The UK equity market is cheap compared with other markets and its long-term average meaning a significant buying opportunity has opened up, according to JPM’s Jonathan Ingram, who says investors can afford to ignore concerns over a potential Brexit. 
The consensual view heading into 2016 was that it was going to be a tough year for UK equities.
Not only is the UK index heavily exposed to international trade in the form of mining and energy stocks (which took a pounding last year as commodity prices plummeted), but rallying mid-caps were showing signs of overvaluation, dividend cuts were expected to increase and there was growing uncertainty in relation to the UK’s future relationship with the EU.
Most UK bears have so far been proved correct as well, with the FTSE All Share underperforming global equities and bonds so far in 2016 with losses of 0.98 per cent. On top of that, data from the Investment Association shows UK funds saw their largest ever monthly redemption compared to other regions in March.
Performance of indices in 2016
Source: FE Analytics
With the vote now just over a month away (and the expectation of another summer lull in markets), many believe now is the time to avoid buying UK equities as greater volatility and further falls are expected in the short term.
These include the likes of Neptune’s Robin Geffen, who continues to have no exposure to the UK in his global funds.
“Dividend cover across a number of sectors is at multi-year lows and further sterling weakness in the lead up to the Brexit vote remains a distinct possibility. As a result, I am actively targeting companies that derive a hefty chunk of their earnings from overseas – particularly the US,” Geffen said.
“We see the US economy as going from strength to strength and expect the currency to continue to strengthen versus sterling.”
However, there are those more contrarian managers who believe that now is the opportune time to be focusing on the UK equity market.
Ingram, who heads up the JPM UK Dynamic fund, is one example. He points out that concerns over further dividend cuts in the UK, fears over further earnings declines and Brexit uncertainty are now very much baked into the index’s valuations – meaning the potential for an upside surprise is high.
Data from JP Morgan shows, for example, that the FTSE All Share is currently trading well below its long-term Shiller Cape price to earnings ratio at 11.6 times.
Source: JP Morgan
Ingram says this dynamic has largely been created by Brexit fears, but also points out another reason the long-run cyclically adjusted P/E ratios are low relative to historical averages is because sectors such as miners and banks are making lower profits than they have in past years.
Nevertheless, he says investors need to take a step back, try to block out the noise and look closely at the valuations on offer.
“If you look for example at the housebuilders, they’ve been punished on the back of Brexit fears, with some down more than 20 per cent since the end of last year,” Ingram said.
“We think that’s reflecting an overly bearish view on the probability of Brexit and has created value opportunities. Bookie odds indicate a higher likelihood of a vote to stay in and if that happens, names such as Barrett Developments, which have been tarred with the Brexit brush, could rebound.”
He added: “Certain value opportunities are also evident in sectors such as insurance, where names like Aviva and Prudential look attractive.”
Another measure that proves the UK market is cheap, according to Ingram, is the levels of dividend yield on offer.
For example, data from JP Morgan shows that the UK is the highest yielding market compared to the other major regional indices.
Source: JP Morgan
Of course, many have argued that the UK market’s yield is artificial given many companies are expected to cut their pay-outs due to falling levels of dividend cover and increased pay-out ratios.
However, most of the concerns surrounding future dividend cuts revolves around the commodity space, which accounts for a large proportion of the index and its yield, due to falls in the likes of the oil price.
Nevertheless, as the chart above shows, even if you remove the energy sector the UK market still yields more than Europe, the US, emerging markets and Japan.
It is also worth noting that, due to the sharp underperformance of smaller companies relative to FTSE 100 stocks in 2016 so far, some of the highest yielding funds in the IA UK Equity Income sector at this point in time are those with a high weighting to mid and small-caps – areas where investors can find higher levels of dividend cover.
One of those is the five crown-rated Marlborough Multi Cap Income fund with its yield of 4.86 per cent.
According to FE Analytics, the £1.4bn fund – which is run by Siddarth Chand-Lall and some 90 per cent weighted to mid to micro-caps – has been the second best performing portfolio in its sector since launch in July 2007, has been one of the highest income distributing members of the peer group and has never cut its dividend.
Marlborough Multi Cap Income’s dividend history
Source: FE Analytics *figures based on a £10,000 investment in January 2012
Peter Toogood, investment director at City Financial, says investors should not be looking to up their exposure to the UK or any equity market at the moment, however.
“Equity prices are increasingly out of touch with economic reality,” Toogood said.
“The brutal and blunt truth is that every valuation measure is flashing red in the US. Before everyone says, ‘well, that’s the US’, Europe only looks cheaper due to some very lowly-valued commodity stocks, notably in the UK, and utilities and financials stocks in continental Europe. “
He added: “The median stock and indeed nearly all ‘growth’ stocks in Europe are as expensive as their US peers.”