Half-year Report

HALF YEARLY REPORT

Performance

During the six month period to 30 June 2017 Temple Bar generated a total return on gross assets of 3.53%, underperforming the benchmark FTSE All-Share Index total return of 5.50%.

The portfolio benefitted from its holdings in builder’s merchant Grafton which performed well on the back of earnings upgrades driven by excellent operational performance in Ireland, and SIG which, following the appointment of new management, bounced back strongly. Notable holdings that detracted from performance were Signet Jewelers, hindered by weakness in malls across the US and concerns regarding its loan book, Barclays which announced results weaker than expected, and Tesco whose bid for food wholesaler Booker worried investors that a reasonably straightforward recovery story had been made unnecessarily complex.

Market background

In recent years, the success of different styles of equity investing has become a slave to bond yields with, in general, Value investors, including Temple Bar, finding progress hard when bond yields have been low and falling. We would therefore expect any significant increase in yields to reverse this trend swiftly; should it occur, many investors are poorly placed for such a reversal.

The language of central bankers modified in late June with hints of a reversal of Quantitative Easing (QE – the printing of money to purchase bonds) and the requirement for higher interest rates as advanced economies return to more normal conditions.

In briefings, the central bankers have raised a number of issues: 1] significant increases in asset values may have created false prices and driven mis-allocation of capital; 2] the effects such increases have had on wealth inequality; 3] the unknown long-term inflationary effects of loose monetary policy; 4] unemployment is falling, possibly to a level which would stimulate inflation; 5] interest rates need to be higher ahead of the next recession.

Markets shrugged off this change in tone, believing either the central bankers were all talk or that any weakness in markets following implementation of this strategy would quickly force its cessation (or even reversal).

While we would prefer to sideline banker/market noise, and focus on picking individual stocks from detailed bottom-up analysis, we cannot ignore the changing attitudes of central bankers.  Their previous decisions have driven bond and equity markets to very high valuation levels, and investors should be alert to the likely consequences of a change of tack.  We identify three scenarios.

Scenario 1: interest rates rise across the yield curve and QE is reversed, with no significant effect on economic growth.  We believe this would depress asset markets.  After all, if interest rates return to historical levels, equity ratings should also revert to long-term norms.  However, it is unclear whether the monetary authorities have the nerve to watch bonds and equities fall without acting.

Scenario 2: rising interest rates slow economic growth, dampening inflation expectations.  This would probably be good for government bonds and for asset classes with valuations most closely linked to bond yields.  Precious metals might also benefit if markets worry that central

banks would find difficulty in unwinding QE. This scenario implies a continuation of low interest rates, low inflation, sub-par economic growth and no significant increase in government spending.  However, around the western world politicians have recently been left in no doubt of voters' resentment of the status quo. As this scenario appears to be unsustainable, we should prepare for scenario 3.

Scenario 3: if central banks fail to increase rates and reverse QE while inflation falls and/or there is an equity market crisis, markets may price in the risks of further QE or, more likely, increased government spending.  Or governments may authorise the creation of helicopter money (ie money printed specifically to be used for increased government spending - a neat blend of monetary and fiscal policies). We assume this would be a very good outcome for precious metals, a bad outcome for bonds (as investors would suspect that governments are desperate to generate inflation) and a mixed outcome for equities.  We believe equities most closely correlated to bonds would struggle, relative to those less sensitive to interest rates.

The portfolio, although not purposely constructed for this outcome, is best placed for scenario 3.  We believe, broadly, that markets are approaching the end of an era.  The long-term trend of globalisation has had very deflationary effects and, combined with extreme monetary policy, has driven bond yields down to very low levels. The current mood among electors and politicians suggests that the globalisation trend of the last few decades could give way to trade barriers, tariffs, protectionist policies and restricted movement of labour, plus greater use of fiscal policy. The consequence of scenario 3 is likely to be a more inflationary future and one, with government debt so high, which the authorities would welcome. 

Portfolio changes

Our new era views are reflected across the portfolio and in the activity of the last six months. We sold out completely from our tobacco holdings BAT and Imperial Brands, the last of our ‘bond proxies’. Both companies have a number of attractive operational and financial characteristics but, we believe, they were more than adequately reflected in the share prices.

