During the first two months of 2024, we saw huge outflows from UK All Companies – the IA’s second-largest category by funds under management – with the beleaguered peer group losing £1.5bn of net retail money.
In 2023, the sector was hit with redemptions during every single calendar month and total net retail outflows for the year reached £10.2bn. The category has now languished at the bottom of the sales rankings for two years in a row.
However, what is interesting about February’s stats is that rather than piling into short-term money market funds as was the preference last year, equity sectors are reigning supreme, with IA North America top of the rankings with net inflows of £770m, followed by £475m of inflows into IA Global.
At the same time, after heading up the charts with inflows of £1.1bn in January, IA Short Term Money Market was least popular with investors in February, with £705m in net outflows.
See also: Advisers expect UK equities to bounce back and property to struggle
So in a sign that investors may be getting their risk appetite back, is it time to reassess UK equities? In this month’s head to head, Alex Wright (pictured left), portfolio manager of the Fidelity Special Situations fund, examines what could be the catalyst for UK equities to re-rate, while Harveer Mata (pictured right), senior investment manager at Sarasin & Partners, looks at the makeup of the UK market and the challenges this presents.
Alex Wright, manager, Fidelity Special Situations
The strength of US equities, led by the ‘magnificent seven’ tech stocks, has continued to dominate the market narrative in the opening months of 2024. With news closer to home that the UK economy has entered a technical recession, there has been no change in the generally weak sentiment towards UK equities that has marked the asset class since the Brexit referendum in 2016.
As a contrarian value investor, this is creating an interesting opportunity set. I would rather invest in attractively valued companies whose share price reflects low expectations, rather than those priced for perfection whose shares will likely fall precipitously should market assumptions prove unrealistic.
Indeed, the relative attractiveness of UK valuations versus other markets, as well as the large divergence in performance between different sectors, creates the potential for attractive returns from UK stocks on a three- to five-year view. With its high dividends and low valuations, I believe the UK asset class offers better prospective returns than many others, including global equities.
Something I get asked most frequently is: what could be the catalyst for UK equities to re-rate?
Some of the often-cited reasons for the underperformance are largely (geo)political and more recently the disproportionate impact of Covid. These headwinds are now abating and indeed UK equities have been holding their own over the past two years, although few appear to have noticed.
Plans announced in the latest spring budget to launch a ‘British ISA’ to encourage investment in UK companies has received mixed reviews so far. The proposal is to give investors an extra £5,000 allowance on top of the current £20,000 to invest in UK shares. While admittedly this extra allowance in itself will not add up to a huge sum, it might just be the nudge investors need to rekindle their interest in the UK. I believe it will incentivise investors to look more into UK stocks and funds and realise that many have had decent performance of late, remain very attractively valued and offer good upside potential.
See also: Spring Budget 2024: British Isa announced
There are other reasons to be positive. The UK is a large and diverse market, and strong corporate governance standards. Its unloved status means we are currently finding overlooked companies with good upside potential across industries and the market-cap spectrum. What’s more, the lack of interest from other investors means that, despite our focus on attractive valuations, we do not have to compromise on quality.
Overseas corporates and private equity firms are seeing the value and are taking advantage of those attractive valuations. We have had decent success with M&A across the portfolio in the past 12 months. After a lull in the middle of last year, activity seems to have picked up over recent months. The low valuations are also reflected in the substantial buyback activity among UK corporates.
Financials remains the largest sector exposure in our portfolios, although we have taken some profits after a period of strong performance. Banks in particular have been boosted by higher interest rates which have significantly improved their profitability.
While we retain a sizeable exposure to banks, our holdings are diversified from both a geographic and business model perspective, with idiosyncratic stock stories.
Overall, we continue to see potential for attractive returns given the upside/downside profile of our portfolio and our small-cap bias. We are also encouraged by the performance of our portfolio holdings in the recent reporting season. We remain confident that our holdings – with lower levels of debt – possess the strength and resilience to navigate what remains a tough macro environment.
Harveer Mata, senior investment manager, Sarasin & Partners
UK equities have underperformed significantly for several years, leading some commentators to suggest the market offers relative value. This may be so, but perhaps deeper questions surrounding the composition of the FTSE need to be asked, as well as the attractiveness of new and exciting companies in the technology world to list in the UK.
The UK-listed large-cap market – with heavy exposure to cyclical industries such as banks, oil majors and miners – has not generally been well positioned to perform of late. The UK does not have a Microsoft or Amazon equivalent or a major company on the cutting edge of artificial intelligence – which is currently dominating the attention of the market. With investors increasingly looking globally for the best ideas, the lack of exposure to areas such as innovative technology is a structural issue the UK will need to solve.
While the makeup of the UK market may partially explain the major price-to-earnings discount to the US, this is not a new phenomenon, and the significant recent widening of the gap is worth exploring.
Investors ascribe increased value to stocks with higher growth and quality, so it is understandable to see a greater multiple in the US, which is dominated by powerful tech businesses. There may also be other elements to consider in terms of the UK discount. For example, the gap in valuations between the UK and the US was almost non-existent at the point of the Brexit referendum.
See also: Could UK GDP uptick finally improve sentiment on UK equities?
However, the primary factor clouding the backdrop of the UK equity market is likely more straightforward – investors are increasingly looking globally. This has heightened selling pressure on the UK market in recent years, alongside a reduction in buyers of local stocks.
Fortunately, much of this move has likely now occurred, which has potentially removed one overhang on the UK market.
At Sarasin & Partners, we invest in global thematic opportunities aligned to our mega themes of digitalisation, automation, evolving consumption, ageing and climate change.
Looking ahead, lower-growth environments are well suited to thematic investing, as investors search for opportunities that are supported by structural tailwinds.
Despite the obvious attraction of the US market, many of our thematic investment ideas reside in the UK and Europe – which also arguably suffers from similar issues to the UK. For example, in the area of automation, we are enthusiastic about companies like the London Stock Exchange, which displays high levels of recurring revenue and is a beneficiary of the growth in indices used in passive investment. A partnership with Microsoft could unlock even more capability for the business and the significant bank of data it owns.
The UK is not alone in taking a back seat to more fashionable markets, but fashions do change. Unfortunately, however, it is becoming increasingly challenging to find global leaders at the cutting edge of exciting new technologies or themes in the UK.
Political discussions, such as a ‘British ISA’, indicate the issue is being acknowledged. Attracting IPOs to list in the UK would be helpful, but in reality, the deeper capital pools and a perceived higher valuation attainable elsewhere suggest this might be an uphill battle.
While we continue to see opportunities to invest in the UK, we maintain our belief that looking globally will ultimately produce improved long-term results.
This article was written for our sister title Portfolio Adviser’s April magazine
