UK equities have seen a swift reversal in fortune over recent months, with the MSCI United Kingdom index having now surpassed its ACWI counterpart for total returns year to date.
And yet, UK equity sectors remain broadly unloved by fund selectors and institutional investors. According to the March 2024 Spring Budget documentation, the average UK pension allocation to the home market stands at just 6%. Meanwhile, data from the Investment Association shows the IA UK All Companies sector has been the single worst-selling sector for the last two full calendar years on the trot. And in the investment company space, the average discount of a trust in the IT UK All Companies sector stands at more than 10% at time of writing (23 May). For trusts in the IT UK Smaller Companies sector, this discount widens to 11.2%, according to AIC data.
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But Ben Conway (pictured), CIO and head of fund management at Hawksmoor Investment Management, says “it beggars belief” that so many firms have such small allocations to UK equities at present.
“We are absolutely frothing at the mouth in terms of how excited we are [about the UK], for so many reasons. I can’t believe what some other firms are doing in terms of their UK weightings,” he explains.
His comments were made at a press event, admittedly the evening before Prime Minister Rishi Sunak announced a general election will take place on 4 July.
Regardless, however, he reasons that the case for the home market remains strong, irrespective of who gains power after the summer. In fact, he later tells Portfolio Adviser that an earlier-than-expected election is positive, if anything, as it “removes the uncertainty sooner”.
“Likely for the first time ever, we have cross-party support and identification that something has gone wrong in the UK. This is so exciting; it means we are seeing lots of takeovers,” Conway says. “There have been a couple of each week in the UK, recently. However, this de-equitisation in the UK is becoming a big problem.
“Politicians are noticing; whether this is Jeremy Hunt in the Mansion House compact, telling pension funds to publish how much they have invested in the UK, or whether this is Labour’s plan for financial services. It literally reads like a manifesto from a UK equity manager.
“They are explicitly saying that the UK equity market is undervalued and this is a problem.
“To me, this is amazing, because [the market] is really very cheap – particularly in small and mid caps, and what we need to make the UK equity market vibrant again is for policy to move back in the right direction. It’s all falling into place.”
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The CIO says there are myriad reasons why the UK has been unloved, which include a torrid combination of capital-unfriendly policies, as well as more than two years of consecutive outflows from UK retail clients.
“Why is that happening? Because the big homogenous splodge of wealth management firms, which are getting bigger and bigger, are taking their equity exposure closer to market cap benchmark [weightings], and the UK is less than 4% of global market cap benchmarks. This has made the UK very, very cheap.
“The whole market is inexpensive, but there is particular opportunity in mid and small caps. This is not just a UK phenomenon, it is a global phenomenon, that the shape of markets has been changing as a result of the trend towards passive, and the trend of providing low-cost solutions through the consolidation of wealth management businesses. Because if you’re a big firm, you need to go where the liquidity is. This leaves the small and mid-cap names behind.
“Even in the US, which we believe is expensive in aggregate, there are small-cap US strategies which look cheap.”
Talented fund managers
Not only is the opportunity set among UK equities themselves tantalising, Conway says there is an abundance of “supremely talented” UK equity managers scouring the market for attractively-priced opportunities.
He cites Ed Legget and Ambrose Faulks’ £2.4bn Artemis UK Select fund as a ‘household name’ option for those looking to dip their toe into the water of UK equities.
However, he says most of the exciting opportunities reside in the small-cap value space.
“Aberforth Smaller Companies is a great example; it is run by a great team based in Edinburgh who have been running the strategy for decades,” the CIO says.
“Investment companies are also a great place to look. One of the best investment companies in UK small-cap land is Odyssean run by Stuart Widdowson. One of his largest positions was only bid for [yesterday]. He adopts a private equity-approach to public markets, identifying companies which have a high probability of being taken over.
“I could also talk about Strategic Equity Capital, another great trust run by a talented manager in Ken Wotton. An interesting one that has been more out of favour than others is the River & Mercantile UK Micro Cap, which is on a double-digit discount. It has more of a growth style and a fantastic manager.”
The importance of valuation
Conway’s bullishness towards UK equity funds ties in with his philosophy that valuation is of paramount importance.
“Valuation drives long-term returns; this is a completely uncontroversial point,” he says. “Valuation is a major explainer of returns over longer time periods. The problem with valuations over a shorter time period, is that they are useless.
“In terms of the cost of investment solutions, would you rather invest in a passive solution which costs 10 or 20 basis points, but has its largest weightings in securities that are expensive? Or would you rather invest in an active solution that costs 10 basis points more, but you’re investing in a part of the market which is cheaper? I know which one I would rather be in – the highly active solution gaining access to cheap parts of the market. Because, over the long term, I believe it will perform the best.”
He adds: “If you’re constructing your portfolios, shouldn’t you have larger weights in things that are really cheap and interesting, rather than because they’re a large part of a benchmark? Isn’t it ironic that the home bias people used to have and rightly complained about, is now being removed at the worst possible time?
“Really, in the UK, you’re spoilt for choice.”