The weighting in the bank sector remains the portfolio’s largest. We believe the market underestimates the changes banks have made to their operating models over the last decade. The high growth and weak and aggressively financed balance sheet approach has been replaced by one focused on low growth and a strong and conservatively financed balance sheet. Although investors typically regard regulatory interference with caution, we believe the regulators’ actions since the Global Financial Crisis significantly reduce the downside risks for equity holders in banks. This downside resilience together with the low valuations of the banks continue to provide us with confidence that they remain undervalued.

We did, however, decide to sell our holding in Lloyds Banking Group. We believe the business has a number of challenges. It has a significant exposure to very profitable variable rate mortgages (vulnerable to both competition and regulation) and has grown quickly in personal and car loans at a time when the UK consumer is under increasing financial pressure. Although we are fairly sanguine about bank regulation overall, we believe Lloyds could be affected by further changes as its mortgage book is currently considered as very low risk. New regulation may demand more capital is held against this book and consequently reduce dividend expectations for the company.

The portfolio retains a significant weighting towards the UK consumer, mostly through holdings in banks, retailers, travel and leisure companies and builder’s merchants. Many UK consumer focused companies are finding trading conditions tough and as Brexit is negotiated there is a clear risk of further deterioration. However, valuations and performance of these stocks reflect a lot of bad news particularly when compared with other areas of the market. We retain some dry powder as absolute valuations remain rather high for our taste. Within the consumer sector

we increased our holding in US jewellery retailer Signet and clothing retailer Next although we did sell our holdings in Best Buy (it having recovered from some self-induced woes) and Sainsbury (our hypothesis of weakness in the discounter market did not play out as expected).

Dividend

A first quarterly dividend of 8.33p per share was paid on 30 June 2017 and the directors have declared a second interim dividend, also of 8.33p per share, an increase of 3%, to be paid on 29 September 2017 to those shareholders on the register of members as at 8 September 2017. The ex-dividend date for this payment is 7 September 2017.

Outlook

The changes underway in central bank attitudes and actions, after nearly a decade of ultra-accommodative policies, may well unsettle markets, leading to a re-appraisal of valuation criteria and enhanced volatility. In such an environment, where predictions become unreliable, strict adherence to our value investing approach becomes more important than ever. The general performance of the value investing style, compared with alternatives, hinges critically on an increase in interest rates towards more historical levels of normalcy.

By order of the Board

Investec Fund Managers Limited

24 July 2017

TWENTY LARGEST HOLDINGS AS AT 30 JUNE 2017

Company	Industry	Place of Primary Listing	Valuation £’000	% of Portfolio
UK Treasury 1.00% 2017	Fixed Interest	UK	139,214	14.11%
HSBC Holdings	Financials	UK	81,451	8.25%
GlaxoSmithKline	Healthcare	UK	68,531	6.95%
Grafton Group	Industrials	UK	52,944	5.37%
Royal Dutch Shell	Oil & Gas	UK	51,884	5.26%
Barclays	Financials	UK	46,527	4.71%
BP	Oil & Gas	UK	44,560	4.52%
SIG	Industrials	UK	38,286	3.88%
Royal Bank of Scotland	Financials	UK	30,468	3.09%
WM Morrison Supermarkets	Consumer Services	UK	28,715	2.91%
Top Ten Investments			582,580	59.05%
CitiGroup	Financials	USA	24,838	2.52%
Marks & Spencer	Consumer Services	UK	22,400	2.27%
Tesco	Consumer Services	UK	21,808	2.21%
ETFS Physical Silver	Physical Gold and Silver	UK	20,257	2.05%
Travis Perkins	Industrials	UK	19,692	2.00%
Signet Jewelers	Consumer Services	USA	18,705	1.90%
Centrica	Utilities	UK	17,769	1.80%
CRH	Industrials	UK	17,491	1.77%
Global X Silver Miners ETF	Basic Materials	USA	17,383	1.76%
Direct Line Insurance	Financials	UK	16,586	1.68%
Top Twenty Investments			779,509	79.01%

STATEMENT OF COMPREHENSIVE INCOME FOR THE SIX MONTHS ENDED 30 JUNE 2017 (unaudited)

