UK equities performed well, as did equities in general globally amid central bank dovishness and an easing in US/China trade tensions towards the very end of the period under review. Expectations for monetary policy shifted materially over the quarter, and notably so in the US where the market began to speculate that the Federal Reserve (Fed) might now cut interest rates this year. Meanwhile, European Central Bank president Mario Draghi indicated that a new round of easing would be required if the economic situation in the Eurozone failed to improve.
A number of forward-looking indicators appeared to roll over, prompting further questions around the outlook for the global economy and inflation. The sizeable downside surprise to US non-farm payrolls caused nervousness in this respect, as did the escalation in trade tensions between America, China and Mexico. Against this backdrop, equities perceived to offer superior and defensible earnings growth extended their run of outperformance experienced since the beginning of 2019. The technology sector enjoyed another quarter of strong relative performance, as did a number of large-cap consumer goods companies which fit the description of “quality growth” stocks.
Conversely, many of the market’s domestically-focused sectors underperformed amid renewed Brexit and political uncertainty. Theresa May resigned as leader of the Conservative Party, which began the process of selecting its new leader and UK prime minister. Despite a further extension of the Article 50 deadline to 31 October, there is still considerable uncertainty as to the path the new prime minister might wish to take. Meanwhile, the distortive impact of the original 31 March Article 50 deadline on the UK manufacturing sector became clearer in the forms of disappointing preliminary GDP data and subdued forward-looking indicators covering the opening months of Q2 after boosting Q1.
Economic data remains under heavy scrutiny given rising concerns of a global economic slowdown. Forward indicators appear to be rolling over, leading to a softening in the outlook for inflation. The sizeable downside surprise to US nonfarm payrolls in May caused nervousness in this respect as did the escalation in trade tensions between America and China and Mexico. We are left with a world economy that resembles an unstable bicycle that can be tipped over by the slightest bump in the road. Central bankers have kept the bike stable through policy easing, but there will be increasing pressure for governments to offer additional support through policy action.
One particular market distortion resulting from a combination of the loose monetary policy of the last decade has been the outperformance of growth stocks versus value, as growth has become an increasingly sought after commodity in the aftermath of the global financial crisis. This feature has again been particularly apparent in the last 6-12 months, as slowing global growth prospects have been met with the prospect of further policy easing. As a result, many growth stocks have continued to outperform the wider market, with seemingly little acknowledgement of fundamental value.
As we are conscious that the price paid for an investment is arguably the single most important factor in determining future returns, one area of the market that we continue to probe is UK domestics, where political uncertainty continues to weigh on sentiment. We continue to be very selective in the types of business model and financial characteristics that we choose to invest in. We are wary of companies whose business models are particularly susceptible to disruption, such as areas of general retail. In addition, we place a large focus on the balance sheet and accounting, as a weak balance sheet can hamper the ability of a company to both invest in its operations or respond to changing market conditions.
Despite the UK equity market being shunned by the global investment community, corporate activity has continued in the second quarter (BCA, Millennium & Copthorne and Merlin Entertainments). This continued corporate activity gives us confidence that there are considerable opportunities in the UK equity market at present and for as long as cheap financing is readily available we would expect this trend to continue.
Performance in the second quarter of 2019 was positive in both absolute and relative terms, with the Fund’s NAV return exceeding the FTSE All-Share Total Return Index.
During the quarter, Intermediate Capital was the most positive contributor to relative returns, performing well on strong numbers and a pleasing dividend hike. Not owning Imperial Brands was also beneficial. This was a function of increased regulatory concerns affecting the tobacco industry’s new product development initiatives, but this positive was correspondingly partially offset by the negative effect of holding British American Tobacco. Pets at Home also added value on the back of better-than-expected results and growing market confidence in the strategy for its veterinary business. Meanwhile, G4S, the security company, also aided performance as investors warmed to management’s plans to release value from the business through ongoing strategic initiatives. Not owning underperforming Glencore was also beneficial.
On the negative side, performance was impacted by a number of UK domestic holdings as sterling weakened. Lloyds Banking Group gave up ground on increased fears of a departure from the EU without an agreed deal with Brussels. Weakness in Whitbread was caused by softer UK regional hotel trading but we believe the company’s strong balance sheet and strategic optionality leave it well placed for the future. Meanwhile ITV, for its part, laboured under investor concerns about the health of the UK advertising market. BT was weak on fears of a dividend cut, albeit we do see scope for share price upside if the incoming CEO and new industry regulator can establish a positive working relationship.
|Q1/2018 - Q1/2019||Q1/2017 - Q1/2018||Q1/2016 - Q1/2017||Q1/2015 - Q1/2016||Q1/2014 - Q1/2015|
|Net Asset Value||5.2||0.1||19.5||-3.9||14.0|
|FTSE All Share Total Return||6.4||1.2||22.0||-3.9||6.6|
Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.
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