Aurora Investment Trust plc
Annual Report 31 December 2022
Company No. 03300814
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Annual Report Contents 1
Contents
Strategic
Report
Financial and Performance Highlights 3
Chair’s Statement 4
Investment Policy and Results
7
Top Holdings
11
Portfolio Analysis
12
Statement from the CIO of the Investment Manager 13
Investment Management Review and Outlook
14
Phoenix UK Fund Track Record 24
Report under Section 172 of the Companies Act 2006
26
Other Strategic Report Information
30
Governance
Directors, Investment Manager and Advisers 35
Directors’ Report 38
Corporate Governance Statement
45
Directors’ Remuneration Report
53
Statement of Directors’ Responsibilities 58
Audit Committee Report
60
Independent Auditor’s Report
64
Financial Statements
Income Statement 73
Statement of Financial Position
74
Statement of Changes in Equity 75
Cash Flow Statement
77
Notes to the Financial Statements 78
Alternative Performance Measures
97
Glossary 98
Notice of Meeting 100
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2 Annual Report Strategic Report
Strategic Report
2 Annual Report Strategic Report
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Strategic Report
Objective
To provide shareholders with long-term
returns through capital and income
growth by investing predominantly in
aportfolio of UK listed companies.
Policy
Phoenix Asset Management Partners
Limited (“Phoenix”) was appointed as
Investment Manager on 28 January 2016.
Phoenix currently seeks to achieve the
Company’s Objective by investing,
primarily, in a portfolio of UK listed
equities.
The portfolio will remain relatively
concentrated. The exact number of
individual holdings will vary over time but
typically the portfolio will consist of
15to20 holdings.
The Investment Policy of the Company
can be found on page 7.
Benchmark
Performance is benchmarked against the
FTSE All-Share Index (total return),
representing the overall UK market.
Dividend
The Board proposes to pay a final
dividend of 2.97p per ordinary share
(2021: 1.84p) to be paid on 4 July 2023 to
shareholders who appear on the register
as at 9 June 2023, with an ex-dividend
date of 8 June 2023.
Annual General Meeting (“AGM”)
The AGM of the Company will be held at
25 Southampton Buildings, London
WC2A1AL on 27 June 2023 at 2 p.m.
There will be no Investment Manager
presentation at the AGM. Instead, there
will be a separate Investment Manager
presentation and Q&A event at 4 p.m. on
10 October 2023 at the Queen Elizabeth II
Centre, Broad Sanctuary, Westminster,
London SW1P 3EE.
Financial and
Performance
Highlights
The chart above shows the Company’s NAV performance (total return) compared to the FTSE All-Share Index
(total return) since Phoenix became the Investment Manager.
Performance
FTSE All-Share Index
Aurora Net asset value (NAV) per Ordinary Share
80
90
100
110
120
130
140
150
160
170
180
Dec-2022Jan-2022Jan-2021Jan-2020Jan-2019Jan-2018Jan-2017Jan-2016
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4 Annual Report Strategic Report continued
This is my first statement as Chair of your Company, since I succeeded Lord Howard
Flight on 28 June 2022. I would like to thank Lord Flight and The Honourable James
Nelson for their service to the Company during their tenure, following their retirement
at last year’s AGM.
Performance
2022 was a difficult year, with concerns over inflation and the war in Ukraine causing
significant market turbulence. The Company’s Net Asset Value (“NAV”) Total Return*
for the year ended 31 December 2022, on a non-IFRS basis, was –17.4% (2021:
+17.1%) and the share price total return* was –16.3% (2021: +13.5%). Over the same
period the Company’s benchmark FTSE All-Share Index (total return) increased by
0.3% (2021: 18.3%), predominantly due to the c.25% weighting in energy and mining
stocks which performed strongly after the Russian invasion. The Mid Cap index is less
exposed to those sectors, and saw a fall of 20% for the year.
The strongest contributor to the Company’s performance was the inflation hedge, put
in place in 2021 and sold early in 2022, while the weakest contributor was Barratt
Developments, where the proceeds from the inflation hedge were invested. We
recognise that this was a disappointing performance for shareholders, but
concentrated portfolios of undervalued holdings are not immune to short or medium
term market volatility. The Board remains confident that the investment approach
followed by the Investment Manager will lead to long term outperformance for
shareholders.
Your Investment Manager, Phoenix Asset Management Partners Limited (“Phoenix”),
has provided a full description of the development and financial performance of the
portfolio over the year in the Investment Manager’s Review on pages 14 to 23.
