positions that are currently loss-making, but where we still believe in the businesses potential to deliver future gains. A good example would be Domino’s Pizza, which has so far cost the portfolio about 0.7% of its value. Domino’s faces rising competition from food delivery operators like Just Eat, which we also hold (and which has added 0.8% to the fund), and Deliveroo or Uber Eats which we do not. But the pizzas still taste great and turn up hot and fast.

Domino’s continue to gain market share and throw off cash in large amounts. So we are hanging on, because in our experience selling rudely profitable businesses is rarely the right long-term decision.

Consumers not commodities

Overall, the biggest sector contribution to the portfolio came from our Consumer businesses, which added a total of 6.7% to the funds value, with Burberry the largest individual contributor amongst that group, not least because we top-sliced our position close to their highs, from which they have now retreated. Our IT holdings, have been another big positive, with a contribution of 4.5% to the fund’s value. Industrials, like Relx, Intertek and Experian added a combined 4.4%.

Not holding commodity producers has been a drag though, and our absence from the energy sector cost 2.8%, and not holding materials and mining stocks a further 1.3%. But we do not intend to change this stance. The commodity sectors can be great dividend generators, but growing the output from oil fields and mines is tough going. The policy can be a drag when commodities are in favour, but we think we can get more growth in the long run investing elsewhere.

In summary

So overall, it has been a rewarding first two years for the fund and we are pleased that our returns have been strong in absolute terms and well ahead of the wider market so far. But in the stock market nothing is guaranteed and the future may be very different. We are excited by the potential of the portfolio, which we think is packed full of great businesses, well placed to exploit the virtuous circle of growth for years to come.

Past performance is not a guide to future returns. Source: Lipper IM to 01/12/2018.

*Source: Bloomberg, 01/12/2016 to 30/11/2018

Please note Charlie Huggins and his connected parties hold shares in Ascential.