The UK stock market finished the year strongly, following much the same pattern as for 2017 as a whole, with a narrow set of stocks, perceived as beneficiaries of accelerating global growth leading the index higher. Among the winners in the market’s popularity contest currently, are oil majors Royal Dutch Shell and BP, commodity businesses Rio Tinto and Glencore, and HSBC.
The sustained momentum of these index heavyweights has further exacerbated the gap between market valuations and the fundamentals that sit beneath them. It also led to a continuation of the challenging performance backdrop for the fund, which delivered a positive return but struggled to keep pace with the overall market.
Both of the portfolio’s largest positions, AstraZeneca and Imperial Brands, contributed positively in December. There was no meaningful news behind these share price moves, which were broadly in line with that of the wider market. The strongest performance, however, came from hybrid estate agent Purplebricks, which reported interim results that showcased the very positive progress it is making across the board. The management of this impressive young business continues to execute its ambitious growth plans successfully, with expansion in Australia very much on track and an encouraging start to trading in the US.
Meanwhile, some of the portfolio’s more domestically-exposed businesses also delivered a positive contribution to returns, perhaps buoyed by the positive progress delivered in the Brexit talks. Shares in housebuilders Barratt Developments and Taylor Wimpey, property company NewRiver Retail and automotive-related businesses Redde and AA, for example, all benefited from a more favourable environment than of late, but in our view, remain at very depressed valuation levels.
As in November, Prothena’s shares were weak with sentiment remaining fragile following the delay to the Vital trial in its lead asset, NEOD001, in AL Amyloidosis. We had a very positive meeting with Prothena’s management team in early December, however, and our conviction in the long-term investment case is as strong as it has ever been. The business is fully-funded to deliver on the significant value inflection points that lie ahead, with NEOD001, in our view, poised to do that in the near future. No external factors can affect that now.
Capita also performed poorly, following the release of its interim results. Although the results were broadly in line with expectations, there were a number of complicating one-off elements and a mixed outlook statement, which came at a time when investors are keen to see clearer evidence of recovery. The shares declined by 12% on the day of the results which looks very harsh to us in the context of Capita’s already low valuation. The shares yield over 7% here which suggests that some investors fear a dividend cut may be required. With a new chief executive now in place, clearly that eventuality cannot be completely ruled out, but having met Jon Lewis during the month, we are reassured that decisions around capital structure and the dividend will be informed by a clearer long-term strategy for the business, something we expect to hear more about later this year. In the meantime, we have maintained the portfolio’s exposure to this business, seeing the potential for significant value creation in the future as Capita is restored to the high quality, successful and well-run business that it used to be.
In terms of portfolio activity, we slightly reduced the portfolio’s exposure to Homeserve during the month, following a period of strong performance from the shares. This is a business which we have been invested in for some time – since it demerged from South Staffordshire Water, in fact, in 2004. It hasn’t always been plain sailing for this business which experienced some very challenging events in 2011, culminating in an FCA investigation and fine. In some respects, these events bear some similarities to what Provident Financial experienced in 2017 and Neil’s reaction was also similar – he remained a patient and supportive investor in the business, determined not to react emotionally to what was clearly a difficult time for the company and giving the company and its share price time to recover. Ultimately, that patience has paid off, because the shares have now rallied more than 400% from the lows of 2012, providing the opportunity to trim the position at a much higher price. Clearly there are many differences between the Homeserve case study and Provident Financial’s recent problems, but we remain confident that the long-term outcome will be similarly rewarding for patient shareholders.
Turning to the investment outlook, there are many reasons to be positive heading into 2018, following a challenging period for performance. We anticipate a very different investment environment to prevail in the year ahead, as macroeconomic conditions increasingly challenge the view of the world that is reflected in financial market valuations. As the year progresses, there will be many events and data points which provide evidence of the changing investment landscape. We will, of course, keep you informed of our progress, as the year unfolds and we remain very confident of delivering very attractive returns, against the backdrop of much more challenging market conditions more broadly.