The Investment Manager and Performance Fees
2022 was the seventh year of Phoenix’s management of the Company’s portfolio,
which began in January 2016. Throughout that time, Phoenix continued to employ
afocused and patient investment approach.
Phoenix receives no annual management fee, which is a unique aspect of the
Company. Instead it is solely remunerated from an annual performance fee, equal to
one third of the outperformance of the Company’s NAV against its benchmark, the
FTSE All-Share Index (total return).
The performance fee is paid by issuance of the Company’s ordinary shares, which are
subject to a fixed three-year clawback period. That means the issued shares will be
returned by the Investment Manager in the event that any outperformance versus the
index reverses on the third-year anniversary. If outperformance fully reverses, the
Investment Manager will receive nothing.
In the years ending 2019, 2020 and 2021 the Investment Manager was awarded
shares in settlement of a performance fee.
In 2022, instead of paying a performance fee, the Company clawed back 530,311
shares from Phoenix, which were delivered to the Company and held in Treasury at
the year end, but cancelled shortly after on 9 January 2023.
Chair’s
Statement
Lucy Walker
Chair
20 April 2023
*Alternative Performance Measure (see page 97).
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Strategic Report
Chair’s
Statement
Continued
Following this cancellation, the Company’s issued share capital is now 76,078,460
ordinary shares of 25p, each carrying one voting right. The Company does not hold any
ordinary shares in Treasury.
Share Premium/Discount
During 2022 the Company saw the discount of its share price to the underlying
NAVper share narrow from 7.6% at the end of 2021 to 4.4% at the end of 2022.
Onoccasions during the year, the shares traded at a small premium.
Closing the discount is one of the Board’s key objectives for 2023, and marketing
activities are considered a key part of the strategy. Phoenix along with Liberum, the
Company’s broker, and Frostrow Capital as investor relations and marketing adviser
continue to promote the Company proactively.
To assist with management of the discount and the liquidity of the Company’s shares,
resolutions to renew the Board’s powers to issue and buy back shares are included in
the Notice of Annual General Meeting beginning on page 100.
Growth of the Company
Growing the Company remains another key objective of the Board, with a
medium-term target of £250 million. This objective was set back during the year, with
the market capitalisation falling from £179 million in January 2022, to £148 million at
the year end. The only shares issued in the year were issued to Phoenix in relation to
the 2021 performance fee. Growing the company will only be possible with the
Company’s shares trading at a premium to NAV per share, and therefore the first
objective is to close the discount.
Annual General Meeting (“AGM”) and separate Investment Manager
presentation event
Historically the AGM included a presentation from the Investment Manager, however
this year the Board is instead introducing an Aurora Investor Event to be held at 4 p.m.
on 10 October 2023 at the Queen Elizabeth II Centre, Broad Sanctuary, Westminster,
London SW1P 3EE. This event is intended to be of interest to both existing and
prospective Aurora shareholders and will include multiple speakers from the
Investment Manager. It is intended for this event to be recorded and made available
afterwards on the Company’s website.
This year’s AGM will be held at the Company’s registered office, 25 Southampton
Buildings, London WC2A 1AL, on 27 June 2023 at 2 p.m. to consider the business set
out in the Notice of Meeting on pages 101 and 102, and will not include an Investment
Manager presentation.
With respect to the AGM, the Board strongly encourages shareholders to register
their votes online in advance of the meeting by visiting www.signalshares.com and
following the instructions on the site. Appointing a proxy online will not restrict
shareholders from attending the meeting in person should they wish to do so and will
ensure their votes are counted if they are not able to attend. Shareholders are invited
to send any questions they may have to the Company Secretary by email to
info@frostrow.com ahead of the meeting.
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6 Annual Report Strategic Report continued
The Board
As mentioned above, Lord Flight and The Honourable James Nelson retired from the
Board at the 2022 AGM. Two new non-executive Directors, Farah Buckley and Helen
Vaughan, were appointed on 8 September 2022. Unfortunately it was necessary for
Helen Vaughan to resign her appointment in February 2023 due to a conflict of interest
that arose post appointment. In line with other investment companies of a similar size
and taking into account the mix of skills and experience of the existing Board
members, the Board has decided not to recruit a fifth member for the time being.
Farah Buckley’s biography is set out on page 36.
Following these changes, Farah Buckley serves as Chair of the Audit Committee and
Lady Rachael Robathan chairs the Management Engagement Committee and the
Nomination & Remuneration Committee.
