Baillie Gifford UK Growth Trust (BGUK) has released its annual results for the year to 30 April 2023, during which BGUK provided an NAV total return of 1.1%, which the trust says compares to a 6.0% total return for the All-Share. During the period, BGUK’s share price total return was -1.3%, reflecting a small widening of the discount over the year. The chairman, Carolan Dobson, comments that, whilst the wild divergence of performance in the share prices of companies perceived to offer either growth or value was more muted this year compared to last, it still persisted, resulting in a disappointing return from a portfolio focused on growth companies. There were also some disappointing individual company outcomes but no more than might be normally expected.
Key highlights from the results are as follows:
- The largest detractors to relative performance were: Molten Ventures, a technology focused venture capital firm; FDM Group, a provider of professional services focusing on information technology; Helical, a property developer; and Farfetch, an online luxury fashion retailer. Not holding BP was also a notable detractor.
- The notable positive contributors to relative performance were toy manufacturer and retailer, Games Workshop, luxury goods retailer, Burberry, and the direct marketer of promotional merchandise, 4imprint.
- Two new positions were initiated in the period: IT infrastructure provider Softcat, and the digitisation specialist Kainos. One position was sold, online food ordering and delivery company Just Eat Takeaway.com. The positions in Euromoney Institutional Investor and Homeserve were exited following takeovers.
- The net revenue return for the year was 4.05p per share (2022: 4.39p). A final dividend of 3.60p per share is being recommended (2022: 3.91p). The dividend is paid by way of a single final payment.
- Over the year a total of 2,975,000 shares were bought back into treasury. Since period end to 14 June 2023, a further 105,000 shares have been bought back into treasury.
- The board and managers believe the portfolio to have attractive growth fundamentals and the vast majority of holdings are expected to grow well in excess of the market over the longer term and are high quality and resilient.
Majority of portfolio companies are performing as expected
Carolan says that, examining in detail the current profits and turnover and the portfolio managers’ expectations for future trading for the companies in the portfolio, shows that the majority of the companies at the profits and revenue level are performing as expected, against a backdrop of a difficult UK economy with interest rates and inflation sharply higher than for the last 15 years. The portfolio managers continue to be enthused by the long term prospects of the companies held, as evidenced by the low level of portfolio turnover over the year, of 5%.
Discount management
There has been little investor appetite to invest in UK equities over the past year and this, coupled with some disappointing performance, has resulted in the shares standing at the financial year end at a 14.1% discount to the company’s NAV compared to 11.8% a year earlier. The discount on the AIC UK All Companies sector was 11.9% compared to 10.6% for the same period last year. BGUK steadily bought back shares throughout the year, buying into treasury 2,975,000 shares, which represents 1.9% of the company’s issued share capital as at 30 April 2022. Since the financial year end, a further 105,000 shares have been bought back into treasury. However, the chairman comments that more investor demand for UK growth equities is needed for BGUK’s discount to see a material narrowing.
Gearing
During the year, BGUK replaced its one-year £20m revolving credit facility with The Royal Bank of Scotland International Limited with a one-year £30m revolving credit facility with the same provider. Drawn and invested gearing stood at 5% and 3% of shareholders’ funds as at the company’s year end compared to 2% for both a year earlier.
Earnings and Dividends
The net revenue return per share for the year was 4.05p, versus 4.39p in 2022. The board is recommending a final dividend of 3.60p per share, payable on 15 September 2023 to shareholders on the register as at 18 August 2023.
Succession plans
The chairman says that she intends to step down from the board no later than next year’s AGM and, in line with good corporate governance, will play no role in the recruitment of her successor. Andrew Westenberger is to chair a Nomination Committee to appoint her successor and an external recruitment consultant will be engaged shortly to undertake the selection of a list of suitable candidates for consideration.
Managers’ Report
“We are disappointed and sorry to be writing to fellow shareholders about a poor year of relative performance for the portfolio. While we totally understand that you might be despondent or frustrated, we remain firmly of the view that the portfolio is well positioned for the future and as a consequence portfolio turnover has remained low at 5%. If one thinks in terms of half-year periods, the Company has endured a difficult period of performance since November 2021 up to the end of October 2022. The principal reasons for that were a toxic combination of our ‘Growth style’ falling out of favour and a few large UK mega-cap stocks such as big oil and big pharma performing better in tougher or more uncertain times. Of course, some of our stock picking hasn’t been ideal either but the data is pretty unambiguous. The style headwinds we have encountered are the biggest factor for the underperformance. For example, the biggest detractor to performance over the year to end April 2023 was Molten Ventures, the investor in private growth businesses. Unsurprisingly, given the fall in valuations of private companies globally, it recently announced that its unaudited net asset value had declined by 17% in the year to 31 March 2023. So yes, a tougher year for Molten but its share price declined by 59% meaning that at our year-end Molten traded at a 60% discount to this lower valuation. Clearly the stockmarket expects further valuation declines but this extreme pessimism seems at odds with the underlying progress Molten has seen in most of its main investments.
