Performance and Market Review

The UK equity market experienced a strong appreciation in the first half of the Company’s financial year, driven by a continued decline in the inflation rate, which has now reached target levels, alongside improving sentiment regarding both UK and global economic activity. The Bank of England joined the global rate cutting cycle at the end of the period, with the first reduction in rates since April 2020.

Against this backdrop, the Company’s net asset value (“NAV”) total return for the six months to 31 July 2024 was 8.2%, which compared to a total return of 12.3% from the FTSE All-Share Index. In the first quarter of the year, cyclical sectors, particularly banks, energy, and mining companies, led the market, with mid-cap stocks outperforming as risk appetite grew and signs of a more resilient global economy emerged. The market exhibited a wide dispersion of stock returns, with investors willing to reward high performers while penalising those missing expectations.

Commodity prices rose, notably for oil amid escalating tensions in the Middle East, and for copper, driven by strong demand against a backdrop of constrained supply, although prices retreated toward the end of the period. Overall, global economic data remained mixed but generally exceeded initial expectations for the year. However, China stands out as an exception, with economic activity continuing to lag and persistent concerns surrounding its real estate market.

At the company level the portfolio benefitted from a number of positive performers. Intermediate Capital has delivered strong performance, and the company has forecast a positive outlook for fundraising within private credit. Morgan Sindall has also excelled, with its fit-out division demonstrating significant growth as clients invest to upgrade office space standards. This has led to strong profit growth and a further significant dividend increase. Unilever has also performed well as the company’s strategy under the new CEO, Hein Schumacher, started to take hold, delivering accelerating revenue growth and greater than expected margin expansion.

There were a number of companies that underperformed over the period. These included the French digital services and payments company Edenred, which was impacted by the political uncertainty generated by the recent elections, expectations of falling interest rates and declining inflation impacting its income, and a regulatory investigation into contract tendering processes in its Italian business. Despite these headwinds, the company has maintained its guidance for double-digit revenue growth, highlighting new client wins and the rollout of new products while the valuation and dividend yield look increasingly attractive. Meanwhile, Diageo’s shares also underperformed, primarily due to weakened consumer demand in Latin America and the Caribbean, compounded by a prolonged destocking cycle in the United States. We believe the downgrade cycle is coming closer to an end, while the underlying valuation remains attractive, presenting us with an opportunity to continue to back a high-quality business going through a challenging cyclical period. The Company’s underweight exposure to the banking sector also detracted from performance during the period under review, where we remain somewhat cautious on the sustainability of profitability and, by extension, dividend generation.

Portfolio Activity

We have introduced several new companies to the portfolio. One notable addition is Genuit, a leading manufacturer of piping solutions for water, climate, and ventilation management. The company has a strong focus on sustainability and, despite operating in a cyclical industry, we believe is well positioned for long-term structural growth and offers potential margin expansion. We also added Convatec, which specialises in advanced wound care, ostomy care, continence care, and infusion care. Convatec benefits from favourable demographic trends, including an aging population and an increasing incidence of chronic conditions. The company has strong brands and is experiencing accelerated growth due to product innovation and improved execution. We believe it has the potential to enhance its operating margins, a positive outlook that is not yet reflected in its valuation.

Additionally, we initiated a position in Azelis, a Belgian-listed specialty chemical distributor. We see strong long-term growth prospects as it supplies chemicals to fast-growing end markets, such as life sciences. Azelis operates a capital-light business model and has a network of application laboratories that provide technical guidance on product development. Finally, we acquired a stake in Gaztransport & Technigaz (“GTT”), a French-listed industrial engineering design firm known for its design of membranes used in LNG carrier ships for the storage of liquefied natural gas (“LNG”). GTT's capital-light model is supported by strong pricing power, with growth driven by the expansion of the global LNG fleet, premium pricing on new designs, and the application of its technology in areas like hydrogen. The company has a net cash balance sheet, generates high cash conversion rates, and returns excess liquidity to investors, in our view positioning it well to provide a growing dividend stream.

