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Markets

UK equities rose over the quarter as a landslide Labour general election win at the start of the period fuelled hopes for a sustained recovery in the domestic economy. This occurred as expectations also built for a cut in UK interest rates, which the Bank of England (BoE) delivered in August, making its first cut in four years. The positive sentiment was somewhat offset by the new UK Prime Minister (PM) Keir Starmer warning of a "painful" autumn budget. He signalled potential tax increases and spending cuts due to an estimated £22 billion shortfall in public finances. The PM added those with the “broadest shoulders" will bear the heaviest burden, sparking speculation around which taxes might rise.
After an encouraging first estimate of Q2 GDP, the Office for National Statistics subsequently revised down growth to 0.5%, a step lower than the 0.7% quarter-on-quarter growth achieved in Q1. Like growth, the official inflation statistics became slightly less encouraging as the quarter progressed. It was revealed annual Consumer Prices Index inflation ticked up slightly to 2.2% after hitting the BoE’s 2.0% target in June. The BoE’s governor Andrew Bailey promised to move ahead cautiously with further interest rate cuts. Meanwhile, the deputy governor Clare Lombardelli added that the Bank’s base case for inflation is benign, but risks remain of an “alternative world” in which inflation moves higher again. The consumer staples, financials and consumer discretionary sectors were the top performers over the period. Energy was a significant detractor.

Performance

The Fund’s NAV return outperformed the FTSE All Share TR over the three-month period to end September, returning 3.6% and 2.3% respectively.
The more economically sensitive areas of the market posted negative returns. As a result, having no exposure to oil major BP was the largest contributor to relative performance. The company has suffered with a declining oil price, China’s slowdown and a general cautious tone on the global economy. Power firm Drax Group was one of our best performers over the quarter as the utility sector rallied. Drax was additionally helped by the conclusion of a long-running OFGEM investigation into how it reports the sourcing of biomass feedstock. Whilst the company received a fine and admitted some wrongdoing, this does draw a line in the sand and removes an overhang on the share price. The regulator acknowledged that improvements in Drax’s processes since 2021/22 mean they do not have reason to believe that Drax have incorrectly reported any subsequent data.
On the negative side, performance was largely driven by companies we do not own – outperforming defensives such as British American Tobacco – and industrial Rolls Royce which continues to strengthen its order book. For companies we do own, Computacenter shares fell - on fears of a slowdown in global IT spend.

Outlook

In financial markets the mood is buoyant with stocks in the US, Eurozone, Japan and the UK at record highs. Markets optimism is based on an expectation of a soft economic landing together with monetary easing by central banks as the perceived risks from inflationary pressures continue to ease.  There are of course risks around this “Goldilocks” scenario.  Markets currently see limited risk of a resurgence in inflationary pressures and are pricing in significant further monetary easing over the next 12 to 18 months. Any shortfall to these market expectations in magnitude or timing could cause disappointment.
Market valuations of UK equities in our view have more cushion to absorb disappointment than the more highly valued US equity market. We do however acknowledge that the US markets set the tone globally. UK economic data on growth and inflation are no longer outliers. The OECD recently upgraded UK GDP growth expectations for 2024 to 1.1%, ranking joint second in the G7. UK CPI inflation in August 2024 was 2.2%, down from 6.7% in August 2023 and 9.9% in August 2022. 
The winner of the US Presidential election in November will undoubtably have implications for policy particularly on energy, geopolitical tensions and conflicts and the financial markets. The outcome at present remains too close to call.  We acknowledge the role of the large fiscal stimulus that has aided the US economy to grow more robustly than other developed economies in recent years as well as the role that the US dollar plays in terms of the world’s reserve currency to enable such stimulus at a time that the fiscal deficit continues to increase.  All politicians, in all countries, face tough choices given the extent of budget deficits and debt near or at record levels post the huge pandemic surplus stimulus packages. Budget watchdogs, and the currency markets, have noted countries where spending pledges are or have been either unfunded or unrealistically costed.  The rise of the price of gold and the decline in the US dollar is a part reflection of the vulnerability of the global economy to financial shocks given the level of debt. Additionally, the ongoing conflicts in the Middle East and between Russia and Ukraine mean that defence and security spending is likely to remain in focus.
In the UK we await the Labour Party budget at the end of October. So far, the new government’s assessment of the UK financial position has been fairly gloomy and has placed much of the blame for this on the previous government. Market participants will be watching closely the extent to which the Chancellor will seek to back economic growth as a way of addressing the budget deficit and as to whether there will be any significant changes to tax policy.
There has been significant attention paid recently to structural reforms that could revitalise the prospects for the UK equity market. This has concerned changes to listing rules to create a more attractive environment to be a UK PLC. There is also focus on whether more UK pension fund capital could be allocated to UK assets. If implemented effectively both policy initiatives should be positive for the prospect for UK equities. Some of this improving narrative may be behind the moderation of UK equity outflows and the improved performance of UK equities over the last 12 months. Despite the recent uptick, there is still a significant valuation disconnect between UK equities and other global markets. We continue to see incoming merger and acquisition interest exploit these valuation inefficiencies. As active investors this external interest validates our view that there are a significant number of mispriced assets on the UK equity market, and we will continue to try and exploit these in the portfolio.

• Capital erosion: Where fees are charged to capital instead of income, or a fixed distribution amount is paid regardless of the Company’s performance, there is the potential that performance or capital value may be eroded.

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• Concentration risk: The fund may be concentrated in a limited number of geographical regions, industry sectors, markets and/or individual positions. This may result in large changes in the value of the fund, both up or down.

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• Gearing risk​: The Company may borrow money to make further investments, this is known as gearing. Gearing will increase returns if the value of the investments purchased increase by more than the cost of borrowing, or reduce returns if they fail to do so. In falling markets, the whole of the value in such investments could be lost, which would result in losses to the Company.

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• Market risk: The value of investments can go up and down and an investor may not get back the amount initially invested.

• Market Risk: The value of investments can go up and down and an investor may not get back the amount initially invested.

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