Latest trust commentary

Markets

UK equities rose over the quarter. Financials and industrials and the energy sector outperformed, in line with some of the other economically sensitive areas of the market.

Market expectations moved to price in a sooner-than-expected first UK interest rate cut as inflation undershot the Bank of England’s (BoE) forecasts. However, at the end of the period the BoE’s Monetary Policy Committee (MPC) decided at its March meeting to keep the UK’s main policy interest rate on hold at 5.25%. Though annual inflation, as measured by the Consumer Prices Index, has fallen from a peak of 11.1% in October 2022 to 3.4% in February 2024 the BoE is being cautious in scaling back the steepest rise in interest rates for several decades.

Meanwhile, official data showed that the economy had entered a technical recession in the second half of 2023. This occurred as the tailwind of post-pandemic revenge spending came to an end and the headwinds of higher inflation and interest rates weighed on activity. The markets’ reaction to the Spring Budget was largely muted, possibly suggesting that investors had anticipated a bolder budget.

Overseas inbound bid activity for smaller and mid-sized UK quoted companies remained an important theme over the period. Merger and acquisition activity in larger companies has increased this year with all-equity mergers announced within the housebuilding and paper and packaging sectors. UK companies are also taking advantage of their lowly valuations through increased capital allocation to share buybacks. Several companies have embarked on major buyback programs – purchasing their own shares and cancelling them – which should, all other things equal, boost the share price.

Performance

The Fund’s NAV return underperformed the FTSE All Share TR over the three-month period to end March, returning 3.2% and 3.6% respectively.

Stock selection in consumer discretionary businesses was a significant detractor to performance this quarter. Retailer and veterinary business Pets at Home had the biggest negative impact as shares underperformed due to regulatory scrutiny of the veterinary market. Positioning in aerospace and defence companies was also detrimental to performance. We do not own Rolls Royce and BAE Systems whose share prices continued to rise as orderbooks strengthened with a strong post covid recovery in civil and defence aerospace end markets.  Our holding in defence services business QinetiQ contributed positively, however its degree of outperformance was not as strong as Rolls Royce.

On the positive side, private equity managers 3i and Intermediate Capital Group both performed strongly. 3i which operates European discount retailer Action, continued to benefit from the consumer choosing cheaper options to offset inflation. 3i's most recent guidance showed revenue growth accelerated from an already high level and their net asset value continues to make progress. Action has a strong pipeline of store rollouts to further enhance growth. At Intermediate Capital Group trading was re-assuring particularly in its debt funds and returns on the investment company have improved after a more difficult period in the previous year.

Within healthcare, Convatec and global pharmaceutical GSK performed strongly. GSK rose on stronger operational performance and receding fears associated with US litigation on historic sales of gastrointestinal medicine Zantac. Convatec’s investment in new products has led to sales growth, which also brings positive operational gearing to boost margins. The company reported positive trading and strengthened medium term guidance.

Companies that we do not own also feature highly in the most positive contributors to performance - miner Rio Tinto and consumer goods group Reckitt Benckiser. The latter has had lacklustre sales growth across the group, needs investment and has issues in its infant nutrition business. Rio Tinto suffered as the iron ore price, on which it is more reliant than some of its competitors, weakened amid China’s softening economic environment.

Outlook

The UK experienced a shallow recession in the second half of 2023, but there are signs of economic activity gradually resuming in 2024, albeit at a slow pace. It is worth noting that UK inflation is not an outlier compared to other major developed markets, and it is expected to decline towards the Bank of England’s 2% target, especially as energy costs drop out of the comparisons. On a global scale, it is important to note that there will be significant elections this year, including the US presidential election in November and a likely UK general election in the second half of 2024. While political risk is a factor to consider, the main parties have mostly shifted towards the centre

Valuations in the UK stock market present attractive opportunities for forward returns, particularly in the Small and Mid-Cap (“SMID”) area. Over the three years leading up to February 2024, the FTSE 100 outperformed the FTSE Small-Cap Index by 25% and the FTSE 250 Mid-Cap Index by 31%. Historical trends indicate that periods of underperformance have often been followed by strong returns for SMIDs. The FTSE 250 Mid Cap Index, in particular, has outperformed the S&P 500 Index in local currency terms since 2000.

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. 

Investors in the emerging markets and the Far East should be aware that this involves a high degree of risk and should be seen as long term in nature. Less developed markets are generally less well regulated than the UK, they may be less liquid and may have less reliable arrangements for trading and settlement of the underlying holdings. 

The trust holds investments denominated in currencies other than sterling, investors should note that exchange rates may cause the value of these investments, and the income from them, to rise or fall. 

The trust Invests in smaller companies that may be less liquid than in larger companies and price swings may therefore be greater than investment trusts that invest in larger companies. 

The trust 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. 

Investments such as warrants, participation certificates, guaranteed bonds, etc will expose the fund to the risk of the issuer of these instruments defaulting on paying the capital back to the fund. 

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. Investments such as warrants, participation certificates, guaranteed bonds, etc will expose the fund to the risk of the issuer of these instruments defaulting on paying the capital back to the fund.