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LF UK Equity Income Fund

Q1 2022 Newsletter

Past performance is not a guide to future performance. The value of an investment and the income generated from it can fall as well as rise and is not guaranteed. You may get back less than you originally invested.
  • The UK equity market had a tumultuous start to 2022. Russia’s invasion of Ukraine added to an already challenging macro-economic backdrop.
  • Our flexible, stock-driven, style-agnostic approach struggled in a macro-driven, risk-off environment.
  • Idiosyncratic opportunities in some areas of the market remain highly compelling.

The UK equity market had a tumultuous start to 2022. Russia’s invasion of Ukraine, which has come at an appalling humanitarian cost, added complexity to an already complex macro-economic backdrop. The prices of energy and commodities spiked, while pressures on supply chains intensified. In the worst squeeze on consumers’ wallets in 30 years, the UK’s CPI reached 6.2% yoy in March, driven by rising prices in energy, food and durable goods. The Bank of England increased the base rate in two steps to 0.75% during the quarter. The Federal Reserve, meanwhile, lifted the fed funds rate by 0.25% in March. Against a backdrop of high inflation and tight labour conditions, Chair Powell was decidedly more hawkish, stating there is an “obvious need to move expeditiously [our italics] to return the stance of monetary policy to a more neutral level”.* This level is estimated to be roughly 2.4% – some way above the current target fed funds rate of 0.25-0.50%. Bond markets sold off sharply at the short end on expectation that next month could see an increase in the order of 50 basis points. A flatter yield curve reflected growing concerns about stagflation.


Stock-level fundamentals were of little consequence in this environment and the market polarised into two camps: 1) areas of perceived safety and beneficiaries of commodity inflation, and 2) everything else. Mid-caps were shunned, while large-caps held their ground: the FTSE 250 Index returned -9.5% against a return of +2.9% for the FTSE 100 Index. Meanwhile, among FTSE All-Share industries, Energy (+25.4%), Basic Materials (+19.6%) and Telecoms (+7.4%) significantly outperformed Technology (-16.1%), Industrials (-12.9%) and Consumer Discretionary (-11.5%). Intra-day volatility also spiked [Figure 1], reflecting a widening of possible outcomes and the market’s sensitivity to short-term news flow.


Figure 1: Intra-day activity follows the news 

Source: Goldman Sachs, 01.03.22

Portfolio update

We are flexible, stock-driven, style-agnostic investors. The quarter has been a macro-driven, risk-off environment which has been of benefit to some of the large sectors such as energy, mining and pharmaceuticals where we have been under-represented. Furthermore, the significant underperformance of midcaps relative to the FTSE 100 Index also proved to be a headwind given the Fund’s current over-representation in midcaps.  The Fund’s 1.2% underperformance should be viewed in that context. Among the Fund’s holdings, consumer-facing holdings Currys, Cazoo (received from the break-up and sale of DMGT) and boohoo were derated as investors became concerned household disposable income was being crimped by high energy prices and also supply chain issues. In the case of Boohoo, the delays in product delivery to customers outside the UK and the investment in newly acquired brands such as Debenhams.com has unnerved investors but we believe both issues are temporary. It retains a strong business model and product offering that has kept our original investment thesis intact. The valuation at 0.5x sales is in our view too low: the business has net cash, nearly 40% of its market value in freehold properly, is very profitable in its more mature, but still under-penetrated, UK market and is expected to see growth re-accelerate from 10%+ to over 20% p.a.. So much so in fact that we believe it might tempt the 25% founder family shareholders to take the company private.


Holdings in BAE and Serco firmed on the prospect of increased defence spending and perhaps broader recognition of the importance to society of defence in maintaining world peace. Ukraine surrendering its nuclear weapons after the break-up of the former Soviet Union begs the question whether Russia’s invasion would have happened had those weapons been retained. Shell also contributed positively as oil and gas prices rose materially as investors processed the consequences of governments’ increased focus on energy security.  


We have made a number of changes to the portfolio in the weeks since the start of the war in Ukraine to hedge against what could become a tougher economic environment exacerbated by central bank action of increasing interest rates and reducing liquidity through quantitative tightening (“QT”). Rentokil, which is defensive, has a top management team and has excellent long term growth opportunities, was purchased along with the gold miner Newmont Corp which provides a hedge against stagflation and a more difficult stock market environment. The favourable supply/demand characteristics of gold is also noteworthy and should naturally be very supportive to the gold price in the medium term. We also established holdings in Standard Chartered and NatWest. Both banks will be beneficiaries of rising interest rates, are well capitalised and should return significant cash to shareholders through dividends and buy- backs over the next few years. These were funded by a complete sale of National Grid after the shares became fully valued following share price strength. Reckitt Benckiser was also sold due to the challenges of significant input price inflation whilst we trimmed HSBC and Legal & General.