David Stevenson now represents the Company on the Board of Castelnau Group
Limited (“Castelnau”). This directorship is in the interest of the Company since it
provides access to, and a deeper understanding of, the Company’s investment in
Castelnau. As a result, the Board continues to consider David Stevenson as
independent.
Administration
2022 was a busy year administratively, with changes of Auditor (now BDO LLP),
Administrator and Company Secretary (now Frostrow Capital LLP) and Depositary and
Custodian (now Northern Trust Investor Services Ltd). The Board thanks our new
service providers for a smooth transition. Further information is included in the
Directors’ Report.
Dividend
The Board is recommending a final dividend of 2.97p (2021: 1.84p) per ordinary share,
to be paid on 4 July 2023 to shareholders who appear on the register as at 9 June
2023. The ex-dividend date is 8 June 2023. This dividend will be proposed at the
forthcoming AGM to be held on 27 June 2023. The Company’s dividend policy, which
is to distribute substantially all net revenue proceeds, remains unchanged and can be
found on page 7 of this Annual Report.
Outlook
Whilst Phoenix’s approach was not rewarded in 2022, market turbulence provides
opportunity. The portfolio was rotated into more attractive names, and in some cases,
companies that had been patiently followed for over a decade. These times, whilst
painful in the short run, are what provide foundations for a strong return in the long
run. Performance from the beginning of 2023 to the end of March saw the NAV return
+14.4% vs. the index +3.1%, demonstrating the potential for significant performance.
Lucy Walker
Chair
20 April 2023
Chair’s
Statement
Continued
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Strategic Report
The Company seeks to achieve its investment objective by investing predominantly in
a portfolio of UK listed companies. The Company may from time to time also invest in
companies listed outside the UK and unlisted securities. The investment policy is
subject to the following restrictions, all of which are at the time of investment:
• The maximum permitted investment in companies listed outside the UK at cost
price is 20% of the Company’s gross assets;
• The maximum permitted investment in unlisted securities at cost price is 10% of
the Company’s gross assets;
• There are no pre-defined maximum or minimum sector exposure levels but these
sector exposures are reported to and monitored by the Board in order to ensure
that adequate diversification is achieved;
• The Company’s policy is not to invest more than 15% of its gross assets in any one
underlying issuer (measured at the time of investment) including in respect of any
indirect exposure through Castelnau Group Limited (“Castelnau”);
• The Company may from time to time invest in other UK listed investment
companies, but the Company will not invest more than 10% in aggregate of the
gross assets of the Company in other listed closed-ended investment funds; and
• Save for Castelnau Group Limited, the Company will not invest in any other fund
managed by the Investment Manager.
While there is a comparable index for the purposes of measuring performance over
material periods, no attention is paid to the composition of this index when
constructing the portfolio and the composition of the portfolio is likely to vary
substantially from that of the index. The portfolio will be relatively concentrated. The
exact number of individual holdings will vary over time but typically the portfolio will
consist of holdings in 15 to 20 companies. The Company may use derivatives and
similar instruments for the purposes of capital preservation.
The Company does not currently intend to use gearing. However, if the Board did
decide to utilise gearing the aggregate borrowings of the company would be restricted
to 30% of the aggregate of the paid-up nominal capital plus the capital and revenue
reserves.
Any material change to the investment policy of the Company will only be made with
the approval of shareholders at a general meeting. In the event of a breach of the
Company’s investment policy, the Directors will announce through a Regulatory
Information Service the actions which will be taken to rectify the breach.
Dividend Policy
The Company does not have a fixed dividend policy. However, the Board expects to
distribute substantially all of the net revenue arising from the investment portfolio.
Accordingly, the Company is expected to pay an annual dividend that may vary each
year.
Borrowing Policy
The Company is not prohibited from incurring borrowings for working capital purposes,
however the Board has no current intention to utilise borrowings. Whilst the use of
borrowings should enhance the total return on the ordinary shares where the return
on the Company’s underlying assets is rising and exceeds the cost of borrowing, it will
Investment
policy and
results
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8 Annual Report Strategic Report continued
have the opposite effect where the underlying return is falling, further reducing the
total return on the ordinary shares. As a result, the use of borrowings by the Company
may increase the volatility of the NAV per Ordinary Share.
The Company has a policy not to invest more than 10% of its gross assets in other UK
listed investment companies. As a consequence of its investments, the Company may
therefore itself be indirectly exposed to gearing through the borrowings from time to
time of these underlying investment companies.
