Fund Manager Comment

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Simon Gergel
Fund Manager

On 4 July, the directors declared a first quarterly dividend, for the year ending 31 January 2018, of 6.1p, compared to 6.0p last year.
In contrast to the first half of the year, July was a quiet month for UK political and economic news. However there was a raft of corporate reporting towards the end of the month, as companies strived to get results into the market before the summer holiday season. There was a major development in the tobacco industry, where the US Food and Drink Administration launched an unexpected consultation into potentially reducing the nicotine levels in cigarettes, aimed at reducing addiction, and ultimately the incidence of smoking. They are also looking at other measures such as restricting menthol cigarettes and encouraging e-cigarettes or alternative “next generation” tobacco products, which may be less harmful.
Volatility was low in the stock market, which traded in a narrow range and produced a total return of 1.2%, although medium sized companies performed better. Oil, copper and other commodity prices were strong, with Brent crude oil rising by 12% on the month, benefiting from inventory reductions. The US dollar weakened in July against the pound, and even more so against the euro as President Trump’s leadership encountered problems, whilst European economic growth accelerated.
Within the stock market, the best performing large sector was mining, with beverages and fixed line telecoms also strong. Tobacco was the worst sector, falling by 10%, as investors reacted to rising regulatory risk in an industry which had been regarded as relatively defensive, and where companies have increased financial gearing significantly in recent years. Pharmaceuticals were also weak, notably AstraZeneca, where a key drug trial failed to meet its target.
The Trust’s NAV returned 4.2% in July, outperforming the FTSE All-Share Index benchmark return of 1.2%. The Trust does not own any tobacco company shares, which have looked expensive for some time, and in our opinion, did not reflect risks inherent in the industry and the high level of company indebtedness. The portfolio also benefited from not owning AstraZeneca. Elsewhere, performance benefited from strong performance from the miners Antofagasta and BHP Billiton, and the life insurer Standard Life. There were fewer negative performance contributors, although GSK was weak following interim results that were broadly in line with expectations. Not owning the miners Glencore, Rio Tinto and Anglo American also held back relative returns.
We did not change the structure of the portfolio significantly, but we took some money out of shares that have performed well and are approaching fair value, such as Carnival, HSBC, Senior and NEX Group. We reinvested bigger positions in cheaper shares, which have lagged behind the market, such as National Express, Lloyds, WPP and Greene King.
Our views have not diverged in the last month. The UK economy faces a number of headwinds, with consumers seeing pressure on disposable incomes, whilst corporate spending is at risk from uncertainty caused by the Brexit negotiations. European and other economies do look more promising, however. UK quoted companies are very international, with the bulk of sales and profits coming from overseas. Within the portfolio we have significant investments in internationally exposed natural resources, engineering, pharmaceuticals, media and financial services companies, amongst others. We also have some domestic exposure in the portfolio, but generally where valuations are low, considerable risk is priced in. We have few investments in consumer staple sectors like food producers, tobacco and beverages, where valuations are unattractive.
Data as at 31.07.2017

Simon Gergel
Fund Manager, The Merchants Trust PLC

The information contained herein including any expression of opinion is for information purposes only and is given on the understanding that it is not a recommendation and anyone who acts on it, or changes their opinion thereon, does so entirely at their own risk. The opinions expressed are based on information which we believe to be accurate and reliable, however, these opinions may change without notice. This is no recommendation or solicitation to buy or sell any particular security. A security mentioned as example above will not necessarily be comprised in the portfolio by the time this document is disclosed or at any other subsequent date. Past performance is not a reliable indicator of future performance. You should not make any assumptions on the future on the basis of performance information. The value of an investment and the income from it can fall as well as rise as a result of market fluctuations and you may not get back the amount originally invested.

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