We added to positions in UK mid-cap companies such as Assura, and Softcat, where we see attractive total return prospects in this segment of the market. We also increased the holding in animal genetics company Genus, given its depressed valuation relative to historical levels and its strong long-term potential. In addition, we significantly increased the Company’s investment in National Grid at the time of its rights issue, which has strengthened the company's capital position and should in our view enable significant future growth.

To fund these purchases, we reduced the position in Intermediate Capital after a significant increase in its share price exceeded our risk appetite. We exited a small position in Moonpig following a strong recovery in its share price, as well as in the specialty chemicals manufacturer Croda, where we have lower conviction in the firm’s competitive position. We divested the holding in Scandinavian bank Nordea after it paid its large annual dividend, trimmed the position in Marshalls following a strong share price recovery, and reduced the substantial position in AstraZeneca, as we believe its prospects no longer justify such a significant allocation of the Company’s capital.

We continued to generate income from option writing. We wrote a number of options to both generate income and to position the portfolio. This included puts over branded consumer health company Haleon which we are looking to introduce to the portfolio. In addition, we wrote puts over TotalEnergies, Genus, Azelis and Prudential where we are happy to increase the holdings, and calls over Taylor Wimpey, Croda and Intermediate Capital.

The level of investment income rose healthily year on year, boosted by the timing of option income, with dividend income more or less flat. Overall, the income delivery from the portfolio was solid, with a number of declarations well ahead of our expectations. While the decision by Close Brothers to pass its dividend given the ongoing regulatory investigation into its auto lending business was frustrating, we were able to largely make up the lost income from other sources.

Gearing

In May we took the decision to increase the level of gearing by just over 1%, drawing down an additional £6 million from the revolving credit facility, reflecting the very healthy pipeline of potential investment opportunities that we have open to us. The last time we increased borrowings was in March 2020 amidst the market turmoil sparked by the pandemic. The Company also continued to buy back its own shares in the market – we consider the current discount to NAV as attractive, particularly when we believe the underlying portfolio is on an undemanding rating.

Outlook

Despite recent market volatility, the UK macroeconomic landscape is gradually improving, with growth set to recover slowly, inflation moderating, and consumer confidence picking up, painting a more encouraging picture than at the turn of the year. The recent change in government in the UK has brought a degree of political stability that reassures markets, although attention is now focused on the upcoming autumn budget, which is expected to have significant implications for various sectors.

The current valuation of the market and the portfolio reflects muted expectations, potentially providing a springboard for strong prospective returns. Mergers and acquisitions remain a prominent feature, while share buybacks continue to provide support. There have also been some encouraging early signs of international investors returning to the UK market. A confluence of a steadily improving economic landscape, declining interest rates, and a softer currency could present a compelling investment case for UK equities, particularly in the mid-cap sector, where the Company holds a strategic overweight position.

However, risks remain, and elevated tensions in the Middle East and Ukraine, along with their potential impact on energy prices, warrant close monitoring. Likewise, the Chinese economy continues to struggle and there are increasing signs of a slowdown in the United States, both factors to remain vigilant to. As ever, we shall continue to seek a balance in our positioning of the portfolio, giving the Company the potential to perform in a range of market environments while keeping watch for new opportunities in high-quality companies with attractive long-term prospects that align with the Company’s sustainable and responsible investing criteria.

Read the full article in the half yearly report here.

Investment objective:

To achieve growth of income and capital from a portfolio invested mainly in companies listed or quoted in the United Kingdom that meet the Company’s Sustainable and Responsible investing criteria as set by the Board.

Discrete Performance (%)

 

Total return; NAV cum income, with net income reinvested, GBP. Share price total return is on a mid-to-mid basis.
Dividend calculations are to reinvest as at the ex-dividend date. NAV returns based on NAVs with debt valued at fair value.
Source: abrdn Investments Limited, Lipper and Morningstar.

Past performance is not a guide to future results.

Company/Companies selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance.

Issued by abrdn Fund Managers Limited, registered in England and Wales (740118) at 280 Bishopsgate, London EC2M 4AG, authorised and regulated by the Financial Conduct Authority in the UK.