Purpose and Key Performance Indicators (“KPI’s”)
The Company’s purpose is encapsulated in its investment objective, which is to
provide shareholders with long-term returns through capital and income growth by
investing predominantly in a portfolio of UK listed companies. The Board measures the
Company’s success in attaining its objective by reference to KPIs as follows:
a. To make an absolute total return for shareholders on a long-term basis;
b. The Company’s Benchmark is the FTSE All-Share Index (total return), against which
the NAV total return is compared. After achieving the goal of making absolute
returns for shareholders, the next aim is to provide a better return from the
portfolio than from the market as measured by the Benchmark;
c. The Board seeks to ensure that the operating expenses of running the Company
as a proportion of NAV (the Ongoing Charges Ratio) are kept to a minimum; and
d. The discount/premium to NAV per share at which the Company’s shares trade is
also closely monitored in view of its effect on shareholder returns.
The Chair’s Statement on pages 4 to 6 incorporates a review of the highlights during
the year.
The Investment Management Review and Outlook on pages 14 to 23 gives details on
investments made during the year and how performance has been achieved.
Performance (KPIs a and b)
The Company’s performance in absolute terms and relative to the FTSE All-Share
Index (total return) benchmark since Phoenix was appointed as Investment Manager in
2016 is shown below:
Cumulative
since Year to Year to
28 January 2016 31 December 31 December
to 31 December 2022 2022 2021
% % %
NAV per Ordinary Share (total return)
1
43.2 (17.4) 17.1
Ordinary Share price (total return)
1
38.1 (16.3) 13.5
Benchmark (total return) 61.0 0.3 18.3
1
Alternative Performance Measures (“APMs”).
Ongoing charges (KPI c)
Phoenix does not earn an ongoing annual management fee, but instead is paid an
annual performance fee, only if the benchmark is outperformed, equal to one third of
Investment
policy and
results
Continued
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Strategic Report
the outperformance of the Company’s NAV against its FTSE All-Share Index (total
return) benchmark.
The Board monitors the Company’s other operating costs carefully. Based on the
Company’s average net assets for the year ended 31 December 2022, the Company’s
ongoing charges figure calculated in accordance with the Association of Investment
Companies (“AIC”) methodology was 0.45% (2021: 0.49%). Expenses are managed
with the intention of keeping costs down and as the size of the Company grows the
ongoing charge ratio should be expected to reduce.
Discount to NAV (KPI d)
The discount of the ordinary share price to the NAV per Ordinary Share is closely
monitored by the Board. The ordinary share price closed at a 4.4% discount to the
NAV per Ordinary Share as at 31 December 2022 (2021: 7.6% discount). During the
year ended 31 December 2022, the Company’s shares traded between a premium of
1.6% and a discount of 13.6% to NAV per share, with an average discount of 5.4%.
Revenue Result and Dividend
The Company’s revenue income after tax for the year ended 31 December 2022
showed improvement towards pre-COVID levels, at £2,263,000 (2021: £1,413,000).
The Board is recommending the payment of a final dividend of 2.97p per ordinary
share (2021: 1.84p per ordinary share). This dividend, if approved by shareholders, will
be paid on 4July 2023 to shareholders on the register as at 9 June 2023; the ordinary
shares will be marked ex-dividend on 8 June 2023. Inaccordance with International
Financial Reporting Standards this dividend is not reflected in the financial statements
for the year ended 31 December 2022.
Five Year Summary
Year end
Published Dividend per Year end
NAV per Ordinary Share in Ordinary Share
Ordinary Share respect of the year price (mid-market)
Year (pence)
1
(pence) (pence)
Year ended 31 December 2018 182.24 4.00 183.00
Year ended 31 December 2019 232.07 4.50 237.00
Year ended 31 December 2020 213.39 0.55 207.00
Year ended 31 December 2021 253.49 1.84 234.50
Year ended 31 December 2022 203.45 2.97 194.50
Investment
policy and
results
Continued
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10 Annual Report Strategic Report continued
Investment
policy and
results
Continued
Net Asset Value per Ordinary Share
The table below is a reconciliation between the NAV per Ordinary Share as at
31December 2022 announced on the London Stock Exchange on 3 January 2023 and
the NAV per Ordinary Share disclosed in these financial statements. The difference is
principally the result of amortising performance fees over the vesting period in
accordance with IFRS 2 - Share-based Payment, in these financial statements,
whereas the NAV as at 31 December 2022 published on 3January 2023 treated the
performance fees as earned on 31December 2022, in accordance with the
investment management agreement. The remaining reconciling balances related to
adjustment of the unquoted investment valuation and expenses, due to timing lag.
