Investors need to tread carefully when buying into the UK market, even though it remains a fundamentally attractive area to invest in, a selection of investment professionals have warned.
The FTSE neared an all-time high on Tuesday, moving above 7,000 for the first time since March 2015.
Performance of index in 2016
Source: FE Analytics
It hasn’t been all plain sailing for the index this year, with the global growth slowdown, low commodity prices and EU referendum fears causing it to bottom out in February
The market has jumped since then, however, due to the fall in sterling, dovish statements from the Fed and a rebound in commodity prices. 
The question then is can the UK market continue to gather momentum or should investors be looking to reduce exposure?
Jason Hollands (pictured), managing director of Tilney Bestinvest, says that an index climbing towards a record high should never be taken as a ‘buy’ signal in itself and argues that it should serve as more of a warning sign.
“The art of successful investing is to buy low, sell high – not the other way round,” he said. “However, fundamentally the level of the bellwether FTSE 100 index and it passing through the 7,000 level – while headline grabbing – isn’t a very useful gauge of whether shares are expensive or good value. Here, metrics like price/earnings or the Shiller ratio (cyclically adjusted price/earnings) are more useful.”
On a relative basis, he says that UK equities look attractive compared with other markets such as the US, both for overseas investors, because of the weak pound, and for domestic investors, because overseas earnings are converted back into sterling.
Hollands adds that the FTSE’s 4 per cent yield looks far more attractive than those across fixed income assets and, given the deployment of further quantitative easing, the push for investors to buy into risk assets is also acting as a tailwind.
“Before you mistake me for a raging bull, I would urge investors to tread with care as asset prices globally have been grossly distorted by central bank policies and there are clear risks of this financial alchemy unwinding in quite a chaotic manner,” he warned.
“The Fed is itching to hike interest rates again, the Bank of Japan and ECB [European Central Bank] appear to have reached the limits of what they can do through expansion of their balance sheets and there is a lot of talk, apparently emanating from ECB officials, of the ECB potentially tapering down its asset-purchase programme. A blowing out of bond yields could trigger a lot of turmoil across capital markets, with a read-through to equities.”
As such, Hollands believes investors should focus on managers with defensive styles and who prioritise quality businesses with strong cash-flow visibility.
Examples of UK funds that he thinks are particularly attractive at the moment include Evenlode Income, JO Hambro UK Opportunities and Liontrust Special Situations.
Neil Jones, investment manager at Hargreave Hale, is fairly positive on the UK market and doesn’t feel as though it is in a bubble. That said, he warns that toppy absolute valuations mean investors have to be selective.
“I think the relative valuation of UK equities is attractive – particularly versus gilts – and you can get the income yields you want, numbers are generally OK, UK economic figures are generally supportive and I think UK companies will benefit massively from the currency devaluation,” he explained.
“I think the UK market is looking attractive but, in the short term, we’ve had such a strong run on the expectation of the benefit of sterling. I suspect it’s going to take longer to come through than has been initially factored in.”
“My understanding of how multinational companies work is they have quite long contracts in terms of their foreign exchange transactions, so they wouldn’t be seeing the benefit straight away. Therefore there is a slight concern that, when some of these multinational companies start coming out with their results, we won’t have seen this big uplift in the benefits of sterling yet.”
While he believes there is room for short-term disappointment, Jones says that the UK market is ultimately in good shape, so long as investors rebalance their portfolios and remain mindful of the macroeconomic and geopolitical risks on the horizon.
One example of a UK investment vehicle he particularly likes is FE Alpha Manager James Henderson’s Lowland Investment Company, which is able to invest across the market cap spectrum and will only hold up to 50 per cent of its portfolio in FTSE 100 stocks at any one time.
Performance of trust vs sector and benchmark over 5yrs
Source: FE Analytics
“I continue to think there are good opportunities in investment trusts because there are still discounts there despite markets having risen, which means it is good to add exposure that way,” the investment manager added.
Laith Khalaf, senior analyst at Hargreaves Lansdown, says that rising commodity prices, a weakening pound, loose monetary policy and low interest rates have all contributed to the FTSE 100’s strong performance.
He also points out that investors have piled into equities in the hunt for income, given that millions of baby boomers are now reaching retirement age and the recent pension freedoms now allow them to park their retirement funds in the stock market.
“While UK stock market indices may be at, or near, historic highs, that does not necessarily mean UK stocks are expensive,” he said.
“If you compare share prices to company earnings, the valuation of the UK stock market is actually somewhere in the middle of its historic range, neither particularly cheap, nor dear, at current prices.”
“This is in stark contrast to the former peak of the market in 1999, when the price-earnings ratio of the UK stock market stood at an eye-watering level.”
Khalaf says that there are always macroeconomic worries to deter investors from buying into the stock market but, despite this, he argues that UK equities could be good investments over the long term.
Examples of UK equity funds that have achieved a place in Hargreaves Lansdown’s Wealth 150 list include Nick Train’s Lindsell Train UK Equity, Carl Stick’s Rathbone Income and Paul Spencer, Mark Hall and Richard Bullas’s Franklin UK Mid Cap.
From an equity fund manager’s perspective, SWMC’s Stuart Mitchell says that the economic outlook for the UK remains uncertain, with survey data released since the vote suggesting there is a sharp slowdown on the horizon.
The manager, who heads up the SWMC European fund, adds that the manufacturing, construction and service purchasing manager indices have dropped to levels last seen in the throes of the global financial crisis.
“As always, we must be very careful how we respond to the data. The numbers are notoriously volatile and are ‘guesses’ about the future,” Mitchell said.
“Companies themselves have been rather more upbeat. Most notably, the banks have reported no changes in trend post-referendum. Likewise, the housebuilders have made a number of encouraging comments.”
Neil Shillito, fund manager at Downing, says that investors shouldn’t be afraid to buy into the UK market strategically. In terms of buying in right now for short-term gains though, he warns that valuations seem toppy.
One of the methods he is using to gain exposure to the UK is through FE Alpha Manager Terry Smith’s Fundsmith Equity fund which, despite being a global product, holds almost a quarter of its portfolio in the UK.
“I’m not suggesting market timing in the sense of waiting for a specific level, I just mean that it has come a long way in the last six months or so and certainly in the last week. I guess some of that froth will come off the top,” Shillito said.
“On a strategic, longer term view, there’s no worry there. If you buy now you’re probably going to take some losses over the next few weeks or months but that’s part and parcel of being in the markets. On a five-year view, that’s irrelevant.”
“The UK is arguably the world’s fifth-largest economy. It’s a very mature market which is well-regulated and well-researched. Why wouldn’t you be in the UK market? We have some very strong companies operating in and out of the UK.”