Marketing material for professional investors and advisers only Schroder UK Mid 250 Fund Quarterly Fund Update Third Quarter 2018 Cumulative returns to 30 September 2018 (%) Z accumulation shares 60.0 40.0 20.0 0.0-20.0 3 months 1 year 3 years 5 years Portfolio Index Schroder UK Mid 250 FTSE 250 (ex IT) TR 3 mths 1 yr 3 yrs 5 yrs -3.1 3.3 27.0 45.3-2.7 4.2 29.2 53.4 Discrete yearly performance (%) Summary The fund slightly lagged a weak market in Q3. UK equities fell over the period amid a tempering of the global growth outlook and renewed Brexit uncertainty, which weighed on domestic areas of the UK stock market. We added to our position in UK homewares specialist Dunelm and used weakness in bookmaker William Hill to increase our holding. We exited generic drugs group Hikma Pharmaceuticals, reduced veterinary products business Dechra Pharmaceuticals and sold out of bid targets esure and Virgin Money. While UK growth has slowed since the EU referendum the economy has continued to expand at a steady pace against the backdrop of a very low unemployment rate and rising wages. The country s fiscal position has recovered as tax receipts have picked up (in excess of the rate of economic growth) further underlining the resilience of UK plc. Fund Benchmark 2017 23.7 18.2 2016 2.0 5.1 2015 6.4 12.0 2014-1.0 2.8 2013 43.2 34.9 Source: Schroders, net of fees, bid to bid, with net income reinvested. Z Acc share class as at 31 December 2017. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested. Portfolio characteristics Fund manager Andy Brough Managed fund since 19/11/1999 Fund launch date 19/11/1999 Fund benchmark Fund size Ongoing charge 0.91% 1 FTSE 250 (ex IT) TR 1,113 million Source: Schroders, as at 30 September 2018. 1 Based on the last year s expenses for the year ending December 2017. Schroder UK Mid 250 Fund Third Quarter 2018 1
What happened in the market UK equities fell over the period amid a tempering of the global growth outlook and renewed Brexit uncertainty. The tempered global growth outlook followed an escalation in the trade war between the US and China. Any slowdown in global growth and trade tends to have an outsized impact on emerging markets (EM), and EM-exposed areas of the UK stock market performed poorly as a result. Closer to home, worries of a no deal exit from the EU came to the fore again after the government published proposals for leaving the bloc the so called Chequers plan was poorly received in Westminster, sparking infighting within the cabinet. Consequently, the share prices of many UK domestic companies performed Performance attribution (%) poorly (driving the poor relative performance of mid caps) amid fears that the UK economy would grow at a lower rate going forward outside the EU. These fears were also reflected in the value of sterling, which resumed its downward trajectory. The nearterm outlook for the domestic economy improved, as growth recovered to 0.4% in Q2 (quarter on quarter) from the slowdown seen in the first quarter, prompting the Bank of England to increase interest rates by 25 basis points to 0.75%. M&A provided something of a counterbalance. Whitbread recommended an offer from Coca-Cola for its Costa coffee chain, while in the mid cap space John Laing Infrastructure Fund, UK insurer esure and Jardine Lloyd Thompson, a global insurance broker and provider of employee benefit services, also recommended bid approaches. Allocation effect Selection effect Sector Total effect 0.0 1.0 Industrials 1.0 0.0 0.6 Basic Materials 0.1 0.5 Consumer Goods 0.6 0.7 0.0 0.2 Telecommunications 0.1 0.0 Technology 0.0 0.0 Utilities 0.0 0.1 0.2 0.0-0.3 Financials 0.1-0.5 Healthcare -0.3-0.4 0.1-0.8 Oil & Gas -0.7-0.1-1.3 Consumer Services -1.4 Source: FactSet. Global foodservice company SSP Group was our top contributor on the back of a strong Q3 trading update, which drove further earnings upgrades. The company, which operates food and beverage outlets in travel locations around the world, said it was on track to deliver another year of steady organic growth in 2018, with its international airport catering business performing particularly well. The cashgenerative company, which is a beneficiary of strong long-term growth trends in both air and rail travel, is run by a high quality management team which delivered a further improvement in the operating margin in the quarter. Marine service specialist James Fisher & Sons also performed very well after publishing solid interim results, which underlined ongoing trading strength. The company has good exposure to niche engineering markets and has successfully used bolton acquisitions to broaden its offering, such as last year s purchase EDS in the UK renewables space. Globally diversified doorstep lender International Personal Finance (IPF) bounced back in response to reassuring interim results. The shares performed poorly over Q2, in line with other areas exposed to EMs as trade war rhetoric ramped up the rhetoric became concrete action in Q3 as the US and China imposed tariffs on each other s goods, however IPF bucked further declines in EM-exposed areas of the market. It performed well after reporting that 2018 pre-tax profits were expected to exceed consensus forecasts by approximately 10%. Redrow also rebounded on the back of robust fullyear results, its shares performing well despite further evidence of a slowing UK residential property Schroder UK Mid 250 Fund Third Quarter 2018 2
market weighing on the wider housebuilding sector. The company reported record profits and declared a final dividend of 19p, taking total distributions in 2018 to 28p a share, an increase of 65% on 2017. Meanwhile, Photo-Me International recovered some of the previous quarter s losses after the photo booth operator published a reassuring set of full-year results. Investors welcomed plans to restructure the Japanese business as it grapples with industry overcapacity (Japan was the source of the profit warning in the previous quarter) and took further comfort in the ongoing strength of Photo-Me s balance sheet. On the negative side, tour operator Thomas Cook fell sharply after the company cut full-year profit forecasts again, leading to the departure of the CFO. It seems that the company increased capacity in anticipation of a very good year (after an unusually wet Q1 led to strong bookings) only to find itself with too many holidays as a very hot summer in Northern Europe