Liontrust UK Growth Fund

December 2018 review

The Liontrust UK Growth Fund returned -4.7%* in December, compared with the -3.8% return from the FTSE All-Share Index.

 

December’s market losses capped off a fairly miserable 2018 for UK and global equities. The FTSE All-Share posted a total return of -9.5% over the 12 months while the MSCI World Index of developed markets lost 3.0% and the MSCI Emerging Markets Index dropped 9.3%.

 

Prior to the fourth quarter, the UK market had just about managed to stay in positive territory despite a number of geopolitical and macroeconomic uncertainties clouding the investment horizon. As we noted following ‘Red October’, these issues began to weigh heavily on investor sentiment in the fourth quarter. The lack of obvious catalysts justifying the magnitude of the market correction is suggestive of investor fatigue in the face of headwinds rather than a sharp deterioration in underlying conditions.

 

The 2018 preoccupation with trade wars, rate rises and oil prices continued in December. In the UK, we can add Brexit to that list.

 

Not all news on these fronts was negative; the US-China trade frictions in particular offered some evidence of improvement as G20 talks in Buenos Aires resulted in a 90-day postponement of planned hikes to US tariffs on Chinese imports. It was perhaps developments in monetary policy that had the most bearish implications however. While the ECB confirmed its previously announced end to quantitative easing, the US Federal Reserve – which has been under attack from Donald Trump over its rate tightening cycle – trimmed its forecast for 2019 rate increases from three to two 25bps hikes. Futures markets suggest that even two hikes might prove ambitious given growing concerns over the pace of economic growth.

 

As in previous ‘risk-off’ bouts, UK mid-caps underperformed large-caps (the FTSE 250’s -5.1% return comparing with -3.5% from the FTSE 100) – a trend further accentuated by the fall in sterling which followed the postponement of a parliamentary vote on May’s Brexit deal. The Fund did not escape the broad-based nature of equity market weakness in December, the majority of its holdings ending lower for the month. Relative returns were not helped by gains for the mining sector (+5.4%), where the Fund has no exposure. Mining strength seems counterintuitive in view of soft resource prices, but makes more sense in context of a potential thawing in US-China relations and the earnings translation implications of a weaker pound.


Investors familiar with the Economic Advantage investment process will be well aware that it is
unashamedly bottom-up in nature, and makes no attempt to predict macroeconomic events. We believe that our investments’ long-term prospects are driven mostly by their ability to successfully execute growth plans and compound profits. In the shorter-term, investor sentiment and other exogenous factors will impact share prices, so we aim to ride out periods of volatility and treat indiscriminate market weakness as a buying opportunity.

 

Of the Fund’s holdings, Wood Group (-20.3%) was hardest hit in December. It issued a 2018 trading statement which prompted a heavy share price fall despite highlighting a return to revenue growth (+10% to around US$11bn) and predicting earnings before interest tax and amortisation in the range of US$620m to US$630m. The company outlined a positive medium-term outlook, but warned that recent oil & gas price volatility could “impact confidence and the pace of contract awards”. With Brent crude dropping a further 8% to finish the year at US$53.8 a barrel, the short-term demand outlook is clearly a concern for some investors.

 

A legal battle with Dr.Reddy’s Laboratories (DRL) has weighted heavily on Indivior’s (+10.2%) share price in 2018. A December trading update confirmed that the dispute between the two rumbles on for the time-being, but stated that it is on track to meet its 2018 guidance of US$990m - US$1.02bn and net income of US$230m – US$255m. The battle centres on Indivior’s Suboxone treatment for Opoid addiction. This drug is responsible for the vast majority of Indivior’s sales, so the outcome of legal proceedings and scale of any generic competition will drive the outlook for 2019. The company is, however, looking to reduce dependence on Suboxone and advised that sales of its new product Sublocade exceeded expectations, giving it confidence that it can grow to US$1bn+ sales and become a new ‘blockbuster’ for the company.

 

Over the course of December, GlaxoSmithKline (-8.0%) CEO Emma Walmsley revealed the major elements of a strategic review which she had initiated 18 months ago. The first statement from the company saw it announce the sale of Horlicks and other consumer nutrition brands to Unilever (which is also held in the Fund). The deal, which also includes the merger of one of GlaxoSmithKline’s Indian units into Hindustan Unilever, is expected to net GSK proceeds of £2.4bn.

 

This news was given a luke-warm welcome, perhaps due to the indication that proceeds would be used to reduce debt and support “strategic priorities” rather than prompting a investor windfall via – for example – a special dividend. Later on the same day, the destination of these funds became apparent as GSK announced a £4.0bn cash acquisition of TESARO, a US-based oncology specialist.

 

Investors began to warm to the restructuring later in December as GSK then detailed the formation of a consumer healthcare JV with Pfizer – a major step towards GSK splitting its consumer health operations out from its pharma business. Earlier in the year, GSK had bought Novartis’ 36.5% stake in their consumer healthcare JV for £9.2bn. By now partnering with Pfizer, it expects to create a joint entity with combined sales approaching US$10bn. GSK will own 68% of the JV which it plans to demerge into a separate UK stock market listing within three years of the deal completing.

 

A couple of the Fund’s mid-cap holdings also engaged in some portfolio management. Spirax-Sarco Engineering (+1.7%) disposed of HygroMatik, its German air humidification equipment business, for a €59m consideration. This business had been owned since 1988, but was described by Spirax-Sarco management as having low strategic fit with the Steam Specialities division in which it sat. Coats (+0.3%) completed the US$12m bolt-on acquisition of ThreadSol, operator of cloud-based digital applications for the apparel and footwear industries, and the purchase of a 9.5% stake in Twine Solutions, an Israeli start-up that has developed a digital thread dyeing system. Coats was added to the Fund earlier this year. It is the world’s leading manufacturer of industrial threads, operating through three divisions: Apparel & Footwear, Performance Materials and Crafts. As well as significant intellectual property, Coats has an excellent distribution network which extends to over 100 countries and 50 manufacturing sites.

 

Positive contributors included:

Indivior (+10.2%), Sage (+3.4%), Intertek (+2.2%), Spirax-Sarco Engineering (+1.7%) and Coats (+0.3%).

 

Negative contributors included:

Wood Group (-20.3%), Brooks Macdonald (-16.8%), WH Smith (-9.8%), PageGroup (-9.4%) and GlaxoSmithKline (-8.0%).

 

Discrete years' performance** (%), to previous quarter-end:

 

 

Dec-18

Dec-17

Dec-16

Dec-15

Dec-14

Liontrust UK Growth I Inc

-6.1

14.2

18.1

9.6

1.8

FTSE All Share Index

-9.5

13.1

16.8

1.0

1.2

IA UK All Companies

-11.2

14.0

10.8

4.9

0.6

Quartile

1

2

1

2

2

 

*Source: Financial Express, as at 31.12.2018, total return (net of fees and income reinvested), bid-to-bid, institutional class. Non fund-related return data sourced from Bloomberg

 

**Source: Financial Express, as at 31.12.2018, total return (net of fees and income reinvested), bid-to-bid, primary class.

For a comprehensive list of common financial words and terms, see our glossary here.

 

Key Risks

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital.

Some of the Funds managed by the Economic Advantage team invest primarily in smaller companies and companies traded on the Alternative Investment Market.  These stocks may be less liquid and the price swings greater than those in, for example, larger companies. The performance of the GF UK Growth Fund may differ from the performance of the UK Growth Fund and will be lower than its corresponding Master Fund due to additional fees and expenses.

Disclaimer

The information and opinions provided 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.  Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.

Tuesday, January 15, 2019, 5:05 PM