Investors waiting for a conclusion to Brexit could be missing out as the UK market looks cheap on several measures, according to Columbia Threadneedle’s Richard Colwell. 
The manager of the £4.1bn Threadneedle UK Equity Income fund said during the last couple of years the market has been led by ‘dumb, smart money’ that has focused on momentum-driven trades, which has led international investors away from the UK market.
But it has been a trend that has been notable since before the EU referendum in 2016, Colwell (pictured) said.
“UK equities as an asset class is well out of favour and had been prior to the Brexit referendum which only accelerated moneys being allocated away from the UK into Europe and Asia,” he noted.
As the below chart shows, the FTSE All Share index began to significantly underperform the rest of the world (as measured by the MSCI AC World ex UK index) from mid-way through 2015.
Performance of indices over 5yrs
Source: FE Analytics
“Globally the trend has very much been against value orientated funds and I would say that it is even narrower than that, in that it has been very much momentum-led,” Colwell said.
“I think there is a big influence of quant-type funds which I would say are dumb, smart money. They jump on trends and extrapolate.
“They are probably the people that were selling oil and commodity stocks two and a half years ago at the lows and are the ones that have been buying more at the back-end of last year.”
This has accentuated trends, with vast amounts of money able to move very quickly into the next new idea.
The best example of this is in the UK, where commodity- and oil-focused stocks have continued to surge ahead on the back of an expected commodities price rebound, despite the net outflows for the asset class.
“In the quantitative easing (QE) world that we have lived in for close to a decade growth generally has been quite scarce, so famously where the market has identified it, it has embraced it wholeheartedly,” the Columbia Threadneedle head of UK equities said.
“In the UK stock market environment the growth that has been evident has been commodity rebound. Within a UK market where there are outflows, the one area that saw support at the back-end of last year was the one area that was delivering earnings upgrades.”
This phenomenon has meant that the gap between the stocks at the top of the market and the unloved companies has reached a very wide point.
While the UK market reached a new peak earlier this year, some stocks are at record highs while others are resembling the type of value that they did in 2009.
Performance of index since 1986
Source: FE Analytics
“You had big swathes of the market hitting one-year relative lows and quite a lot of big stocks out of favour hitting 10-year relative lows,” said the Threadneedle UK Equity Income manager.
While some of this is down to the potential disruption from firms such as Amazon, other reasons include the potential for a poor Brexit outcome and a Labour government led by Jeremy Corbyn.
The Columbia Threadneedle manager said: “Those [domestic] stocks are already trading as though it is late-2008 or early-2009 – they are pretty beaten up.
Meanwhile, more broadly, international stocks that happen to be listed in the UK have seen their ratings lowered greatly compared with their overseas peers in the US or Europe thanks to the weight of money leaving the UK market.
As such, it is not just the domestic stocks that are attractive, but international earners too, despite their appeal to UK investors.
“I think there is this big valuation arbitrage opportunity. It is not just about do you get brave in beaten up domestic stocks or do you keep running international stocks it is not that black or white,” he said.
“But if investors continue to say it’s all too difficult and we will revisit the UK when we know what is going on with Brexit, you are creating a vacuum where corporate raiders and activists will come in and take the value instead.”
However, the much-anticipated rotation from momentum stocks into more value-orientated companies and regions like the UK have yet to take place.
“We haven’t really had a rotation. Not really. We have had rumblings and a tremor, if you like, but we haven’t had the earthquake yet,” Colwell noted.
“There has not been a valuation trigger yet, so the elastic has got very stretched and at some point you will see a meaningful rotation I think.”
Should this occur however, the UK should be pretty resilient in that environment thanks to misery around UK equities from a sentiment, weight of money and, therefore, valuation standpoint.
But investors waiting for a sign that this is about to happen may be left disappointed as there is rarely a root cause.
“Why did the Nasdaq fall in 2000? I don’t know. There was no announcement from [Federal Reserve chairman Alan] Greenspan at the time and no shock interest rate move – it just happened,” said the UK equity income manager.
“If you are waiting for some blue-sky moment where you know exactly how Brexit is going to play out it could be too late.”
Colwell manages the £4.1bn Threadneedle UK Equity Income fund, which over the long-term has been a top quartile performer in the IA UK Equity Income sector, returning 126.74 per cent over the last decade.
Performance of fund vs sector and FTSE All Share over 10yrs
Source: FE Analytics
However, it has struggled over the past year and sits in the bottom quartile with a 2.29 per cent return.
“Ideally you want to deliver resilience in a down market at the end of a cycle and get on the front foot when markets are cheap,” he explained.
“If you are going to underperform you would rather do it when markets are quite narrowly-led and quite frothy and it is all about delivering risk-adjusted returns through the cycle rather than trying to deliver very quarter.”
Despite this, Colwell said he is “more animated about UK equities” than he has been for five years, but that currently active managers need to “try to be brave and lean-in selectively to some of the opportunities”.