NAV per
NAV share
£’000 p
NAV as published on 3 January 2023 157,967 207.64
Reversal of performance fee clawback accounted for under
non-IFRS 2 approach
(4,240) (5.57)
Add back performance fee clawback accounted for under
IFRS 2
1,385 1.82
Year end adjustments on unquoted investment valuation
and expenses
(334) (0.44)
NAV as disclosed in these financial statements 154,778 203.45
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Strategic Report
Date Average
Holding Percentage of first cost per Share Market
Company Sector in Company Valuation of net assets purchase share* price capitalisation
£’000 % Million
Frasers Group plc Retail 5,114,011 36,309 23.5 Jan-16 £3.07 £7.10 £3.390
Barratt Developments plc Construction 5,866,312 23,278 15.0 Nov-18 £4.87 £3.97 £3,957
Castelnau Group Limited# Financial 24,563,184 16,212 10.5 Oct-21 £1.00 £0.66 £127
Ryanair Holdings Plc Leisure 928,600 10,060 6.5 May-19 €8.34 €12.21 €13,903
easyJet Plc Leisure 2,975,768 9,659 6.2 Sep-16 £6.86 £3.25 £2,461
Lloyds Banking Group plc Financial 19,618,000 8,909 5.8 Jan-16 £0.62 £0.45 £30,551
Netflix Inc Technology &
Entertainment 33,500 8,212 5.3 Apr-22 $164.00 $294.86 $129,554
Hotel Chocolat Group plc Food &
Beverage 3,876,800 5,932 3.8 Jul-22 £1.33 £1.53 £214
Bellway Plc Construction 306,940 5,855 3.8 Jan-16 £21.47 £19.08 £2,356
RHI Magnesita N.V. Materials 260,970 5,757 3.7 Jan-20 £33.55 £22.06 £1,046
Other holdings (less than 3%) 19,045 12.3
Total holdings
149,226 96.4
Other current assets
5,552 3.6
Net assets
154,778 100.0
* Average net cost including sales.
# Castelnau is a multi-sector financial holding company, listed on the Specialist Fund Segment of the London Stock Exchange. Castelnau is also managed by Phoenix
and its value is excluded from the Company’s net assets when calculating performance fees earned by Phoenix to avoid double charging.
Top Holdings
as at 31 December 2022
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Portfolio Analysis
as at 31 December 2022
Percentage of Net
Sector Assets
%
Retail 23.5
Financial* 20.8
Construction 19.4
Leisure 15.6
Technology & Entertainment 5.3
Food & Beverage 4.3
Materials 3.7
Industrials 2.1
Insurance 1.7
Other current assets and liabilities 3.6
Total 100.0
* Castelnau is included in the Financial classification as it is a multi-sector financial holding company.
23.5
20.8
19.4
15.6
5.3
4.3
1.7
3.7
2.1
3.6
Other current assets
and liabilities
Insurance
Industrials
Materials
Food & Beverage
Retail
Financial
Construction
Leisure
Technology &
Entertainment
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2022 was the year that the clawback process did its work and reversed the
performance fee earned in 2019. Although I imagine you appreciate the fairness of this
act, I know you would have preferred that we delivered the performance instead. 2022
was a difficult year for our portfolio to outperform with outsized gains in the energy
sector triggered by the war, but those effects will wear off in time and the extreme
under valuation of the portfolio should result in the sort of outperformance that is
deserving of performance fees.
Instead of a portfolio that trades at intrinsic value and a great run of recent
performance that would lead you to think you had the right people looking after your
money we instead have for you a portfolio trading at 40% of what we think it is worth
and ask for your patience which we believe will be well rewarded in future
performance.
The UK market seems to be getting incrementally cheaper with each wave of
negativity that has hit since Brexit. History tells us that these effects are transitory
even if they can persist for long periods of time. We had negative interest rates for so
long that some thought they would be here forever, and the UK has been cheap for so
long now that you hear some who think it is also going to be a permanent attribute.
We don’t profess to make forecasts about the near term however we do expect
fundamentals to reassert themselves in the long run and the wonderful value that we
are accumulating in these times of cheapness will turn into the sort of excellent
long-term returns that make this approach to investing so worthwhile.
