There are plenty of reasons to be positive on the outlook for UK equities if the market is analysed as though it were an individual stock, according to Fidelity International’s Amit Lodha.
The past decade hasn’t been the best one for the UK market as the FTSE All Share has struggled to keep pace with its international peers. This has been particularly apparent since 2016, when the vote to leave the EU ushered in an extended period of uncertainty.
While the FTSE All Share has made a total return of 116.61 per cent over the past 10 years, the chart below – which shows performance in local currencies rather than rebased to sterling – highlights how most other major equity markets have outpaced the UK.
Performance of indices over 10yrs in local currencies
Source: FE Analytics
In addition to this, UK economic growth has averaged 1.3 per cent over the past 10 years while the pound has fallen to 1.32 to the US dollar – having started the decade at 1.62.
Global investors have shied away from the UK market, with the closely watched Bank of America Global Fund Manager Survey showing it as being the consensus underweight among asset allocators for some time.
However, Lodha – who runs the £444.4m Fidelity Global Focus fund – believes that now is an opportune time for investors to reallocate to the UK.
“40 per cent of the decade (i.e. the last four years) were by and large a write-off given the clouds of Brexit. Government, households and corporates were in stasis as we awaited the outcome of this fractious process. Thankfully, on the last Friday 13th of the decade, the UK population seems to have voted themselves out of this stasis,” he said.
“As a global manager, I am fortunate to have the opportunity to invest in only those markets where I see the strongest investment potential. To cut to the chase, I am positive on the UK for the next decade – well at least for the first four years. If we assess UK equities through the same lens as individual companies, there are several reasons to be positive from a fundamental perspective.”
When assessing an individual stock, Lodha considers: the quality of its management team; the growth prospects and robustness of the industry structure that the company operates in; and the valuation upside (or the difference between his estimate of the company’s franchise value and the market’s).
Starting with valuation and sentiment (“the easy part”), Lodha reiterated that the UK has generally underperformed global markets over the past 10 years. “Consequently, there are none of the happy valuations you see in other markets,” he said. “On most measures, UK equities are fairly valued to under-valued versus their own history, and undervalued relative to the rest of the world.”
Of course, some of this undervaluation is “deserved” given the Brexit uncertainty of recent years. But the weeks since the Conservatives’ convincing victory in the December general election have seen global investors warm somewhat towards the UK.
Performance of indices since Brexit referendum
Source: FE Analytics
“Recent months have been great as the election results have been reflected,” the Fidelity Global Focus manager said. “However, on most long-term relative measures – if your definition of the long-term is three to five years and not the next quarter – there is indeed a long way to catch up. So, on valuation and sentiment the UK gets a quick relative tick.”
The second consideration – or the attractiveness on the back of growth prospects and robustness – is another positive for UK market. Lodha noted a number of structural advantages to the UK, including rule of law, functioning democracy, good healthcare system, vibrant corporate ethos with great governance, an independent central bank and culture.
While there are some challenges in the form of an ageing population, entitlement spending and what Brexit – and the country’s relationship with the rest of world – will ultimately look like, he argued that the market has been paying more attention to near-term uncertainty and forgetting some of the long-term positives.
He suggested that an example of this is how investors in the UK sometimes undervalue the quality of the management teams they have access to. He pointed to Unilever, where the UK parent has been trading at a large discount to its subsidiaries in Indonesia and India.
“Amongst the many reasons for this differential, a primary one in my view is that what is par for the course in the UK (great corporate governance led by superb management teams) is very rare and hence highly valued in markets like Indonesia,” he explained.
“It is my view that if you are positive on the outlook for emerging markets (which incidentally had an even poorer decade), then UK multinationals offer you some of the best risk-adjusted exposure to growth in those markets given high market shares and strong governance.”
Finally, Lodha considered the quality of the UK’s management in the form of Boris Johnson and his Conservative majority government.
“Whilst taking a view on management teams, we believe in spending time not only with the chief executive and chief financial officer (who generally tend to be well coached) but also various layers of the management team. We would recommend similar for the UK – more specifically a focus on Dominic Cummings, the prime minister’s chief of staff. Convenor of the vote leave campaign and then widely considered one of the key architects of the recent Tory landslide,” the manager said.
“While his style of politics may not be for everyone, if you are interested in either British politics or the intersection of multi-disciplines like technology and management or the reform of bureaucracies, his 10,000-word blog posts are worth perusing. Cummings is not a complete outsider, but he brings a fresh outside-in perspective to what needs to be done.”
Along with this analysis of the UK, the Fidelity Global Focus manager highlighted a number of milestones that offer some insight into how the UK is doing, including the new government’s first Budget, how accommodative monetary policy remains, any changes in private sector capital expenditure and improving consumer confidence.
“The UK market has been in the woodshed these past four years and indeed a lot of wood still remains to be chopped,” he finished. “However, with a five-year mandate, a management team which at least seems to have the right diagnosis of the problem, and valuations and sentiment scores at 10-year lows, it is time for asset allocators and investors to do work on the UK. I am positive.”
Performance of indices over 10yrs in local currencies
Source: FE Analytics
Since Lodha took over Fidelity Global Focus in October 2010, it has made a total return of 204.79 per cent – putting it in the top quartile of the competitive IA Global sector. The fund has an ongoing charges figure (OCF) of 0.93 per cent.