		30 June 2017 (unaudited)			30 June 2016  (unaudited)			31 December 2016  (audited)
		Revenue £’000	Capital £’000	Total £’000	Revenue £’000	Capital £’000	Total £’000	Revenue £’000	Capital £’000	Total £’000
Investment income		18,985	-	18,985	18,969	-	18,969	34,069	-	34,069
Other operating income		4	-	4	4	-	4	5	-	5
Total Income		18,989	-	18,989	18,973	-	18,973	34,074	-	34,074
Gains on investments
Gains on investments held at fair value through profit or loss assets		-	17,767	17,767	-	14,550	14,550	-	128,792	128,792
		18,989	17,767	36,756	18,973	14,550	33,523	34,074	128,792	162,866
Expenses
Management fees		(699)	(1,048)	(1,747)	(596)	(893)	(1,489)	(1,380)	(1,990)	(3,370)
Other expenses including dealing costs		(353)	(511)	(864)	(344)	(609)	(953)	(633)	(1,039)	(1,672)
Profit before finance costs and tax		17,937	16,208	34,145	18,033	13,048	31,081	32,061	125,763	157,824
Finance costs		(1,308)	(1,980)	(3,288)	(1,311)	(1,992)	(3,303)	(2,645)	(4,012)	(6,657)
Profit before tax		16,629	14,228	30,857	16,722	11,056	27,778	29,416	121,751	151,167
Tax		(108)	-	(108)	-	-	-	(163)	-	(163)
Profit for the period		16,521	14,228	30,749	16,722	11,056	27,778	29,253	121,751	151,004
Earnings per share (basic and diluted)		24.71p	21.28p	45.99p	25.01p	16.53p	41.54p	43.74p	182.06p	225.80p

A first interim dividend of 8.33 pence per share in respect of the quarter ended 31 March 2017 was paid on 30 June 2017.

A second interim dividend of 8.33 pence per share in respect of the quarter ended 30 June 2017 was declared on 24 July 2017 and is payable on 29 September 2017. 

The total column of this statement represents the Statement of Comprehensive Income, prepared in accordance with IFRS. The supplementary revenue and capital columns are both prepared under guidance published by the Association of Investment Companies.

All items in the above statement derive from continuing operations.

STATEMENT OF CHANGES IN EQUITY FOR THE SIX MONTHS ENDED 30 JUNE 2017 (unaudited)

	Ordinary share	Share premium	Capital	Retained	Total
	capital	account	reserves	earnings	equity
	£’000	£’000	£’000	£’000	£’000
BALANCE AT 1 JANUARY 2017	16,719	96,040	735,178	32,003	879,940
Profit for the period	-	-	14,228	16,521	30,749
Unclaimed dividends	-	-	-	11	11
Dividends paid to equity shareholders		-		(16,390)	(16,390)
BALANCE AT 30 JUNE 2017	16,719	96,040	749,406	32,145	894,310

STATEMENT OF CHANGES IN EQUITY FOR THE SIX MONTHS ENDED 30 JUNE 2016 (unaudited)

	Ordinary share	Share premium	Capital	Retained	Total
	capital	account	reserves	earnings	equity
	£’000	£’000	£’000	£’000	£’000
BALANCE AT 1 JANUARY 2016	16,719	96,040	613,427	29,569	755,755
Profit for the period	-	-	11,056	16,722	27,778
Unclaimed dividends	-	-	-	24	24
Dividends paid to equity shareholders		-		(16,023)	(16,023)
BALANCE AT 30 JUNE 2016	16,719	96,040	624,483	30,292	767,534

STATEMENT OF FINANCIAL POSITION AS AT 30 JUNE 2017 (unaudited)