Gary Channon
Chief Investment Officer
Phoenix Asset Management Partners
20 April 2023
Statement from
the Chief
Investment
Officer of the
Investment
Manager
Gary Channon
Chief Investment Officer Phoenix
Asset Management Partners
20 April 2023
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14 Annual Report Strategic Report continued
During the year, the NAV per share fell by 17.4% and the share price by 16.3%. The
FTSE All-Share Index rose by 0.3% over the same period. Since Phoenix began
managing the Company’s portfolio on 27 January 2016 to 31 December 2022, the
Company’s NAV per share total return was 43.2% versus 61.0% for the FTSE All-Share
Index. Net assets at year-end were £158million (2021: £194 million).
The underperformance in 2022 ensured that no performance fee was payable. As a
reminder, if a performance fee is payable, it is paid by way of the issuance of ordinary
shares, which are subject to a fixed three-year clawback period. If the outperformance
versus the index reverses on the third-year anniversary, some or all the issued shares
will be returned, and if outperformance fully reverses, Phoenix will receive nothing.
On 31 December 2022, a clawback test for the year ending 31 December 2019 was
carried out and, due to underperformance in 2022, the clawback was triggered in full.
The 530,311 shares awarded to Phoenix for the 2019 fee have been returned to the
Company and the NAV per share increased by 1.66p as a result.
Following a review and dialogue with advisers, prompted by ourselves and the Board,
we agreed that accounting for the clawback in the daily NAVs better represents the
economic impact of the clawback and is more informative to investors.
The impact of the fully clawed back 2019 fee and the 2020 & 2021 fees, which would
be clawed back if the underperformance as at 31 December 2022 continued, but
which have yet to be subject to the final three-year clawback test, was to increase the
NAV by 5.44p per share in total.
2023 has started positively as the market looks towards inflation, and therefore
interest rates, falling. As of 28 February 2023, the NAV has risen 16.8% for the year,
with the FTSE All-Share Index rising 6.1%.
Performance Review
From a performance perspective, 2022 was dominated by concerns over higher
inflation and the impact of higher interest rates. The war in Ukraine was also a
significant factor as it led to an increase in commodity prices, which added to the
existing inflationary forces.
The first half of the year saw falls across the portfolio, with the NAV down 16.6%
versus 4.6% for the benchmark at 30 June 2022.
The year ended slightly weaker with the portfolio down 17.4% whilst the Index
recovered to end the year up 0.3%. Within the second half of the year, Q3 was weak
as the NAV fell a further 9.7% before a 9.5% recovery in Q4.
It has been a tough year in which to beat the UK indices. The main UK indices have,
unusually (from a global perspective), returned a positive performance in 2022, largely
owing to the weighting in energy and miners, whose prices jumped in response to the
elevated profit opportunity that followed Russia’s invasion of Ukraine. Between them,
those sectors make up c.25% of the market and they are up 42% and 23%
respectively in 2022. We do not have any ownership in those areas.
The Mid Cap Index, which has a lower exposure to those sectors and is more
domestically focused, fell 20% in the year.
The 17.4% decline in Aurora was after a positive 6.5% contribution from a hedge
against inflation, through put options on a short sterling future contract, which was
disclosed in detail in the Company’s last annual report. The biggest contributor to our
decline was Barratt Developments where we re-invested the proceeds of that
Investment
Management
Review and
Outlook
Steve Tatters
Director
Phoenix Asset Management
Partners
20 April 2023
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hedge, it was down 41% in 2022, which results in a –5.4% effect on the return.
Castelnau Group contributed a –4.3% effect after it declined by 35%.
The other stocks to make negative contributions of over 2% were Randall & Quilter
and easyJet, which were down 3% and 2.8% respectively.
Last year’s biggest riser, Frasers Group, the Company’s biggest holding, fell 8% in
2022 (having risen 71% in 2021). When combined with its large weight, this had a
–1.5% effect on the Company for the year.
The best performer in the portfolio in 2022 was Netflix, rising 50% from when we
purchased it and making a +1.3% contribution to the overall performance.
Activity Review
In the June 2022 monthly factsheet, we highlighted the valuation opportunities
afforded by the fall in the NAV during the half year. This piece was titled “Christmas in
Valueland”.
Please refer to the June factsheet on our website for the full details, but it highlighted
the counter intuitive thinking of value investors as bad fundamental news can often
provide good investment opportunities. The essence of “Valueland” is the ability to
buy the future for less, and it follows that the less you pay the higher the return you
will enjoy in the future.
