Since the EU referendum in 2016, the uncertainty surrounding trade negotiations and a potential ‘no deal’ Brexit has seen vast sums leave UK equity strategies. This has been exacerbated by the impact of the Covid-19 crisis and the UK’s slow response to the pandemic.
However, Alexandra Jackson – manager of the £42.2m Rathbone UK Opportunities fund – sees reasons to be optimistic heading into 2021 despite ‘Brovid’ – the twin threats of Brexit and Covid.
Any potential trade deal with the EU, combined with attractively low equity valuations and encouraging economic data could begin to entice investors back to the UK, she said.
This will likely be a slow and steady return as the UK starts to regain a semblance of stability.
However, there are issues to resolve first.
Jackson explained. “‘Brovid’ has contributed to why the UK has underperformed and why it doesn’t seem to be able to bounce back.
“The FTSE’s basically flatlined since June, and while other countries are back to pre-Covid multiples it’s pretty clear to me that Brexit and Covid have really hurt that.”
In addition, the UK market is also struggling with structural and dividend issues, according to the fund manager.
She said: “We have too many banks, energy companies, miners and struggling old fashioned retailers in the FTSE. Global investors don’t want to buy those names anymore; it’s anathema, at the moment.”
Performance of S&P 500 vs FTSE 100 over 20yrs
Source: FE Analytics
Jackson said that comparing the UK with the US – dividing the price-to-earnings ratio (P/E) of the UK divided by the P/E of the US – it was clear that valuations were at the lowest level for two decades.
“The valuations are really low, but the last two times that happened the UK actually managed to outperform in the following 12 months,” she explained. “However, valuation isn’t the catalyst for outperformance alone.”
One catalyst that could spur performance is a Brexit deal, something that investors will be aware of as the final round of negotiations were due to begin this week before the 15 October deadline.
“The good news is it can’t go on that much longer,” said Jackson. “The bad news is there’s still plenty of time for potential damage.”
A deal will likely influence the value of sterling and UK equities, but what that deal will look like remains to be seen.
“Even a slim deal will be enough to send sterling quite a lot higher,” she said. “This will encourage global investors to revisit their portfolios and assess their underweight position in the UK.”
“The risk premium will come down too, it’s become very high in the last few years since we’ve made ourselves look more like an emerging market.”
Rathbones’ Jackson also noted that historically when UK valuations have been this low, the levels of mergers & acquisition (M&A) activity have picked up.
“This is another catalyst we’re going to need to see alongside low valuations in order to get people excited about the UK again,” she said.
She referred to UK companies such as Greene King and Entertainment One that were deemed undervalued and bought up by foreign companies.
Investor sentiment aside, recent data has shown that a slow and steady recovery is building in the UK after the sharp contraction in output during the lockdown.
“Now our economic activity has recovered to a higher level than in the US, things are a lot better than the valuations are suggesting,” she added. “With all of those combining you will start to see the touch paper being lit under UK equities.”
However, while that could tempt global investors back to the UK it remains to be seen whether it will be more sustained.
“What we saw in December after the election was a very sudden return of global investors back into the UK,” Jackson added. “What you saw in the final trading days of 2019 and in the first few days of January, were people buying FTSE 250 trackers, all of which fizzled out because of Covid.”
She expected that if sterling spikes there would be quite a sharp inflow as investors re-examine their portfolios.
“They’ll be asking themselves, ‘what with US tech companies looking so expensive, do I want to be adding fresh money in those expensive areas?’” she said.
This is why highlighting the interesting ‘new economy’ companies that the UK has to offer is so important, the manager argued.
“We need to show investors the real upside, and hopefully it’s not in high street banks and massive oil companies, I think we can do better,” she said. “We also let these national champions get sold quite quickly, because we don’t value them properly.”
One such company Jackson holds in the Rathbone UK Opportunities fund is venture capital firm, Draper Espirit.
“I like the way they run it,” she said. “They look at it like I look at the fund, adding to their investments in their best performing businesses.”
Draper Espirit have invested in companies such as Graphcore, TransferWise and Trustpilot, mainly dealing in the consumer tech and healthcare tech space.
“That feels like the best growth area to be in,” said Jackson. “It’s a great way to get exposure to a bunch of these little companies which I can’t access because they’re all private.
“It’s an interesting but low risk way to get exposure to these companies before they get floated.”
Performance of fund vs sector & index over 6yrs
Source: FE Analytics
Having managed the fund since June 2014, Jackson has presided over returns of 25.48 per cent for the fund, versus 16.22 per cent from the IA UK All Companies sector and 13.56 per cent from the FTSE All Share benchmark. It has an ongoing charges (OCF) of 0.66 per cent.