How did you navigate a challenging 2024 for UK smaller companies?

In the first three quarters of 2024 the fund benefitted from peaking interest rates, falling bond yields and inflation returning to the Bank of England’s 2% target. This helped UK equity market valuations stabilise and ushered in a strong recovery in UK consumer and business confidence. At that time, the fund’s exposure to UK domestics, in particular interest rate-sensitive companies such as housebuilders and UK RMI (repairs, maintenance, and improvement) names performed well.

The anticipation of a Trump victory followed by the confirmed “red sweep” in the US caused bond yields globally to rise materially as his tax lowering and tariff raising policies are sensibly perceived to be inflationary. However, bond yields rose most acutely in the UK.

Nervousness around a Labour Government’s first budget in 14 years turned out to be well-founded as a sharp increase in taxes on business (increase in employers national insurance contributions (“NICs”)) and business owners (reduction of business property relief (“BPR”)) could logically lead to higher inflation, slower real wage growth, higher unemployment and is more likely to deter rather than encourage private sector investment. We reduced our exposure to some of our more interest rate sensitive names as a result.

However, in spite of the rise in national insurance contributions impacting profit margins, the valuations of UK shares remain cheap relative to their earnings.

At the smallest end, technical pressure on the AIM market was somewhat alleviated as IHT relief was only tapered and not abolished. We continued to invest in this market on a stock-by-stock basis, taking advantage of the technical pressure where we believed it to be unjustified by business fundamentals.

Regardless of the Labour party’s landslide victory at the general election in the summer, it has been a short honeymoon period for this new Government. It is now trying to reassure business and investors that the tax raising budget was a “once in a parliament budget to wipe the slate clean.” While we remain sceptical of this claim, we believe that the relative political stability in the UK in comparison to Europe leaves it better-placed to attract investment and drive stronger economic growth in the near term.

What were the most interesting opportunities you found for the portfolio this year?

We added 13 new names to the portfolio this year across a broad spectrum of sectors.

In June, we took advantage of the UK IPO market opening up again and bought Raspberry Pi, a specialist computing provider. What makes RPi unique is its continuous innovation in both hardware and software R&D. The company’s primary ethos is to provide the highest compute power at the cheapest possible price. Its attractive product offering and price point, in conjunction with its international ambitions, make this an exciting long-run growth story.

We initiated a position in Morgan Sindall, the diversified UK construction company, as the company has benefited materially from the troubles of its major competitor, ISG, in the office fit-out market. It is also well-positioned to benefit from the likely upswing in the affordable housing and urban regeneration markets, where its timely sizeable capital investment should reap significant rewards in coming years.

Our recent new position in Keller, a leading provider of ground engineering services to the construction industry, provided us with cheap exposure to increasing infrastructure investment in the US. It has reduced debt on its balance sheet and increased cash, which gives it the flexibility to conduct M&A and/or capital returns.

Following a period of share price weakness, we took the opportunity to start a position in Domino’s Pizza on a lowly valuation. We believe that the new management team had a credible plan in place to reinvigorate volume growth at this high returns franchise.

What didn’t work?

The Labour party’s budget. It was an ill-thought through endeavour, in which the Government seems to have snatched defeat from the jaws of victory. Corporate margins have been dented in the immediate aftermath. Subsequent earnings downgrades have brought a return to technical pressure in the UK stock market, as investors sell down their holdings.

We believe that after the dust has settled on this budget, investors will find businesses with strong fundamentals trading on lowly valuations that have never been more willing to return cash to shareholders through dividends and share buy-backs.

What is your outlook for UK interest rates and how will these impact the portfolio?

Trump’s policies together with the structural inflation injected into the market by the UK budget all point to rates staying higher for longer. This is what the market is currently forecasting. However, markets are never this straightforward. Both the timing and implementation of the tariffs could stifle economic growth in Europe and China leading to deflationary pressures and the need to reduce interest rates faster-than-expected to stimulate growth.

The evolution of geopolitical tensions in Ukraine and the Middle East will also have some bearing on energy prices, which can impact inflation but whose outcomes feel as unpredictable as ever.

Regardless of the uncertainty, starting valuations are materially lower as we enter 2025 than they were when we entered 2022.

Discrete year performance (%)	Share price (total return)	NAV (total return)
30/9/2023 to 30/9/2024	27.0	24.7
30/9/2022 to 30/9/2023	4.2	2.0
30/9/2021 to 30/9/2022	-40.5	-37.6
30/9/2020 to 30/9/2021	66.1	56.3
30/9/2019 to 30/9/2020	-10.6	-4.0

All performance, cumulative growth and annual growth data is sourced from Morningstar.

Source: at 31/10/24. © 2024 Morningstar, Inc. All rights reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete, or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance does not predict future returns.

Glossary

Balance sheet

A financial statement that summarises a company’s assets, liabilities and shareholders’ equity at a particular point in time. Each segment gives investors an idea as to what the company owns and owes, as well as the amount invested by shareholders. It is called a balance sheet because of the accounting equation: assets = liabilities + shareholders’ equity.

Bond yield
The level of income on a security expressed as a percentage rate. For a bond, this is calculated as the coupon payment divided by the current bond price. There is an inverse relationship between bond yields and bond prices. Lower bond yields mean higher bond prices, and vice versa.

Capital investment cycle
The purchasing of fixed assets by a company for the purpose of supporting day-to-day operations.

Deflation/negative inflation
A decrease in the price of goods and services across the economy, usually indicating that the economy is weakening. It differs from ‘disinflation’, which implies a decrease in the level of inflation. Deflation is the opposite of inflation.

Dividend
A variable discretionary payment made by a company to its shareholders.

Downside protection
Limiting or reducing losses in the case of a decline in the value of the underlying security.

Earnings per share (EPS)
EPS is the bottom-line measure of a company’s profitability, defined as net income (profit after tax) divided by the number of outstanding shares.

Fundamental analysis
The analysis of information that contributes to the valuation of a security, such as a company’s earnings or the evaluation of its management team, as well as wider economic factors. This contrasts with technical analysis, which is centred on idiosyncrasies within financial markets, such as detecting seasonal patterns.

Inflation
The rate at which the prices of goods and services are rising in an economy. The Consumer Price Index (CPI) and Retail Price Index (RPI) are two common measures. The opposite of deflation.

Initial Public Offering (IPO)
The process of issuing shares in a private company to the public for the first time.

Share buybacks
Where a company buys back their own shares from the market, thereby reducing the number of shares in circulation, with a consequent increase in the value of each remaining share. It increases the stake that existing shareholders have in the company, including the amount due from any future dividend payments. It typically signals the company’s optimism about the future and a possible undervaluation of the company’s equity.

Share price
The price to purchase (or sell) one share in a company, not including fees or taxes.

Technical analysis
The analysis of esoteric factors such as market liquidity and investor behaviour, in an effort to identify how they influence security prices. This contrasts with fundamental analysis, which looks at factors such as corporate health and the quality of management teams.

Valuation metrics
Metrics used to gauge a company’s performance, financial health and expectations for future earnings, eg. price to earnings (P/E) ratio and return on equity (ROE).

 

Disclaimer

References made to individual securities do not constitute a recommendation to buy, sell or hold any security, investment strategy or market sector, and should not be assumed to be profitable. Janus Henderson Investors, its affiliated advisor, or its employees, may have a position in the securities mentioned.

There is no guarantee that past trends will continue, or forecasts will be realised.

Past performance does not predict future returns.

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