Performance, Commentary & Portfolio

Fund Manager’s Review

Two events dominated market attention during October, the first budget from a Labour government in 14 years, and the impending US presidential election on November 5th. Government bond markets overshadowed equity markets, with bond investors frightened about a pre-Halloween tax and spend budget and nervous about potential political fireworks on bonfire night. 

Ahead of the budget, gilt (UK government bond) prices fell and yields rose, mostly in response to similar movements in America, as polls indicated an increasing likelihood of Donald Trump winning the presidential race. Investors were taking the view that a Trump victory could be inflationary, due to trade tariffs and greater borrowing. 

Chancellor Rachel Reeves’ first budget included around £40bn of tax increases and approximately £70bn of spending increases. There was a loosening of fiscal rules to allow for greater long term investment spending. Most of this was expected by commentators, and the Chancellor avoided some of the more controversial policy ideas that had been rumoured. However, bond markets still fell further in the immediate aftermath. This seemed to be due to the inflationary impact of policies like employer national insurance increases, the necessary increase in government bond issuance, and investor positioning (expecting bond prices to recover) ahead of the event. Over the whole month, 10-year government bond yields rose by over a tenth, from 4% to over 4.4%. 

The UK equity market pulled back, particularly in the second half of October, partly in response to the pressures in the bond market. Sterling weakened against the US dollar. Medium sized companies, which tend to be more exposed to the domestic economy, underperformed the broader market. The market was led down by many of the interest rate sensitive sectors, like housebuilders, real estate and retailers, which responded to the bond market movements. The stronger sectors included banks, where several of the large banks reported healthy results, oil & gas and media. 

The Net Asset Value (NAV) total return was -2.13% versus -1.64% from the benchmark index. The portfolio also underperformed the benchmark index. Housebuilders and real estate stocks were weak, as explained above, but much of the underperformance came within the banks sector. Although most big banks’ shares performed well, Close Brothers was impacted by a high court ruling, in a case concerning historic commission payments made to car dealers for selling motor finance packages. The court ruled that these commissions should have been separately disclosed and agreed with the car purchaser. This was a surprise ruling, as it overturned the original court decision, and the policies were compliant with FCA rules at the time. This potentially opens up significant liabilities for Close Brothers and other similar lenders. Close Brothers are going to appeal this case to the Supreme court, and in the meantime have suspended this finance, while they update procedures. There is already an ongoing FCA review into motor finance, which now seems likely to be extended, to take into account any Supreme court ruling. Close Brothers shares fell heavily on this news. Lloyds and Bank of Ireland also have exposure to UK motor finance and their shares fell too, although not to the same extent. The other main performance detractors were not owning HSBC, which rallied, and a weak performance at Inchcape, which reported slightly weaker than expected third quarter results. 

On the positive side, Tate & Lyle shares rose by nearly 10%, in response to a Financial Times article saying the company could be a target of private equity interest. WPP shares rose, after the business returned to underlying revenue growth in the third quarter. Energean shares were also strong. The company, which produces gas and a small amount of oil off the coast of Israel, was supported by a slight easing of tensions in the region as Israel carried out a measured response to Iran’s earlier missile attacks. 

There were relatively few changes to the portfolio in October. We sold some Unilever shares via an option exercise after a strong rally in the shares this year. We used the proceeds to build up the positions in other companies where we have a high level of conviction, such as GSK, DCC, Harbour Energy and Assura. 

Labour’s first budget has not materially changed the outlook for UK economic growth, inflation or interest rates. With the election and budget out of the way, the UK now has a relatively stable and predictable political and economic environment compared to many other western countries. The stock market remains modestly priced, and there is a high level of buyback and takeover activity. We think this combination of factors should support the UK stock market in general, and we continue to be optimistic about the outlook for income and capital returns from the portfolio. 

Simon Gergel
8 November 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.

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