“It begs the question of whether our growth style is simply misguided and we need to adapt to different times? We can only address the question with humility as we cannot be sure that we ‘know’ the correct answer. Our experience tells us two things: firstly, many people want simple answers to complex problems, which explains the rise of populist politicians in many countries. This type of thinking is seductive and persuasive after poor periods of performance and probably explains why ‘style drift’ is the biggest ‘killer’ of fund managers. We are not complacent and have debated between ourselves, and also with the Board (one of the great benefits of the investment trust structure), as to whether we could or should have done things differently in the last two years. The answer in both cases is that, as bottom-up stock pickers, we should continue to back our judgement. Indeed, to be blunt, had we tried to chase short term performance, it would have meant endorsing a skill that we have repeatedly said we lack and also abandoning our investment principles. Attempting both would have created more problems and concerns without necessarily having improved performance.
“The second observation from experience is that as individual managers we have been through long patches of underperformance before and the key lesson learnt is to stay true to one’s beliefs and investment style, no matter the temptation. Thus, we have tried to remain focussed, stay long term in our investment horizon and to keep appraising the stocks in the portfolio as to whether we think they will be additive to its performance. We probably sound like a broken record, but we believe that share prices follow fundamentals and the latter are good in this portfolio. Again, this is probably only of partial reassurance. The elephant in the room is of course when will growth as a style come back into favour? It would give us no greater pleasure to answer that positively but we have to be honest and say that we simply have no idea when this will happen. At least we can report that in the second half of the financial year being reported on, the portfolio modestly outperformed the index that itself rose by a healthy 13%. Of course, we have absolutely no idea if this is a turning point or a random event, but at the very least this gives us a little encouragement that some of the domestic doom and gloom that we reported on at the half-year has started to lift as the aftershocks of the Truss administration fade and the economic data proves not to be as dire as widely predicted.
“Perhaps understandably there has been a focus on top-down factors such as political instability, the war in Ukraine, rising inflation and, more recently, the banking crisis in both the US and Europe. But as some of these factors fade, or at least are ‘managed’ by both businesses and consumers, we suspect that at some point there will be a return to focussing on company fundamentals and growth prospects, and here we remain greatly encouraged.”
Managers’ comments on the portfolio
“As noted above, portfolio activity remained low. In addition to Just Eat Takeaway.com, our two main sales, as reported at the half-year, were the takeovers of Euromoney Institutional Investor and Homeserve, both of which we reluctantly accepted. In the interim report we also talked about new purchases in the IT suppliers Softcat and Kainos and in the second half we added to both; they have continued to report robust growth. We also added to the heat treatment business Bodycote, as we thought the market was too preoccupied with the undoubted cyclical nature of some of its end markets, such as automotive and general industrial, and is underappreciating the restructuring of the business by management into a far more focussed and profitable business with some interesting growth angles. We also added to the financial platforms AJ Bell and Integrafin having previously reduced our position in Hargreaves Lansdown. This reflects our conviction that the first two businesses have clearer propositions in their end markets (both deal with IFA customers with AJ Bell also serving the direct-to-consumer market). Both suffered share price weakness due to tougher markets which brought their ratings down to even more attractive levels.
“Elsewhere, we resisted the temptation to tinker with the portfolio. Looking at growth, or sometimes the lack of it, has been made tricky by the pandemic, the recovery from pandemic and now the gloom about a deteriorating economic picture across many countries. Throw in the impact of soaring inflation, higher interest rates and taxes, and optically you have an uncertain and unattractive backdrop for businesses. Yet that is not what the vast majority of our companies are reporting. For sure, they all have to navigate the challenges listed above and it would be irresponsibly naïve to think one’s portfolio is immune to short-term challenges, but it is also important to note that good companies can manage the challenges and find new opportunities, whether it be: the plant hire business Ashtead finding new areas to rent (very lucratively in the case of hiring out floor cleaning equipment for example); the platform business Autotrader offering additional services and thus deriving more revenue streams from second-hand car sales; or, hobbyist retailer Games Workshop making progress in potentially monetising, with Amazon TV, some of its vast intellectual IP. There are reasons to be optimistic. Finally, on unlisted investments, we made no new investments in the year and our only exposure here is through Wayve, an autonomous vehicle technology business.”
Managers’ comments on outlook
“It has been a challenging time for investors and, as we’ve already noted, there are many economic and geopolitical worries and issues. Despite this, we look at the portfolio of companies held and most have strong market positions, healthy balance sheets and good management teams. We are therefore reassured and excited about its prospects. While we understand that performance has to improve to warrant this optimism, we believe the attractive growth fundamentals of the portfolio remain in place and we have the necessary patience to see them reflected.”