MPS June Newsletter

The Information Technology (“tech”) sector was again a key driver of returns, particularly across US and emerging market equities which, alongside Asian markets, drove the headline index gains. Korean and Taiwan indices were among the strongest-performing markets over the month, supported by the significant representation of tech companies expected to benefit from rising artificial intelligence (AI)-related spending by the world’s largest (and largely US-based) businesses. This theme was reinforced during earnings season across US stocks, as the large cap tech companies highlighted continued investment across the AI supply chain. While NVIDIA’s much-anticipated earnings were met with a mixed market response, with the shares falling around 1% in the immediate aftermath, semiconductor stocks exhibited considerable strength over May.

Elsewhere, European equities performed well over the month, driven by a strong earnings season and the prospect of a peace deal in the Middle East providing favourable tailwinds. The UK delivered a small positive return, lagging other major markets due partly to the index’s lack of exposure to the AI-led technology theme, alongside its larger weighting to the Energy sector. Political developments have also shaped sentiment toward UK assets, with ongoing questions regarding Sir Keir Starmer’s leadership and the future direction of this government creating continued uncertainty. However, despite this overhang UK government bonds recouped some of their recent underperformance, with conventional gilts returning 2% as inflation data came in below expectations. Signs of a weaker domestic economy and a falling oil price also helped reduce the prospect of interest rate rises.

Strategy Returns & Activity

May saw positive returns across the MPS strategies. A robust earnings season benefited North American equity exposures, with the allocation to the tech sector driving headline returns. Sector allocations (e.g. being “overweight” semiconductors and semiconductor equipment / “underweight” Consumer Staples) proved positive. In contrast, from a security selection perspective a weak update from animal health company Zoetis impacted relative returns. Positive contributions were seen from the European, Asian and emerging market equity exposures, while the UK equity allocation returned 2%, ahead of the broader market. Towards the lower end of the risk spectrum, hedge and absolute return fund and fixed interest allocations were modestly additive to overall strategy returns.

During the month we implemented a rebalance of the MPS strategies. At the headline level we selectively:

• Increased exposure in favour of equities, most notably North America and emerging markets, as we look through to the resilient economic backdrop and earnings growth continuing to support risk assets.
• Increased the weighting to hedge fund strategies, seeing merit in adding to diversified sources of return less correlated to mainstream asset classes.
• Reduced fixed interest, being mindful of heightened volatility, renewed inflation concerns and a less supportive central bank environment.

Under the bonnet, and starting in the UK, we added to Glencore, bolstering our positive stance on UK Materials, with the company’s thermal coal assets and strong trading division both expected to benefit from current strained energy and commodity market dynamics. The remaining position in 3i Group was sold to fund this increase, ahead of the company’s most recent earnings update.

In the US, we initiated a new position in KLA Corporation. The company is a leading provider of process control and inspection equipment for semiconductor manufacturing, supplying tools that help chipmakers reduce defects as chip complexity increases. To fund this move, we sold our position in Intuit following disappointing quarterly results, which prompted a change in thesis as concerns regarding slowing growth, pressures from AI replacement in their core tax business, and uncertainty around reorganisation in their workforce raised doubts about the durability of their business model.

In contrast, we see KLA as offering more predictable growth, supported by strong industry trends in AI-driven semiconductor capital expenditure, a healthy recurring services business, and a leading market position. This move further reflects our preference for being “overweight” this segment of the tech sector across the strategies, at the expense of software companies.

In Europe, we increased the strategies’ position in world-leading photolithography systems supplier ASML, another key player in the semiconductor supply chain. We also added to the existing holding in Engie, the French utilities company initially bought in February. Engie announced late in that month that it had secured a deal to acquire UK Power Networks at a lower premium to that paid recently by peers, a move that will support its reliable growth forecasts. The company continues to trade at a discount to peers and offers an attractive dividend yield.

Lastly, in the alternative investment space we exited the remaining position in flexible office business Workspace Group. With weakening labour market indicators, and London employment now lagging the national average, not to mention the as-yet undetermined impact of AI on companies’ long-term hiring policies, we continue to see a diminished case for retaining material exposure to London offices.

Outlook

Developments in the Middle East appear to be moving in a more favourable direction, albeit it is important to highlight that the situation remains extremely fluid. A deal to reopen the Strait of Hormuz would help ease the drag on global growth, which has nevertheless remained resilient. Meanwhile, central banks remain cautious on the impact of higher energy prices continuing to feed into official inflation data, while we are also mindful of potential indirect effects across sectors should the Middle East situation remain in limbo.

To summarise, although outstanding risks lead us to closely monitor markets and the geopolitical and macroeconomic environment, we continue to position the MPS strategies to reflect a constructive outlook, with the corporate and economic backdrop remaining robust and opportunities presenting themselves across sectors. Stocks and bonds may have generated positive returns during May, but with both asset classes having their own individual drivers, coupled with an additional contribution from the alternative investment allocation, the benefits of diversification are alive and well. Indeed, portfolios diversified at asset class, geographic and sector levels continue to offer investors an attractive risk / return profile, especially when held for the longer term.