Those “Valueland” type opportunities persisted for much of the year and even after
recent positive performance valuations remain at an historically attractive level.
We took advantage of the opportunity set and instigated four new holdings. We
reported in detail during the year on two; AO World and Netflix, a third, Hotel
Chocolat recently went over 3% and we will be formally introducing it in the next
monthly factsheet. A fourth, Wayfair, remains below our 3% disclosure level and will
be introduced when it exceeds that 3% threshold.
The investments in Netflix and Wayfair are outside our historic focus on UK listed
equities, but if they sit within our circle of competence, they are investable, and the
Company’s mandate allows up to 20% of the portfolio to consist of non-UK holdings.
Ryanair for example is another member of the portfolio from outside the UK. When we
stray outside of the UK, it is to multinational businesses where we think we bring
some initial knowledge and insight. Unilever is listed in the UK and Proctor & Gamble
in the US, but the expertise required to understand one is highly applicable to the
other.
The rationale behind the purchase of Netflix was also outlined in the June factsheet,
and it is repeated below:
Rather than cover the story of Netflix, which you probably know and has been covered
well elsewhere, including in founder Reed Hasting’s book collaboration with Erin
Meyer called “No Rules Rule”, which is written up in the Phoenix Reading Room, we
thought we should explain why we have invested in it.
Long-term holders will remember that we have owned media production broadcast
businesses before, initially Carlton Communications and then, following its merger
with Granada, ITV. At the time of that merger in 2003 the competition and media
regulators decided that ITV would have too much power, and so restricted their ability
to change their business and capped their prices and advertiser contracts at 2003
levels. This hobbled them in a changing world. They tried something called ITV Digital,
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Review and
Outlook
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which was a failure, but even in 2008 when this was reviewed by Ofcom, they were
still thought to need restrictions. In that report streaming, though mentioned, was not
expected to be significant. What they called Broadband TV, or internet TV, was held
back because only two thirds of households had access to the internet at the time.
The internet itself was underestimated because they said it didn’t allow the same
ability to target audiences the way broadcast TV did.
We sold our ITV and our WPP viewing that the world was changing fast in a way that
undermined both those businesses. All this time later, ITV trades 40% below where
we sold it and whenever we have reconsidered it as an investment, for example in
2018 when Carolyn McCall moved there from easyJet, the fear of Netflix has
undermined its attractiveness. A show like The Crown would have been a natural for
ITV before the emergence of Netflix.
Now, 43% of UK households subscribe to Netflix, streaming services are in 59% of
households and Netflix dominates the Top 10 list of most enjoyed titles watched
according to Kantar. ITV finally got together with the BBC, and in 2017 created
something called BritBox to compete. Currently Netflix has 100 times more
subscribers.
What has been playing out in the UK has been going on everywhere at different paces
and in different ways. Streaming is a superior way of receiving media content.
Toyoung people who have grown up with it, the idea of scheduled linear timed
broadcasting is quaint, anachronistic, and not the way they tend to consume media
unless it’s a live broadcast. Around 300 million households around the world now
utilise a streaming service and we think over the next 10 years that could grow to
arange of numbers averaging about 1 billion. Netflix, as the first and biggest, we
expect to lose share as others get up and running, but they will have a smaller share
of a much bigger market. Their growth trajectory will be different to newcomers
because they have reached points of deep penetration in many markets. The
pandemic has distorted numbers and made trends harder to discern, but it seems
reasonable to assume that lockdown had a positive impact upon them and so the end
of lockdown should be negative. They entered the lockdown with 167m subscribers
and have emerged with 220m. Netflix is not just the UK’s no.1; it is the World’s.
Whilst many focus on Netflix versus Disney, we think the real pain points will be with
the likes of ITV and their ilk around the world.
Netflix has built this business whilst charging for it. ITV is free. ITV doesn’t have churn
numbers because it is free, and advertisers pay for it. This dynamic gives Netflix a
great opportunity to vary its business model to reduce subscription price as a point of
friction. Netflix is already the streaming service that consumers say is their favourite
and would be the last one they cancel. As Netflix experiments with the advertiser
funded model that has served Google, YouTube, Facebook and most of the world’s
commercial broadcasters well, we believe it will increase its competitive advantage.
Netflix has a founder led culture that is always adapting and evolving, using trial and
error combined with a good understanding of data to develop. We see this in many
successful businesses and so when we consider the management team and culture
at Netflix, we think it will outcompete its rivals.
