UK managers have been banging the drum for the domestic market ever since the Brexit referendum in 2016 caused an exodus of investors and a fall in valuations relative to domestic peers.
But this year, managers without a vested interest in the UK agree with them. In a recent poll conducted by the Association of Investment Companies (AIC), the UK was the region backed by most investment trust managers to outperform over one and five years, chosen by 25% of respondents over both periods. In second place over one year was the US, at 19%, and over five years was Europe, at 18%.
Paras Anand (pictured right), chief investment officer of Artemis, claimed that the change in sentiment towards the UK can be traced back to September’s disastrous mini-Budget.
“Twelve months ago, we could have made a case for UK equities being undervalued on an absolute and relative basis looking back over history, and maybe we could have made an argument that sterling was undervalued from a purchasing power parity basis,” he said.
“But we couldn't have made the case that gilts were offering substantial value. The fact that you then had that sell-off in the bond markets made me feel like we were at the end of the peak of negativity.”
Anand said this was underlined by the commentary at the time, with every article he read on investment, inflation and the economy reaching a negative conclusion.
“I always find it to be an interesting point in markets when there's no room given to interpretation,” he added.
“Yet some of the narratives were contradicting one another – they couldn't all be true simultaneously. That's what really made me feel that we were at the end of the sell-off in UK assets.”
In any case, he said macroeconomics are not as important as most investors tend to think. James de Uphaugh, manager of the Edinburgh Investment Trust and a member of the Liontrust global fundamental team, said the UK’s reputation for being in a “permacrisis” could even work in investors’ favour, for three reasons.
“Firstly, valuation trumps sentiment over the long term; secondly, shares are rarely a bargain when all the news is rosy; and thirdly, the consensus tends to over-focus on the short term,” he explained.
“The UK equity market has had a subdued period since the Brexit vote in 2016. UK equity flows have been persistently negative since and yet in 2022 there was a stabilisation as the quality and low valuation came to the fore.
“Markets are anticipatory, and if we are right that the economic news becomes less bad, then we are in the foothills of a renaissance of UK equities.”
Performance of indices since 23/06/2016
Source: FE Analytics
Jeremy Podger, manager of the Fidelity Global Special Situations fund, said the correction seen in markets this year means valuations in every region “now appear roughly fair and increasingly attractive on a longer-term view, especially outside the US”.
However, he cited the UK along with Japan as regions “likely to bring good value opportunities in the coming year”.
So which parts of the UK market look attractive?
Kartik Kumar, manager of the Artemis Alpha Trust, said that the prospects for the FTSE 100 look reasonable: sectors such as energy are benefiting from elevated returns due to underinvestment when prices were low; meanwhile, rising interest rates provide a margin tailwind for banks and other financials.
However, he said it is the prospective returns in the FTSE 250 that he finds most appealing, with negative sentiment towards the UK economy leading to a sharp fall in domestic stocks.
Performance of indices in 2022
Source: FE Analytics
“The state of both consumer and corporate balance sheets is healthy as we have only very recently come out of the pandemic,” Kumar explained. “This recession is also unusual as unemployment is not leading the way.
“And yet, many stocks have declined by 30 to 50%, leaving a variety of strong franchises trading on low multiples of earnings.”
Alexandra Jackson, manager of the Rathbone UK Opportunities fund, went even further.
“There is a huge disconnect between what companies are telling us (in the main, the news is still good outside retailing), and how shares are doing (getting pummelled).
“UK stocks are cheaper now relative to the rest of the world than since the 1990s; this is the only major developed market trading at levels consistent with a recession. A single-digit P/E [price-to-earnings] multiple has proved a good buying opportunity in the past.”
In addition, she said many of the pressures that have weighed on mid caps are dissipating, with sterling bouncing, interest rates and inflation close to their peak and stability returning to government.
Rebecca Maclean (pictured right), manager of the Dunedin Income Growth trust, was more cautious, saying she was sticking with quality companies – those providing essential products and services, with strong competitive positions and resilient financials – as these will be best placed to navigate through what is likely to be a challenging economic environment.
However, Jackson claimed that being overly cautious could be counterproductive. In particular, she warned against waiting for more positive news before investing.
“While investors are busy searching for the bottom and agonising about a few basis points, someone else will have snapped up these world-class businesses trading on a postcode-driven discount.”
Kumar agreed with her.
“In bear markets, cheap stocks tend to get cheaper when the news flow is ugly and deteriorating,” he added.
“But to quote Jeremy Grantham, stocks don’t turn when there’s light at the end of the tunnel, but when there’s a subtle shade less black than the day before.”