UK equities recorded modest gains in what was a mixed quarter for global equities. Amid concerns around the world economic outlook, investors favoured stocks with defensive qualities over cyclical areas of the market, many of which performed very poorly. Merger and acquisition (M&A) activity was supportive to mid caps, and, against a backdrop of readily-available cheap debt financing, there were a number of new private-equity (PE) backed bids. There were new PE-backed bids in the period for UK pub operators Greene King and EI Group and aerospace and defence group Cobham. M&A activity was a contributory factor to mid caps outperforming, with the FTSE 250 (ex investment companies) index rising 3.6%, versus a 1.0% return from the FTSE 100, whose heavyweight commodity and financial sectors performed very poorly.
We benefited from not owning challenger bank CYBG, which performed very poorly after revealing that the likely financial impact of PPI compensation claims would be significantly greater than it had previously thought. As with other companies with legacy PPI exposures, it experienced an unexpectedly sharp pick-up in complaints in the run up to the claims deadline expiring at the end of August. However, news of the size of additional provisions which would likely be required, of up to £450 million, was taken very poorly by the market, prompting questions around the bank’s ability to fund shareholder distributions.
Avoiding CYBG peer Metro Bank was also a positive performance driver amid ongoing fears around the strength of its capital position. The group struggled during the period to find backers for a bond fundraising. Meanwhile, Sirius Minerals experienced a pronounced decline in its equity value, in its case related to questions around funding a proposed new potash mine in Yorkshire. Sirius, which we also don’t own, withdrew a $500 million bond sale which was an integral component of plans to finance the project. On a total return basis the share prices of Sirius, Metro Bank and CYBG respectively fell over Q3 by 73%, 45% and 40%.
Serviced office space specialist IWG performed very well as the company elaborated on plans to transition to a franchise model, which was well received by the market. Investors also welcomed firm progress on this front as Japanese meeting rooms business TKP acquired the franchise for IWG’s Taiwanese assets, following its milestone purchase of the franchise for Japan earlier in the year. We continue to believe that the challenges facing competitor WeWork will create opportunities for IWG. Housebuilder Redrow performed well on the back of robust full-year results. We benefited from not owning oil services company John Wood or commodity sector-exposed engineer Weir, which performed poorly amid concerns around a slowdown in capital expenditure in the global oil and gas sector.
On the negative side, instrumentation and controls business Spectris and specialist engineer Renishaw performed poorly. Despite both companies publishing broadly inline results they recorded double-digit share price falls over the period amid weak sentiment towards cyclical areas of the market. UK multi-utility provider Telecom Plus was another holding to perform poorly despite there being no change in the fundamental outlook for the business. Homewares retailer Dunelm detracted after investors took profits following a very strong year-to-date share price performance. Not owning M&A targets Greene King, EI Group, Cobham and media business Entertainment One also detracted from returns.
We exited industrial thread manufacturer Coats as we have concerns around where future growth will come from. We booked a profit in price comparison company Moneysupermarket.com after the shares hit our price target. We established a new holding in technology products and services supplier Oxford Instruments which has exposure to a number of high growth areas including 5G. We also initiated a new position in speciality chemicals business Synthomer following its proposed acquisition of US-based peer Omnova Solutions, which will significantly enhance the company’s growth profile.
Recent surveys indicate that UK consumer confidence remains stable and data most months show that UK consumers are more confident about their personal economic situation than about the country’s general economic prospects. It is perhaps not that surprising therefore that Brexit uncertainty has yet to have much of an impact on UK consumers’ outlook and overall household spending. In fact, household spending (three quarters of all spending in the economy) rose by an estimated £52.5 billion in 2018, following similar rises in prior years (source: Lazarus Economics). Recently released data from the Office for National Statistics (ONS) show that growth in household spend has continued in 2019.
It would also appear that this growth in household spend is reasonably sustainable, underpinned by a strong jobs market, higher wages and tax changes. The UK unemployment rate is at its lowest since the 1970s, and wages are growing at the fastest rate in a decade, outstripping the rate of inflation. There has historically been a close correlation between real wage growth and retail sales and labour market data from the ONS suggests that the backdrop for wages remains supportive.
In the meantime we are starting to see an increase in corporate activity as private acquirors take advantage of cheap sterling assets. It appears that valuations are such that acquirors are no longer waiting for a resolution to the Brexit negotiations. We are also continuing to see companies using the environment of low interest rates to make acquisitions to supplement organic growth, and it seems likely that this interest rate environment can endure.
We will continue to seek companies demonstrating organic growth and pricing power where possible and to avoid companies with too much debt. Disruption continues to be a feature for a lot of companies, putting pressure on earnings for a number of sectors, and we will therefore endeavour to identify and avoid these companies.
|Q2/2018 -Q2/2019||Q2/2017 - Q2/2018||Q2/2016 - Q2/2017||Q2/2015 - Q2/2016||Q2/2014 - Q2/2015|
|Net Asset Value||-1.8||11.7||27.8||-8.8||11.4|
|FTSE 250 ex Investment Trust TR||-5.9||11.2||21.5||-5.7||15.0|
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.
The Company invests in smaller companies that may be less liquid than in larger companies and price swings may therefore be greater than investment companies that invest in larger companies.
The Company will invest solely in the companies of one country or region. This can carry more risk than investments spread over a number of countries or regions.
As a result of the fees and finance costs being charged partially to capital, the distributable income of the Company may be higher but there is the potential that performance or capital value may be eroded.
The Company may borrow money to invest in further investments, this is known as gearing. Gearing will increase returns if the value of the investments purchased increase in value by more than the cost of borrowing, or reduce returns if they fail to do so.