Performance, Commentary & Portfolio

Fund Manager’s Review

As the UK moved into full general election mode ahead of the vote on July 4th, political attention shifted overseas. European elections in early June, saw strong gains for far-right parties. This was most notable in France, where the National Rally party performed so well, that President Macron decided to call an early national election in a high risk gambit to pull the country back to the political centre. At the end of the month, the first US presidential debate saw incumbent Joe Biden perform so poorly against Donald Trump, that some senior Democrats were speculating openly about a change to their party’s contender for the next election. In contrast to the international news, the UK election campaign was far less eventful, with Labour maintaining a strong lead through to the actual result in the first week of July, although Nigel Farage taking over leadership of the Reform Party provided some fireworks.

In economic news, the headline Consumer Prices Index (CPI) inflation rate returned to the Bank of England’s target of 2% for the first time in three years. This was not enough for the Bank’s Monetary Policy Committee to cut interest rates for the first time this cycle, which would have been controversial during an election campaign, but commentary suggested a rate cut is becoming more likely.

Rising political risk weighed on European equity markets, particularly France, and French government bond prices were also under pressure. In contrast, the US stock market made further gains, led once again by technology shares. The UK stock market was subdued, with a small drop over the month, and weakness among medium sized companies in particular. There was a slightly defensive bias to the market, with gains in sectors such as utilities and tobacco but also media. The weakest sectors included more cyclical industries such as retailers and metals & mining.

Performance lagged behind the benchmark in June, following a couple of strong months. The Net Asset Value (NAV) total return for June was -4.9%, versus -1.2% from the benchmark index. In a nervous market, several large portfolio holdings reacted negatively to specific newsflow, and there was broader underperformance from other, typically cyclical stocks. Shares in the Mediterranean energy company Energean fell, as the company announced some asset sales. The share price reaction seemed excessive, as the disposals will focus the business on more attractive, longer life, gas producing assets and free up finance for further investment. The biopharma company GSK was weighed down by a negative court judgement in the ongoing Zantac litigation, although this judgement was only concerning the admittance of evidence to trial, rather than any more definitive news. Tate & Lyle shares also reacted negatively to an acquisition announcement. This deal will significantly increase Tate’s scale in speciality food ingredients, making it clear world leader in the “mouthfeel” area. The market reaction may have reflected the headline price paid, but we believe there should be opportunities to raise the profitability in the acquired business.

There were fewer positive stock contributors to performance, but the recently purchased Dowlais, as well as British American Tobacco and Pets at Home appreciated. Relative performance also benefitted from not owning Glencore or Diageo, which were both weak, and helped to pull back the index.

There was little change to the portfolio in June. We increased a couple of holdings where we felt the market had over-reacted to news, creating an opportunity. These were Legal & General, which held a capital markets event, and Tate & Lyle, after the acquisition announcement. These were funded by profit taking in Keller, IG and other shares after strong performance.

With the general election out of the way, the UK should be in for a period of political stability, really for the first time since the Brexit referendum in 2016, and just as political risk has been rising in much of Europe and the USA. Since 2016, the UK stock market has significantly de-rated compared to other markets and political risk was often cited as one of the two main concerns. The other main concern was the UK’s economic performance. This too seems to be more secure now, as inflation has returned to target and first quarter GDP growth has accelerated to 0.7%. We think this creates the conditions for the UK stock market to start to regain investor support. A large number of share buy-backs and continuing takeover interest are further supportive factors. In addition, there remains a wide dispersion of valuations within the stock market, providing exceptional stock picking opportunities. We see considerable value in the investment portfolio, and it should be well positioned to deliver Merchants’ income and capital growth targets.

Simon Gergel
18 July 2024

This is no recommendation or solicitation to buy or sell any particular security. Any security mentioned above will not necessarily be comprised in the portfolio by the time this document is disclosed or at any other subsequent date. Past performance does not predict future returns.

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