Market Review
Markets began the year in reasonable form with early gains for both the UK and Global equity indices. There were however, some extraordinary moves taking place beneath the surface. Investor enthusiasm for AI has evolved from the initial rush to gain exposure to AI chipmakers, to fear surrounding which established companies might be hurt by others deploying AI capabilities to create new competition.
Particular attention was directed toward companies rich in Intellectual Property (IP) with industries like software and data management coming under severe selling pressure. Natural resource industries fared better, with little prospect of AI creating alternatives to energy or metals.
But then on February 28th the US and Israel attacked Iran. With the conflict rapidly spreading out across the region as Iran retaliated, investors were faced with higher energy costs and the risk of material disruptions to the flow of trade. Markets sold off aggressively in response.
Interest rate expectations were impacted by the conflict. Higher energy prices tend to raise inflation over time and central banks seem likely to either defer planned reductions or possibly even raise rates to try and stem the inflationary pressures. This impacted industries like housebuilding, where higher mortgage rates are likely to limit consumer demand for new properties.
By the end of the quarter the MSCI Global equity index was 1.6% lower and some 4.6% below the level it had reached before the conflict began. UK markets fared a little better, with the FTSE All Share Index delivering a total return of 2.4% over the quarter. This was some 6.7% lower than the market’s pre-conflict level.
Oil prices rose substantially in response to the attacks and unsurprisingly the Energy sector delivered the strongest performance globally, rising by 37%. The laggards were Financial Services, IT and Consumer Discretionary sectors, falling as much as 11%.
Fund Review
The fund delivered a return of -2.4% over the quarter, significantly lagging the wider market. Our performance was impacted by the weakness seen in IP-rich businesses as speculation over the impact of AI upon traditionally profitable business models intensified.
We saw a strong contribution from our holding in Shell, but because we were underexposed to the wider energy sector our overall Energy contribution lagged that of the wider market sector. 3i suffered from some downbeat trading news, which we cover below. Experian, Relx and Sage were all significant losers in Q1 reflecting the shift against IP-rich business models mentioned earlier.
Total Return (%): Fund v Index v Peers
01/04/2021 to 31/03/2022 | 01/04/2022 to 31/03/2023 | 01/04/2023 to 31/03/2024 | 01/04/2024 to 31/03/2025 | 01/04/2025 to 31/03/2026 | |
|---|---|---|---|---|---|
HL Select UK Income A Acc | 11.3 | -4.5 | 7.4 | 7.4 | 10.9 |
FTSE All Share TR GBP | 13.9 | 2.9 | 8.4 | 10.5 | 21.5 |
IA UK Equity Income | 10.8 | -0.1 | 7.7 | 7.2 | 16.1 |
Shell and BAE Systems were both boosted by the conflict in Iran. Higher energy prices will obviously feed through into Shell’s earnings, whilst BAE Systems benefits from the greater defence spending forecast for the years ahead. Irrespective of the outcome in Iran, Western nations are recognising a need for stronger military capabilities as they face up to more assertive threats from Russia and China. The position of the US as the leader of NATO is also unclear. Should it step away from its traditional role, the need for European rearmament will be even starker.
Rio Tinto has benefited from robust pricing for Iron Ore and Copper, the key commodities that it mines. The growing electrification of the global economy is expected to drive strong demand for copper in particular, at a time when supply is tightening. If these predictions prove correct then Rio Tinto’s copper assets should generate strong returns over the longer term.
HSBC’s Q4 results were well received by the market, with the group delivering an outcome that was comfortably ahead of analyst expectations for both revenue and earnings growth. Hopes that the Asian banking giant can deploy AI to drive further cost cutting in the next few years provided further support for the stock.
AstraZeneca continues to perform solidly, with no particular new drivers in recent weeks. The group reported some positive trial results within its portfolio of research molecules, but nothing that could be described as a game-changer for the group. It is becoming apparent however that AstraZeneca’s Imfinzi cancer drug is capable of being applied to a wider set of use cases, potentially becoming capable of generating over $10bn a year of revenues for the group.
Experian, Sage and Relx are all data-driven businesses that possess huge amounts of intellectual property. As such they came under significant selling pressure as investors speculated on where AI may undermine existing business models. Our view is and always has been, that AI cannot substitute for data ownership, but that it can enhance the value of data by automating interpretation. We expect each of these three companies will ultimately be able to benefit from deploying AI to leverage their data’s value to clients, in stark contrast to the markets’ present view.
Barclays saw sentiment impacted by the conflict in Iran, although it was hardly the only bank to face such risks. Exposure to private credit is another risk factor for the group, with the bank facing write-offs relating to its lending to collapsed lender Market Financial Solutions. Barclays is believed to have around £15bn of private credit exposure in total.
3i Group reported that France’s intractable political environment was impacting consumer sentiment and holding back revenue growth in the French division of Action, the value-retailer that is the group’s largest single investment.
Outlook
The months ahead will hopefully see some sort of a resolution to the conflict in the Middle East, possibly Ukraine too.
The Middle Eastern conflict remains ongoing at the time of writing. This makes it especially difficult to make predictions with confidence. The longer that oil and gas shipments are unable to traverse the Straits of Hormuz, the greater the scope for disruption of economies becomes. This can be in the shape of fuel shortages or the shutdown of industrial processes due to feedstock shortfalls.
Inflation and interest rates are also less predictable. Central banks will not wish to allow inflation to become further embedded, but nor will they happily risk recession by hastily raising rates.
The AI revolution is ongoing and the quantum of capital being staked on building out the physical infrastructure to support this is breathtaking. This should provide a degree of support to economic activity, especially in the US where much of the AI build is taking place. However, much of recent market activity has been driven by concerns over the scope for the disruption of existing businesses, especially those operating in data and IP-driven sectors.
Politics can be unpredictable at the best of times. Currently we have President Trump in the White House, whilst in 10 Downing Street Prime Minister Starmer commands a massive majority in the House, but a polling performance in the mid to high teens with the prospect of challenge rising. There is an acute need to re-examine spending priorities across European nations, but little sense that the current crop of political leaders have much appetite to rock the apple cart.