Performance and Market Review

Despite the sharp gyrations in markets caused by the conflict in Ukraine and concerns over inflationary pressures, the Company’s net asset value total return performance was in line with the benchmark index over the period, recording a fall of 0.1% in total return terms. The first quarter of the financial year was particularly challenging, following on from a difficult last few months of 2021/22. The increase in bond yields combined with surging commodity prices made for a tough period for relative returns. The second quarter, however, saw more favourable conditions emerge and we were also aided by continued good operating performance from a number of the holdings in the portfolio as well as a takeover offer for Euromoney Institutional Investor, the events and database business.

Aside from Euromoney, positive contributions came from a number of the portfolio’s largest absolute positions including AstraZeneca, London Stock Exchange, Relx and SSE as they continued to deliver good growth through what were volatile market conditions. On the negative side, Direct Line Insurance, Marshalls, Persimmon and Pets at Home all detracted from performance. While the immediate outlook is undoubtedly uncertain for these businesses, the valuations look appealing and the midterm prospects are attractive.

Pleasingly, income delivery was ahead of our expectations over the period. This was driven by a continued recovery in more cyclical dividends post-pandemic from the likes of retailer Pets at Home and construction companies Marshalls and Morgan Sindall where, despite share price weakness, their cash generation and robust balance sheets allowed for substantial increases. We have also seen shareholders rewarded due to stronger underlying trading at Croda, Dechra Pharmaceuticals, Edenred, London Stock Exchange and Relx. It was also pleasing to see AstraZeneca return to dividend growth for the first time in a decade.

We continued to generate income from option writing, where relatively elevated levels of volatility have facilitated higher prices. We have also been able to implement a number of strategic actions through options, most notably writing calls over the holding in GlaxoSmithKline ahead of its spin-out of Haleon, generating significant revenue from a position which we wanted to exit over the medium term.

Given the timing of dividend declarations, our visibility over the income out-turn for this financial year is high. We also take comfort from our focus on higher quality businesses with strong balance sheets. Given the challenging outlook, we will continue to be watchful. It is worth noting that the Company’s future dividend prospects are tied into businesses with exposure to structural over cyclical growth, stronger pricing power and, consequently, greater control over their own destiny. Ultimately, this will prove supportive if we enter into more economically challenging times.

We continue to be very active in our engagement approach with holdings in the portfolio. During the period, this included, amongst many others, seeking to improve governance at Abcam and Prosus, discuss water and supply chain security at Diageo, decarbonisation strategy at SSE and human capital management at Prudential and Ubisoft. Being aware of these potential risks to the companies’ long-term strategies and looking to drive mitigation and create opportunities is a key part of our investment approach.

Portfolio Activity

We are actively investing to bring together what we believe are the best opportunities, but this was a period of relatively modest levels of activity within the portfolio. Given tough market conditions, we preferred to focus on existing holdings with the potential to yield attractive returns. As a result, we added to industrial software developer Aveva, Eastern European and African beverages company Coca-Cola Hellenic Bottling Company, private markets asset manager Intermediate Capital and Asian insurance group Prudential. All four of these had seen their share prices weaken for a range of reasons but we consider them to be very strong businesses with excellent long-term prospects. After a series of reassuring meetings with the company, we also increased the position in London Stock Exchange, which has had some issues in the integration of its acquisition of Refinitiv, but where the business now appears to be back on the front foot and performing well. We have also significantly increased the position in Unilever, where the company’s brand portfolio remains solid and its exposure to emerging markets is attractive at a time of more subdued growth elsewhere. With activist shareholders on the board and a relatively modest valuation, we believe this is a strong addition to the Company’s income and capital return generating capabilities.

To fund these purchases, we exited several smaller positions including Prosus and Abcam. Abcam had seen question marks build over corporate governance and eventually we concluded that management had failed to adequately protect and prioritise shareholder interests. Prosus’ shares had held up relatively well at the start of the year and we opted to exit the holding. Finally, we sold out of the position in German reinsurer Hannover Re as we sought to manage the overall exposure to financials within the portfolio.

Outlook

Given the rapid tightening of monetary policy and the ongoing war in Ukraine, we retain the cautious outlook that we have had for some time but remain positive on the potential returns on offer from the existing portfolio, believing that good stock selection has the potential to help mitigate challenging market conditions. During the year so far, our priority has been to add capital to existing holdings, particularly where returns are looking increasingly compelling. We also continue to look at a number of attractive potential new investments. Overall, we will seek to keep a balance to our positioning, giving ourselves the potential to perform in a range of market environments. We will be aiming to protect capital, but also to participate in upside opportunities in companies with strong long-term prospects, and at the same time meeting our sustainable and responsible investing criteria.