saw customers opt to stay at home. Despite the disappointing performance from the holiday business, trading at the airline remained resilient against a challenging backdrop, with rising crude oil prices and industrial action making for a difficult operating environment. While the earnings outlook for next year remains uncertain, the market is now expecting very little from the company, whose shares are trading on a distressed multiple of less than 10x expected earnings in 2019. Not owning Wood Group also detracted after the company performed well on the back of robust interim results, underpinned by a pick-up in capital expenditure in the group s end markets. Meanwhile, oil services group Lamprell gave back gains of the previous quarter when a major shareholder in the company had doubled its stake, creating upward pressure on the stock. Lamprell continues to await confirmation of a long-term agreement with Saudi Arabia s state oil company Saudi Aramco. Top stock contributors (%) Top stock detractors (%) Stock contributor Relative weight Total return Stock contributor Relative weight Total return SSP Group +2.5 +0.4 Thomas Cook +1.7-0.9 James Fisher +3.4 +0.4 CMC Markets +1.3-0.4 IPF +2.5 +0.3 John Wood -1.4-0.3 Photo-Me +1.6 +0.3 Lamprell +0.9-0.3 Redrow +1.9 +0.3 Sports Direct +2.6-0.3 Source: FactSet, average positions over the quarter. Portfolio positioning as at 30 September 2018 (%) Sector Relative weighting (%) Consumer Services 5.1 Telecommunications 3.2 Consumer Goods Basic Materials 2.0 1.9 Oil & Gas 0.3 Utilities Healthcare -1.7-1.8 Technology Industrials -2.7-2.4 Source: FactSet. Financials -5.4 Schroder UK Mid 250 Fund Third Quarter 2018 3
Key portfolio activity We added to our position in UK homewares specialist Dunelm following a visit to the company, which underlined the potential for online sales to drive strong medium-term growth. The acquisition of the Worldstores businesses has increased online exposure while the new CEO is focused on improving operating performance. After a difficult 2018 Dunelm is beginning to benefit from self-help initiatives, as underlined by the very strong Q1 trading statement published following the period under review, which also reminded the market how growth in this niche remains robust. Key stock positions (%) Overweights Sector Relative weight Grainger Financials +3.8 James Fisher Industrials +3.7 SSP Group Industrials +2.7 Telecom Plus Telecoms +2.6 IPF Financials +2.6 Source: FactSet as at 30 September 2018. Meanwhile we used weakness in bookmaker William Hill to top up our holding after the shares struggled in the quarter as the market focused on the shortterm negative earnings impact of investment required in its US business and changes in the regulation of fixed-odds betting terminals (FOBTs) in the UK. In contrast to the market we remain focused on the potential for material long-term growth as the US sports betting market de-regulates. We exited our holding in generic drugs group Hikma Pharmaceuticals which bounced back very sharply after we initiated a new holding in Q1. We exited our position in esure following the recommended bid for the company, and entirely sold out of Virgin Money shortly after it recommended an approach from rival challenger bank CYBG. We reduced our holding in international veterinary products business Dechra Pharmaceuticals where an increase in the pace of acquisitions adds additional risk to the investment case, at a time when shares in the group are trading on a rich multiple of future earnings. We exited gaming group Rank given reservations around the company s growth prospects. In general, we reduced the fund s holdings in smaller companies. Schroder UK Mid 250 Fund Third Quarter 2018 4
Outlook and strategy While UK growth has slowed since the EU referendum the economy has continued to expand at a steady pace against the backdrop of a very low unemployment rate and rising wages. The country s fiscal position has recovered as tax receipts have picked up (in excess of the rate of economic growth) further underlining the resilience of UK plc. Despite their depressed levels of confidence in the general economic outlook, consumers are positive about their personal financial situation and the surveys show their confidence to make major purchases (furniture, electrical goods etc ) has improved over recent months. We certainly see evidence from our portfolio holdings that consumers are willing to spend, whether that be on soft furnishings (see Dunelm comment, page 4), pet supplies (Pets at Home) or drinking and eating out (Restaurant Group). More widely, we continue to find many mid-cap companies which are delivering good levels of organic growth, sensible bolt-on acquisitions and underpinned by strong balance sheets. Schroder UK Mid 250 Fund: Risk factors Funds that invest solely in the companies of one country or region can carry more risk than funds spread over a number of countries or regions. The fund can be exposed to different currencies. Changes in foreign exchange rates could create losses. Equity prices fluctuate daily, based on many factors including general, economic, industry or company news. Investments in smaller companies can be less liquid than investments in larger companies and price swings may therefore be greater than in larger company funds. In difficult market conditions, the fund may not be able to sell a security for full value or at all. This could affect performance and could cause the fund to defer or suspend redemptions of its shares. Failures at service providers could lead to disruptions of fund operations or losses. Important Information: This material is not suitable for retail clients. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested. Andy Brough has expressed his own views and these may change. The data contained in this document has been sourced by Schroders and should be independently verified before further publication or use. This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroder Unit Trusts Limited (Schroders) does not warrant its completeness or accuracy. No responsibility can be accepted for error of fact or opinion. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions. Issued by Schroder Unit Trusts Limited, 1 London Wall Place, London EC2Y 5AU. Registered No: 4191730 England. Authorised and regulated by the Financial Conduct Authority. Schroder UK Mid 250 Fund Third Quarter 2018 5