The geopolitical landscape has dramatically shifted, with energy security becoming a top priority for governments. The history of past conflicts is instructive [Figure 2] and serves as a reminder that markets are forward looking and have looked through previous military crises relatively quickly, with the obvious caveat that no two conflicts are alike and this conflict has come at a time of pre-existing macro challenges related to inflation, supply chains and energy security. Even if there is an agreement or resolution, it is likely the market, economic and political regime has changed irreversibly due to the conflict: this means higher inflation, higher spending on defence, a greater focus on the security of supply, and ongoing isolation of Russia and potentially cooler relations with China.


Figure 2: Market responses to past conflicts

Source: JP Morgan, Global Equity Strategy, 28.02.22

Meanwhile, central banks are increasing interest rates and remain keen to unwind quantitative easing. Against a background of strong inflationary pressures feeding through into rising wages, stagflation becomes a risk. It is therefore important at a stock level to invest in companies that have market leadership, pricing power and high gross margins to offer protection against cost pressures. We believe the Fund is well positioned for this scenario.


In terms of our recent activity, it is important to note that recent changes to the portfolio, while tactical in nature, have emerged from our ongoing commitment to deep fundamental analysis. The market has been rattled by the conflict in Ukraine and has inevitably adjusted for a wider array of potential outcomes (as have we). However, some of these moves have been severe, in our view, and several oversold holdings should not only revert in time but could make quite meaningful gains as the market reappraises their potential. Examples include pessimistically priced consumer-facing names we mentioned above.


For investors, uncertainty creates opportunity, and as harrowing as the current crisis is on humanitarian grounds, we believe the current market environment offers a rare opportunity for investors in the UK. Since September last year, the FTSE 250 Index has experienced its largest drawdowns against the FTSE 100 Index since the financial crisis, underperforming by some 19% [Figure 3]. While the drawdown has several causes – e.g. a wider flight to safely, in part on growing concern about inflation and hawkish central bank policy – historically these drawdowns have been relatively short lived. We are certainly not making a case for buying the FSTE 250 Index, but believe this dynamic supports the case for continuing to identify companies in that area of the market we believe are well placed to grow and deliver decent returns in the years ahead. These include businesses with a good degree of operational resilience, backed by structural growth drivers and low levels of debt – businesses that are firmly on our radar as part of our flexible pursuit of opportunities for the Fund.


Lastly, the UK equity market remains a fertile hunting ground for private equity (PE) which has seen huge growth in assets over the last decade and has “dry powder” that needs to be invested to earn its full fees. We believe there will be more Morrisons – snapped up by PE last year – as the gap between the earnings yield and the cost of borrowing remains wide. Shareholder activism is also on the rise and is accelerating potentially positive change among UK businesses. Activists are currently on the register of three of the UK’s largest companies – Shell, Unilever and GSK – for example. Mega cap is no longer too large for such action. Notwithstanding the uncertain macro backdrop, there are multiple reasons why we believe the UK equity market could be at the foothills of a multi-year rehabilitation with the potential to provide enduring returns for investors.


Figure 3: FTSE 250 Index relative drawdown

Source: Bloomberg, 20.04.22


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Key Risks 
Past performance is not a guide to future performance. The value of an investment and the income generated from it can fall as well as rise and is not guaranteed. You may get back less than you originally invested. The issue of units/shares in Liontrust Funds may be subject to an initial charge, which will have an impact on the realisable value of the investment, particularly in the short term. Investments should always be considered as long term. Investment in the Fund involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. 
This is a marketing communication. Before making an investment, you should read the relevant Prospectus and the Key Investor Information Document (KIID), which provide full product details including investment charges and risks. These documents can be obtained, free of charge, from www.liontrust.co.uk or direct from Liontrust. Always research your own investments. If you are not a professional investor please consult a regulated financial adviser regarding the suitability of such an investment for you and your personal circumstances. 
This should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Examples of stocks are provided for general information only to demonstrate our investment philosophy. The investment being promoted is for units in a fund, not directly in the underlying assets. It contains information and analysis that is believed to be accurate at the time of publication, but is subject to change without notice. Whilst care has been taken in compiling the content of this document, no representation or warranty, express or implied, is made by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified. It should not be copied, forwarded, reproduced, divulged or otherwise distributed in any form whether by way of fax, email, oral or otherwise, in whole or in part without the express and prior written consent of Liontrust. 

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