There is a “yawning valuation gap” between UK growth and value stocks that investors should consider taking advantage of, according to Liontrust Asset Management’s Stephen Bailey and Jamie Clark.
Clark – co-manager of the £97.6m Liontrust Macro Equity Income fund with Bailey – said that the low rate, low inflation environment of the post-global financial crisis era has created a huge demand among investors for long-duration growth stocks over their value counterparts.
This has been compounded in the UK by the uncertainty over Brexit, with businesses more wary of investment and depressed expectations of economic growth.
As such, UK value stocks have been shunned by most investors.
During the past decade, the MSCI United Kingdom Value index is up by just 96.47 per cent compared with a 131.53 per cent gain for the MSCI United Kingdom Growth index.
Performance of style indices over 10yrs
Source: FE Analytics
“This tendency has created enormous anomalies,” said Clark. “We see a yawning valuation gap between growth and value.”
As such, across a range of valuation metrics, UK value stocks are “staggeringly cheap” with UK growth stocks currently trading at an “unprecedented” premium.
“History tells us that cheap stocks outperform expensive stocks over time,” he added.
Clark said there are two key catalysts that could trigger strong outperformance by UK value stocks.
In the near-term, the manager said Brexit was likely to be the most important.
“It’s very important to understand Brexit,” he said, noting the lack of investment – and confidence – by businesses since the EU referendum in 2016.
However, the Liontrust Macro Equity Income manager said the lack of certainty shouldn’t worry investors too much.
“Ask yourself this,” he said. “When do we have any absolute certainty of what to expect in the future?
“Instead, we expect businesses to become confident for investment to increase, for UK rates to rise and global investors to readjust their asset allocations.”
The second structural catalyst that could enhance the prospects for UK value stocks is the prospect of further support for the economy in the shape of more aggressive fiscal policy, which many politicians have been advocating.
Any greater support should be beneficial for the prospects of the UK economy and the value stocks that are more geared towards it.
“We believe now is a great time to consider increasing your allocation to value in the UK,” said Bailey. “But be careful and proceed with caution: not all value is indeed good value.
“We continue to see risks attached to tobacco, real estate and retail sectors. In fact, we avoid half of these names, but we firmly believe there is a huge UK value opportunity.”
The general election has meant that companies with more direct gearing to the economic cycle have performed strongly and continue to look attractively valued, particularly after three years of political uncertainty.
Companies in the housebuilding, materials and financials sectors in the Liontrust Macro Equity Income fund have all performed strongly since the election.
“Lloyds was a mainstay of many a private client’s portfolio, until the great financial crisis,” said Bailey. “Now, restored to financial health and paying quarterly dividends, it must surely benefit from the assurance of the general election result and getting Brexit done.
“Legal & General might have rallied nicely since the general election but it’s still trading at a valuation of 9x [price-to-earnings], comfortably below the pre-Brexit vote of 13x,” he said.
“And yet, since 2011 has increased dividends, EPS [earnings per share], and profits in excess of 10 per cent each and every year.
“Rio Tinto, we remain optimistic, indeed bullish, for iron ore – the company’s mainstay. We see sustained growth in demand being driven by continued urbanisation. There is no more new supply to upset pricing.
“Finally, [housebuilder] Taylor Wimpey is a high cash-generative business. Since 2016, it has paid £1.3bn in special dividends – that’s on top of its annual £250m dividend.”
Each of these stocks, he said, comfortably pays out more than the 4.5 per cent yield of the FTSE All Share but trades at lower valuations than the index and with the prospect for further growth.
“How often do you get the genuine chance to own a company that yields higher than its earnings multiples?” said the manager. “Not often, I would argue.”
Bailey concluded: “It might be found that most of you believe the market is currently too high, but at the start of this century – just 20 years ago – back in January 2000, the FTSE All Share was yielding a meagre 2.2 per cent or less than half its current yield and was priced at 27x earning. Now that’s food for thought.”
The Liontrust Macro Equity Income fund is up by 17.37 percent over the past three years, underperforming the average IA UK Equity Income peer’s gain of 18.51 per cent and a 20.13 per cent rise in the FTSE All Share benchmark.
Performance of fund vs sector & benchmark over 3yrs
Source: FE Analytics
The fund has an ongoing charges figure (OCF) of 0.89 per cent and a yield of 5.36 per cent.