Brexit has been like a dark cloud over the UK market since the EU referendum in June 2016 and it remains out-of-favour among foreign investors.
Indeed, according to the latest Bank of America Merrill Lynch Global Fund Manager Survey, UK equities remains the consensus underweight among international asset allocators, although there has been some improvement in sentiment during recent months.
Uncertainty surrounding Brexit has seen many global managers shun the UK, while the FTSE All Share has also lagged its developed market peers over the past two years or so.
As the below chart shows, the FTSE All Share has underperformed the FTSE World ex UK index by 27.56 percentage points in the post-referendum period.
Performance of indices since EU referendum
Source: FE Analytics
As such, Alan Custis, co-manager of the £207m Lazard UK Omega fund, said the ability to generate returns will likely depend on investors’ time horizons.
“If you ask, ‘can I make money in the next six months by investing in the UK’ then there is a question mark,” he said. “If you ask, ‘can I make money in the next five years by investing in the UK’ then I would say the answer would be ‘yes’.”
Custis explained: “I think the UK market, as we know, has been challenging from an investment performance standpoint relative to other markets.
“We are all cognisant that overseas investors have been studiously avoiding the UK market because of the B-word and the uncertainty that it is creating.
“But I think that what that has led to is a market where a number of the multinational names are looking pretty cheap in terms of their historic valuations.”
He said that over the medium term, the UK market looks to be relatively attractive from a valuation standpoint.
In the aftermath of the referendum internationally-focused stocks rose substantially as sterling plummeted, a benefit to large-caps over those in the more domestically-oriented FTSE 250 index.
So, what can investors learn from this as the deadline for Brexit at the end of next March continues to grind closer?
“If we have a disorderly Brexit, quid pro quo, sterling will fall and international earners – which make up the majority of the FTSE 100 – will perform pretty well,” said Custis.
In this scenario it would be fair to expect mid- and small-caps to perform less well because of the domestic nature of the companies.
However, while the market will “gap down” on a disorderly ‘hard Brexit’, the manager said it would likely not be for very long. 
“A disorderly Brexit would clearly create uncertainty within the market which would create weakness in sterling, bond yields would go up so certain stocks and sectors would do pretty well over the medium term,” the manager said.
While a more negative picture could be painted if a disorderly Brexit led to a general election – which would cause even more uncertainty – such a scenario is some way off.
Conversely, if there is some kind of Chequers-esque ‘soft Brexit’ then sterling could appreciate and the domestic stocks would outperform.
“Either way, you are going to get different stocks doing different things,” Custis (pictured) said.
However, the Lazard manager said the market will likely keep believing a soft Brexit is possible, certainly until Christmas, although it may shift the closer we get to the deadline in March.
As such, he said investors do not want to be too overly-exposed to one outcome or another as things can move pretty quickly.
However, Brexit is not the only thing to impact the market – although it may feel like it to some.
Perhaps just as important is the outlook for global growth, with much of the developed world being more closely connected thanks to globalisation.
Indeed, in the past few weeks, global markets have sold off as expectations have flipped from growth to recession and the embattled UK was not immune to this shift either, as the below chart shows.
Performance of indices over YTD
Source: FE Analytics
“The market has obviously got concerned about global growth and valuations but I think putting that to one side – which I think is more a ‘taper tantrum’ than anything and we have had a number of re-runs of that over the last five years – the UK market, in our view, is trading on 12.3x P/E [price-to-earnings] with a yield of 4.52 per cent,” Custis said.
“That in anybody’s language is pretty good value unless you think we are going to fall into a full-blown recession.”
The manager said he does not believe this is the case, as the reason the market is selling-off is because the US economy is too strong, however, if a recession were to occur, being cheap will not be enough to make the UK market perform any better than the others.
“The negative for the UK is that we have got a lot of resources, so if there was a global recession then demand for oil and broad commodities would come down and that would therefore affect 20 per cent of your index, which would be under pressure straight away,” he said.
Meanwhile, the UK has a lot of US-exposed names such as plumbing supplies company Ferguson and equipment rental group Ashtead, which are effectively US companies that happen to be listed in the UK.
As such, while these stocks are trading at 12x P/E, “valuation is no defence – it is never in the price,” Custis warned.
“Initially I think that there are aspects to the UK which mean it would not defend particularly well because it is so allied to the US,” he said.
Indeed, 40 per cent of Diageo’s sales are into the US, while Cineworld has just bought the second-biggest cinema chain in the US. There are numerous examples.
However, whether or not you should invest in the UK market comes down to time horizons again as, over the medium term, the UK might be quicker to turn around than other markets.
“All those companies would get impacted but I think ultimately you would like to think that we are not buying a bunch of stocks on 27x so therefore the downside would be quite limited,” he said.
“Therefore, over six months, I don’t think the UK market would defend any better than any other market but on a two-year view, because that starting point is much lower the UK market could see stability quicker than other markets.”
Custis has run the Lazard UK Omega fund since its launch in 2005 and currently co-manages alongside Lloyd Whitworth, who joined him in 2010.
Performance fund vs sector and benchmark since launch
Source: FE Analytics
Since inception the portfolio has returned 170.77 per cent to investors, beating both the FTSE All Share and IA UK All Companies sector, as the above chart shows.
The predominantly large-cap strategy is currently overweight financials, miners and oil stocks, although it also holds some consumer staples. FE Trustnet will consider this positioning more closely in an upcoming article.
Lazard UK Omega has a yield of 2.47 per cent and a clean ongoing charges figure (OCF) of 0.8 per cent.