Background 

Global equity markets performed strongly in the first half of 2024. They started the year in fine fettle as inflation trends towards the end of 2023 led to optimism about future interest rate cuts. However, equities weakened in April as higher than expected inflation in the first quarter led to renewed fears of interest rates staying higher for longer. Equities rebounded in May and June due to fresh hopes of those elusive interest rate cuts by the end of the year, as well as a solid first quarter corporate earnings season. Capital market participants are currently navigating a complex landscape characterised by several conflicting factors. On the one hand, the recent economic and corporate environment for many developed markets has been robust, with equity markets in Japan and the United States reaching record highs. On the other hand, there has been no significant reduction to key interest rates, except for some activity by the European Central Bank. Additionally, a dynamic political climate and ongoing geopolitical tensions are introducing substantial uncertainties that could disrupt the market outlook. This dichotomy creates a challenging environment for investors as they balance optimism stemming from solid economic performance, against the risks posed by stubbornly high interest rates and geopolitical instability.

North America

Share prices in the United States rose over the period. The technology sector performed particularly well, especially artificial intelligence (AI)-related stocks. Faced with a relatively robust economy, the US Federal Reserve has, to date, kept the target range for the Fed funds rate at its highest level since 2001. The much discussed "Magnificent Seven" account for a potentially alarming proportion of the earnings growth and index price moves that we have seen thus far. Market participants are rightly becoming more concerned about concentration risk, potentially exuberant expectations for these stocks and the broader market's underlying health. 

The Company’s health care exposure in the United States has been mixed in terms of performance. Prominent pharmaceutical names, including AbbVie and Merck & Co, have enjoyed a solid first half. Other exposures to Bristol-Myers Squibb and Johnson & Johnson have delivered little other than positive dividend growth. Communication services investments have also had differing fortunes. Verizon, the largest and highest quality provider in wireless communications, is more of a defensive stock with solid free cash flow generation and a well covered dividend. However, year to date, it has delivered an attractive level of total return. Telus on the other hand, dividend aside, has been disappointing on competition concerns.

Europe & the UK 

The Eurozone and the UK emerged from mild recessions, with growth returning in the first quarter of 2024. The European Central Bank kept its base rate on hold for much of the period, as it strove to bring the annual inflation rate down to its target level, before cutting it to 4.25% in June. Meanwhile, French President Emmanuel Macron called for a snap general election after his centrist alliance suffered a shock defeat to the far-right National Rally in the European Parliament elections in June. The resulting political uncertainty, coupled with concerns about France's future fiscal position and the stability of the EU, led to a sell-off in French equities. Prime Minister Rishi Sunak also called a General Election in the UK in which the Conservative Party lost power after 14 years to the Labour Party.

In terms of holdings, BE Semiconductor, a Dutch-based designer and manufacturer of semiconductor assembly equipment, has seen its shares buoyed by the excitement surrounding AI. Consumer staple stocks British American Tobacco and Unilever also performed reasonably well. Investments in industrial stocks Siemens AG and Atlas Copco AB added value, and both companies continue to report solid demand for their products

Asia & Latin America 

These regions had differing fortunes in the first half of 2024. Both had unexpected election outcomes to digest. In Asia, while Prime Minister Narendra Modi claimed a historic third win in a row in India, his ruling alliance failed to secure as large a majority as predicted. The opposite was true in Mexico, where Claudia Sheinbaum was elected as the first female president in an historic, landslide victory. Overall, the Asia Pacific region performed well over the period, with the notable exception of China. This was due to growing risks in the country's property sector and weak domestic investor sentiment. As a result, the Chinese authorities announced various stimulus measures aimed at boosting sentiment; however, these have yet to have the desired impact. In contrast, the Taiwanese and, to a lesser degree, South Korean stock markets both recorded solid gains, helped by their relatively high exposure to the technology sector. 

Investments in TSMC, the world's leading semiconductor foundry, and Hon Hai Precision Industry, another Taiwanese holding involved in electronic manufacturing services, both performed well. While dividends remained robust, capital returns in Latin America were weaker. 

Income Generation 

The portfolio's total income in the period under review fell by £1.8 million, or 3.7%, to £46.0 million. Given the relative strength of Sterling against most global currencies in the first half and the Company's reduction in gearing by £90 million since May 2023, this is not surprising. Selling positions in an equity portfolio yielding 4.5% to repay the debt that would have cost shareholders 6% to renew was deemed the correct course of action by both the Board and Manager while also considering the potential impact on income generation.

The portfolio tends to generate more than half of its revenue in the first half of the year. This is due to several European investments paying annual dividends, as opposed to semi-annual or quarterly dividends that we see in other geographies. We remain confident in the sustainability of the income picture as it relates to the portfolio and wait to see what happens in the second half of the year. One important factor to highlight here is the potential impact of currency. This is most apparent over the shorter term and less marked over the long term. Being a Sterling-denominated fund, but with over 90% of assets invested, unhedged, in overseas securities denominated in a basket of over fifteen different currencies, it is essential to keep currency in mind when it comes to shorter-term impacts, which can be both positive and negative in nature.

Portfolio Changes 

Trading activity was at a similar level to prior years, and, as with 2023, the first half has seen some disposals from the portfolio to repay debt, of which the cost to renew was going to be unattractive given the interest rate picture.

The Swedish industrial Epiroc AB, which manufactures construction and mining machinery, was sold. The stock has performed well since Atlas Copco spun off the business back in 2018. Roche AG, the Swiss listed developer and manufacturer of pharmaceuticals and diagnostic products, was also divested. Roche AG remains a solid business; there was simply higher conviction in the other healthcare names in the portfolio. Chinese property developer China Vanke proved to be a disappointment, with the investment thesis not playing out as intended; therefore, it was another low conviction holding and an easy candidate to exit in order to reduce gearing. The portfolio exposure to North American midstream companies was consolidated into one position. TC Energy was sold, and the capital recycled into Enbridge. The belief is that Enbridge carries less balance sheet and execution risk than its Canadian peer. The only new addition to the portfolio in the first half of the year was German luxury car brand Mercedes Benz Group. The company is looking to structurally improve its profitability by increasing the proportion of higher priced vehicles it sells, thereby improving margins and shareholder returns via dividends and share buybacks.

Outlook 

There are positive signs of economic recovery and growth in specific sectors, the global economy faces several significant risks and uncertainties. Inflation, geopolitical tensions, market concentration and consumer confidence are all factors that could derail equity markets trading at lofty levels and lead to increased volatility. Policymakers and businesses must navigate these challenges carefully to sustain growth and stability in the coming months. The investment focus will remain on quality companies, ensuring the portfolio is well diversified on a regional and sectoral basis and exposed to income and capital growth opportunities. We continue to seek companies robust enough to preserve capital in periods of market weakness, with attractive, growing, and sustainable dividends, exposed to strong structural drivers for long-term growth.

Read the full article in the half yearly report here. 

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