	30 June 2017 (unaudited) £’000	30 June 2016  (unaudited) £’000	31 December 2016  (audited) £’000
NON-CURRENT ASSETS
Investments held at fair value through profit or loss*	986,691	868,130	973,353
CURRENT ASSETS
Receivables	4,557	12,610	4,266
Cash and cash equivalents	18,108	6,303	17,340
	22,665	18,913	21,606
TOTAL ASSETS	1,009,356	887,043	994,959
CURRENT LIABILITIES
Interest bearing borrowings	(25,000)	-	(25,000)
Payables	(1,200)	(5,713)	(1,169)
TOTAL ASSETS LESS CURRENT LIABILITIES	983,156	881,330	968,790
NON-CURRENT LIABILITIES
Interest bearing borrowings	(88,846)	(113,796)	(88,850)
NET ASSETS	894,310	767,534	879,940
EQUITY ATTRIBUTABLE TO EQUITY HOLDERS
Ordinary share capital	16,719	16,719	16,719
Share premium	96,040	96,040	96,040
Capital reserves	749,406	624,483	735,178
Retained earnings	32,145	30,292	32,003
TOTAL EQUITY	894,310	767,534	879,940
NET ASSET VALUE PER SHARE	1,337,33p	1,147.75p	1,315.84p

*Includes £139.2 million UK Treasury holding considered by the Board to be held in lieu of cash.

STATEMENT OF CASH FLOWS FOR THE SIX MONTHS ENDED 30 JUNE 2017 (unaudited)

			30 June 2017		30 June 2016		31 December 2016
			(unaudited)		(unaudited)		(audited)
			£000		£000		£000
Cash flows from operating activities
Profit before tax			30,857		27,778		151,167
Adjustments for:
Gains on investments		(17,767)		(14,550)		(128,792)
Finance costs		3,288		3,303		6,657
Purchases of investments 1		(180,266)		(168,101)		(335,164)
Sales of investments 1		184,694		170,145		346,228
Dividend income		(18,306)		(18,373)		(32,841)
Interest income		(683)		(600)		(1,233)
Dividends received		16,525		16,452		32,078
Interest received		701		917		1,683
Decrease/(increase) in receivables		1,470		(8,284)		(1,231)
Increase in payables		30		4,639		95
Overseas withholding tax suffered		(108)		-		(163)
			(10,422)		(14,452)		(112,683)
Net cash flows from operating activities			20,435		13,326		38,484
Cash flows from financing activities
Unclaimed dividends			11		25		24
Interest paid on borrowings			(3,288)		(3,287)		(6,587)
Equity dividends paid			(16,390)		(16,023)		(26,843)
Net cash used in financing activities			(19,667)		(19,285)		(33,406)
Net increase/(decrease) in cash and cash equivalents			768		(5,959)		5,078
Cash and cash equivalents at the start of the period			17,340		12,262		12,262
Cash and cash equivalents at the end of the period			18,108		6,303		17,340

1. Purchases and sales of investments are considered to be operating activities of the Company, given its purpose, rather than investing activities.

RESPONSIBILITY STATEMENT

The Directors confirm to the best of their knowledge that:

• the condensed set of financial statements contained within the half-year report has been prepared in accordance with the Accounting Standards Board’s Statement ‘Half-Yearly Financial Reports’;

• the half yearly financial report includes a fair review of the information required by Disclosure and Transparency Rule 4.2.7R of important events that have occurred during the first six months of the financial year and their impact on the condensed set of financial statements and a description of the principal risks and uncertainties for the remaining six months of the financial year; and

• in accordance with Disclosure and Transparency Rule 4.2.8R there have been no related parties transactions during the six months to 30 June 2017 and therefore nothing to report on any material effect by such a transaction on the financial position or performance of the Company during that period.

The half-yearly financial report was approved by the Board on 24 July 2017 and the above responsibility statement was signed on its behalf by:

John Reeve
Chairman

Notes

1.         Comparative figures

            The financial information contained in this half-year report does not constitute statutory accounts as defined in section 434-436 of the Companies Act 2006.  The financial information for the six months ended 30 June 2017 and 30 June 2016 has not been audited.

            The information for the year ended 31 December 2016 does not constitute statutory accounts, but has been extracted from the latest published audited accounts, which have been filed with the Registrar of Companies.  The report of the auditors on those accounts contained no qualification or statement under section 498(2) or (3) of the Companies Act 2006.

2.         Publication

            This half-year report is being sent to shareholders and copies will be made available to the public at the Company’s registered office and on its website.

For further information please contact:
 

Alastair Mundy
Investec Fund Managers Limited             020 7597 2000