Background

The UK equity market, as measured by the Benchmark FTSE All-Share Index, rose by 13.0% on a total return basis over the Year. Investor sentiment around the timing of central banks beginning interest rate cutting cycles continued to be a main driver of market performance. Optimism that interest rates across major economies had peaked began to build in November, leading to an equity market rally at the end of 2023. By the start of the new calendar year, that optimism wavered as central banks suggested rate cuts may come later than expected. This concern was especially prevalent in the UK when December inflation came in higher than expected, which led to the UK stock market ending January lower. By March, central banks in the US, Europe and UK opened the door for cuts in the near term which was a boost to markets and continued to lead to positive market performance through May. Global equities continued their rise in June, boosted by positive corporate results and falling inflation figures. US stock indices reached fresh highs with the technology sector particularly strong and the potential for Artificial Intelligence driving sentiment. However, equity indices in the UK and Europe pulled back against a backdrop of elevated political uncertainty ahead of July's elections in the UK and France.

The UK economy fell into a technical recession in the second half of calendar 2023, when a 0.3% decline in GDP in the fourth quarter was the second sequential quarter of negative GDP growth. Since then, there have been signs of economic improvement in the first half of this calendar year with GDP expansion of 0.7% and 0.6% in the first and second quarters, respectively, helped by the strength in the services sector. The UK's unemployment rate fell to 4.2% in the three months to the end of June down from 4.4% in the previous quarter. Annual earnings growth, although above inflation, slowed to the lowest rate in almost two years in the three months to the end of June.

Performance

The Company generated a positive Net Asset Value per share total return of 9.9% for the Year (based on debt at fair value) underperforming the benchmark FTSE All-Share Index which returned 13.0%. On a total return basis, the Company's share price increased by 7.6%, reflecting a widening of the discount to Net Asset Value (debt at fair value) at which the shares traded from 8.2 to 10.5% by 30 June 2024.

Turning to the individual holdings, the positions in Novo Nordisk and Intermediate Capital generated the greatest stock level outperformance, delivering 82% and 58% share price increases respectively. Not holding Reckitt Benckiser which is a constituent of the benchmark index also contributed positively to relative performance. As has been a theme in the UK market in recent years, corporate and takeover activity has been elevated. Of the holdings in the portfolio, during the year, Anglo American and Direct Line rejected approaches at a premium to the level at which the shares had been trading prior to the approach.

The holding in Close Brothers detracted most from relative performance as its shares fell heavily when the FCA launched a review of motor finance practices in the industry. The company subsequently decided to suspend its dividend to conserve capital in anticipation of potential customer redress. Non-held Rolls Royce (which did not return to the dividend list during the Year) and Shell (where we prefer BP and TotalEnergies) also had a negative impact on relative return over the Year.

Portfolio Activity and Structure

The portfolio added nine new holdings in the Year. Four of these, HSBC, Haleon, Berkeley Group, and Smurfit Kappa are UK large-cap company introductions.

There was one UK mid-cap addition to the portfolio in the Year. Rotork is a leading global actuator business with strong quality characteristics and under-appreciated growth opportunities. A new position was also initiated in Coca-Cola Europacific Partners, which trades at an attractive valuation and gives exposure to a number of high quality consumer brands.

Outlook

The portfolio is aligned to compelling long-term trends such as an ageing population, the increasing wealth of the middle class, the digital transformation and energy transition. We identify and invest in high quality companies capable of delivering appealing long-term earnings and dividend growth at a relatively modest aggregate valuation.

We expect the trajectory of inflation data and the associated path of monetary policy will continue to influence markets over the next year. Recent data points, particularly relating to the labour market, have brought into question the extent to which the US economy will achieve a 'soft landing' but our economists still believe this to be the case. We expect the rate cutting cycles that have been started by the BoE and ECB to continue with the Federal Reserve reducing rates imminently. Political risk remains elevated through 2024 with the US election in November, while following the election of a Labour government in the UK in July we do not expect significant changes to the growth outlook in the near-term but policy could increase growth potential in the longer-term.

In summary, we feel optimistic that our long-term focus on investments in high quality companies with robust competitive positions and strong balance sheets, which are led by experienced management teams will be capable of delivering premium earnings and dividend growth.

Read the full Annual Financial report here.

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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.

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