As a big horse racing fan, Christmas comes in March for me when the best jumpers in Britain and Ireland go head to head at the Cheltenham festival.
The last time I was there, I remember talking to someone who won big on the day. With his shoulders back, he confidently told me his approach: “You can either bet to win or bet not to lose”. The latter, he reassured me, is just a defensive option when you feel there are simply too many variables in play to make a confident decision (essentially, he bet on several horses to win his money back with a bit of profit).
It’s a saying which has stuck in my mind and is exactly how I feel about UK equities at the moment. Yes, they are unloved and undervalued, but trying to figure whether growth, value or income is the best horse to bet on is no easy task.
What we do know is the UK has been a laggard in financial markets for the last five years. In that time, the FTSE All Share has returned 44.8%, compared to a return of 114.6% for the MSCI World*. Investors have voted with their feet, with money flowing out of UK equities.
Two catalysts affecting UK’s form
But do we finally have hope? Pessimists would point to me saying this 12 months ago, when the Conservatives won a majority in the December 2019 General Election – but in fairness who could’ve foreseen what 2020 had in store?
We seem to be getting more solutions this time with two catalysts paving the way for a better 2021 and beyond. The first was the last-minute trade deal between the UK and the European Union – bringing an end to much of the Brexit uncertainty which has blighted the UK market for the past five years.
Fidelity Special Values manager Alex Wright says while the resolution has removed the uncertainty for the UK, we have yet to see the impact of this, as Covid-19 lockdowns have continued to cause uncertainty**.
The second big concern was the speed of the vaccine roll-out, something the UK appears to have excelled at, with 15 million jabs given at the time of writing.
Wright says these two macro-issues have strengthened his outlook for the home market. He believes when the UK economy re-opens, the bounce back will be stronger in comparison to other regions, having taken a bigger hit due to the services-related nature of the economy**.
M&A activity is on the rise
M&A activity is also on the rise again – having begun to gather pace just prior to the onset of the pandemic. Schroder Income Growth manager Sue Noffke says the bid interest underlines the unloved status of many UK shares. She points to a large number of companies trading on very depressed price-to-earnings ratios, similar to the situation we saw in the wake of the Great Financial Crisis more than a decade ago***.
Of course, we are by no means out of the woods and, I think selectivity will be essential. Sectors like travel and entertainment will take longer to recover, but others may surprise. For example, a move such as the Bank of England resorting to negative interest rates would make bank shares more appealing than they have been for some time, particularly as the Prudential Regulation Authority is happy for banks to start paying dividends again****.
The final point I’d like to touch on is value. The UK has always had a value tilt, compared to the likes of the US, which has also contributed to underperformance. Wright says his value strategy produced its strongest level of outperformance in the final quarter of 2020. Crucially, he says, not only are there numerous investment opportunities on offer, but they are also not having to compromise on quality**.
So, when it comes to UK equities, the optimist in me says there is more than one way to skin a cat. Fidelity Special Values is a good example of a value offering while for income, investors may consider the likes of LF Gresham House UK Multi-Cap Income or the Schroder Income Growth Trust. Those who still prefer growth may like the Liontrust UK Smaller Companies or Marlborough UK Micro Cap Growth funds.
*Source: FE Analytics, total returns in sterling, 15 February 2016 to 15 February 2021
**Fidelity: Twin catalysts boosts the outlook for cheap UK market
***Schroders: Outlook 2021 – UK Equities
**** Lazard: Outlook on UK Equities – January 2021
