Performance, Commentary & Portfolio

Fund Manager’s Review

January 2025 was an eventful month. Donald Trump’s second term as US president started with a deluge of executive orders, ranging from proclaiming a “national emergency” on immigration and changing the automatic birthright to US citizenship, to renaming the Gulf of Mexico as the Gulf of America. He decided to withdraw from the Paris agreement on Climate Change, just after huge fires swept through Los Angeles, as well as threatening to “take back” the Panama Canal and approaching Denmark about buying Greenland. Elsewhere, a tentative ceasefire came into effect in Gaza, between Israel and Hamas, after 15 months of fighting.

Financial markets were also eventful. Towards the end of January, US tech giant Nvidia lost a record near $600bn in value in one day. Nvidia’s prospects were threatened by the Chinese Artificial Intelligence (AI) company DeepSeek apparently demonstrating sophisticated AI capabilities at a fraction of the cost, and using cheaper silicon chips, than the leading AI platforms like Chat GPT.

In the UK, the month started with a sell-off in Gilt prices and a rise in yields, as concern grew about whether slow growth would force Chancellor Rachel Reeves to raise taxes or cut spending to balance the books, only a few months after her first budget. Market nerves were calmed later in the month, with the Chancellor and Prime Minister emphasising that economic growth is their main priority and looking for stimulative policies, even including expanding Heathrow airport. Gilt yields fell back and ended the month little changed.

Once gilt yields had peaked, the UK stock market had a strong rally, ending January with a total return of over 5%. However, the underlying mood was nervous, with the more domestically oriented mid cap index significantly underperforming the FTSE 100 index of leading, largely multi-national stocks. There was a wide range of sector returns, with banks, tobacco and media up between 8% and 10%. On the other hand, construction & materials, beverages and retail were down or flat.

The modestly priced UK stock market continued to see mergers & acquisitions activity, which impacted one of the portfolio investments. The automotive parts business, Dowlais, announced an agreed bid from a US peer American Axle, at a 25% premium to the prevailing price. This offer was roughly half in cash and half in shares of the US company.

Merchants’ portfolio significantly lagged the strong market, held back by the high exposure to medium sized businesses and a more cyclical positioning than the broader market, at a time when investors were more nervous about the domestic economy. The Net Asset Value (NAV) total return was 2.93% compared to 5.52% from the benchmark, FTSE AllShare index. The largest detractor from performance was car distributor Inchcape, which fell sharply after a research report highlighted a couple of contract losses and raised some questions about current trading conditions. We did not see the issues raised as that material, for a business which had won over twenty new contracts last year, so used the fall in the share price to add to the holding. The energy companies Energean and Harbour Energy both underperformed after trading statements that led to some downgrades to cash flow expectations. In both cases, we believe the companies are capable of generating robust cash flows for the next decade and beyond. This quarter, Harbour Energy is due to hold its first capital markets event since completing a transformational deal last year. We expect that event could start to build investor confidence in the business’ prospects.

There were some brighter spots in the portfolio too. Burberry shares continued their sharp recovery, rising over 20%, after reporting much stronger sales than expected over Christmas. This was the first quarter, since the new Chief Executive has started to refocus the brand on its heritage range of scarves and trench coats. There was also a very sharp rally in the banks exposed to an ongoing legal dispute over motor finance commissions. This followed highly unusual public intervention, from the Chancellor and the Financial Conduct Authority (FCA), ahead of a supreme court appeal. The Treasury and FCA want to avoid a perception that UK regulation is uncertain, and to keep the motor finance industry functioning properly. Close Brothers shares rallied over 30%, from a depressed base, and Lloyds was up well over 10%.

The continuing wide dispersion of share price movements, provided many opportunities to take profits on better performers and reinvest in companies offering more compelling value for the portfolio. We took some profits in IG Group, Imperial Brands, Barclays and Burberry, amongst others. We used this money to finance additional purchases of Unite Group, Bellway, GSK, Harbour Energy, Whitbread and several other shares. 

Although the UK stock market had a strong January, UK valuations remain low on a historic basis. Furthermore, recent movements have increased the extreme polarisation of the stock market, presenting compelling investment opportunities for value and income oriented investors. Whilst our shorter-term performance has been disappointing, recent movements have only increased our confidence in the potential of Merchants’ portfolio to deliver superior capital growth and income, in line with the company’s objectives. 

Simon Gergel
14 February 2025

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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