There are many scenarios you can model at Netflix. Our base one gives a value of well
over $500, and our downside stress test comes out around $200. We have now
invested 3% of the portfolio at an average price of $211.49 and, given that it represents
a new area for us, we will restrict ourselves there until we believe we have developed
our expertise further. In the past, that cap has taken years not months to lift.
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Strategic Report
In January 2023, Phoenix Asset Management Partners, through Castelnau Group
Limited, launched an offer for Dignity PLC in conjunction with Sir Peter Wood. For full
details of that Offer, please refer to the Castelnau Group website
www.castelnaugroup.com.
Outlook
In the year-end factsheet for the Company published in January 2023, Gary Channon,
Phoenix CIO, outlined some thoughts to shareholders on inflation and the general
outlook for the year ahead. It is repeated below, as those thoughts remain relevant
today:
Inflation
Given the significant contribution of the inflation hedge to our recent performance, it is
worth commenting on our current thoughts and why we were happy to take it off and
not extend it.
There seems to be some general misunderstanding as to whether inflation is
controllable or not, which at times draws upon the 1970s as an example. However, it
is important when considering that period to understand that the prevailing view of
politicians and policy makers at the time was that inflation could not be controlled with
interest rates or money supply. The way in which governments sought to control
inflation was through government intervention in prices and wages.
In the UK we had the National Board for Prices and Incomes, which was set up in
1965 and through which the government attempted to impose controls on prices and
wages through direct legal constraint and coercion. Periods of wage freezes were
imposed, where no businesses could raise pay, followed by mandated pay rise levels
set by the government. This even extended to dividends. All these measures seem
unworkable today and they were even then. Much mental and legal resource was
spent trying to operate around them and huge misallocations of capital were caused
by those distortions, but their ultimate undoing was that they failed to work. Inflation
took off and labour represented by unions went on strike bringing the UK to a
standstill. (Plus ça change, plus c’est la même chose!)
Some lessons of history are learned because they result in a change that works, and
so it was with inflation. We learned that inflation could be controlled by the setting of
interest rates and paying attention to the money supply and that, even better, if you
gave this as a mandate to an independent central bank, then it would gain real
credibility in the pricing of long-term obligations from the government.
The lesson of history that you cannot control inflation by imposing below market wage
settlements looks like it is about to be relearned in the UK.
We were worried about inflation in 2021, because we saw the huge growth in money
supply caused by the pandemic interventions, which were funded by effectively
printing money. Because “quantitative easing”, as it became known, worked so well
in the Global Financial Crisis of 2008, it was assumed not to cause inflation. But the
big difference then was that the money printing occurred as the banking system
shrank and the overall effect on money supply was minimal. With COVID-19 there was
no offsetting shrinkage. To make matters worse, the interruption to the world trading
system that COVID-19 caused meant that supply could not respond to all the extra
money in the system and so price rises were the inevitable outcome.
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To throw fuel to the fire, the invasion of Ukraine, accompanied by a restriction on the
supply of Russian energy, caused a surge in oil and gas prices which quickly feeds into
all prices.
The key central banks all have a clear policy objective of controlling inflation, and this
hiccup has undermined their credibility, which they are acting quickly to regain. They
have the tools and there is no reason not to expect them to succeed. Money supply
has already stopped rising and has even been declining in the US for the first time in
decades. It is a reasonable assumption that long term inflation will be around the goals
set for central banks (UK is 2.0%), and that in focusing on restoring their credibility
they will tend towards undershooting that level.
2023 will be the year of transition and given the unsustainably elevated level of energy
prices (i.e. they are at such a high level that the excess profits incentivise increased
supply, whereas elevated prices reduce demand and incentivise alternatives), it is
highly possible that inflation could be negative before the year is out.
Once central banks can see the trajectory is on target, we will see where peak
interest rates are, and also whether a greater recession is needed, albeit that is the
ultimate effect of raising rates to restrain inflationary pressures.
Outlook
You know us better than to expect a forecast for 2023, but we do want to share a
thinking framework for someone with, or thinking of, making a long-term investment
in equities and then in particular with our investment philosophy.
For all the talk about inflation, interest rates and wars, the most important factor for
considering an investment in equities is the underlying economic miracle engine that
has been running now for some 300 years. Whatever you call it, industrialisation, or
capitalism, starting in the UK a force has been at work that has raised the productive
output of the world at a rate faster than population growth. In the previous 1,000 years
this did not happen.
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