Market Review
Despite an uncertain backdrop, the UK market posted a positive return in the second quarter of over 4%, with most of the return coming in May following the announcement of a UK/US trade deal. The mid-cap index made a strong recovery following a discouraging Q1, outperforming the large-cap index by over 9%. Exposure of the larger, more international companies to US dollar earnings may have been a factor, as the currency weakened a further 6.5% against sterling over the quarter.
Almost all the UK sectors contributed positively to the market returns, with industrials, financials and consumer discretionary sectors leading the way. Only energy and healthcare dragged on the market.
Once again, Rolls Royce and BAE Systems were the main drivers behind the industrials and also overall market return. Positive market sentiment continued to drive Rolls Royce despite the business having in our view a very full valuation, as far-off prospects of building small modular reactors are being factored in at this early stage. For us, BAE, although also benefitting from positive market sentiment, is far easier to justify on valuation grounds. British American Tobacco and Barclays also provided useful contributions and both benefit from attractive valuations. At the other end of the spectrum, Astra Zeneca struggled with uncertainty about drug pricing policy in the USA. Shell and BP also detracted in response to oil price volatility as the conflict with Iran escalated.
Fund Activity
The fund produced a positive return but slightly underperformed the benchmark. Our overweight position in financials contributed positively relative to the benchmark as the banks offset a small negative contribution from other financial services and insurance, with Lloyds and Barclays driving returns. Our overweight position in utilities also lifted relative performance, with Drax and National Grid offering contributions.
From a more negative perspective, materials, industrials and healthcare were headwinds to relative performance. Materials suffered as Ibstock (the UK’s largest brick maker) disappointed the market as the company struggled to pass on cost increases and Smurfit Westrock (box and packaging maker) continued to suffer from the unsettled environment in its US business.
At a stock level Rolls Royce was yet again our largest negative contributor despite reducing our underweight position as it continued to rise strongly.
During the second quarter we added new holdings in RS Group, JD Sports and Rosebank Industries. RS is a value-added electronics supplier undergoing a turnaround in a difficult market. We think the valuation now more than reflects the current and likely future environment and offers very attractive medium-term prospects.
JD Sports has had well-publicised issues with poor communication, weak consumer spending in the US and the underperformance of Nike, its largest supplier. However, this is a global retailer that still makes attractive returns on its capital and is now at a valuation that, on balance, offers attractive returns for the risk.
Rosebank Industries was set up by a management team with an excellent track record in buying, improving and selling on businesses. We participated in its heavily discounted rights issue to purchase Electrical Components International, a design and manufacturer of large-scale electrical systems. We also gained a holding in the platinum business spun out of Anglo American (Valterra Platinum) which we subsequently sold for a small profit.
As mentioned above, we added to our holding of Rolls Royce, continuing the process of reducing the risk profile of the fund. We also increased our overweight in Glencore which has had a challenging H1 and should be benefitting from more robust commodity prices, copper in particular. We have been adding to betting group Entain as we think it is beginning to turn a corner after a long period of undermanagement, supported by a surprise positive trading statement and what we view as an attractive valuation.
Meanwhile, we took some profits in Autotrader prior to its disappointing update at the end of May, as well as BAE Systems, Barclays and Lloyds, and again trimmed our holding in Shell as the outlook for the oil price looked unfavourable.
Outlook
There remain many crosswinds in the UK and across the world. From conflict in Europe and the Middle East, through to the machinations of US tariffs, tax policy and interest rates and of course closer to home how the taxation policies of the government will play out in the real economy. During the quarter, evidence of effects on the UK economy began to emerge as we saw the number of payrolled employees fall, unemployment tick up, real wage growth slow and the savings ratio fall. That said, in the quarter consumer confidence ticked up to -18 from a 2025 low point of -23 at the end of April. Therefore, we are thinking more cautiously about the UK economy than we were at the beginning of Q2, and keeping a close eye on the data as it unfolds.
Important Information
Past performance is not a guide to future performance. The value of investments may fall as well as rise and investors may not get back the amount invested. Income from investments may fluctuate.
The views expressed in this document are those of the fund manager at the time of publication and should not be taken as advice, a forecast or a recommendation to buy or sell securities. These views are subject to change at any time without notice.
This document is issued for information only by Canada Life Asset Management. This document does not constitute a direct offer to anyone, or a solicitation by anyone, to subscribe for shares or buy units in fund(s). Subscription for shares and buying units in the fund(s) must only be made on the basis of the latest Prospectus and the Key Investor Information Document (KIID) available in the literature section.
