It’s (more than) fair to say UK equities have been unloved over recent years as investors wary of turmoil have stayed away. But is it time for a renaissance in interest in our domestic market? Calmer waters suggest yes.
The UK has suffered a whole host of volatility-provoking events since Brexit through to more recent political scandals, and investors have responded by exiting UK equity funds en masse: the Investment Association recorded net outflows of £1.45bn from UK funds in January and a further £1.55bn in February.
That said, the UK is home to both market-leading global franchises as well as compelling opportunities further down the market cap scale, and the sector as a whole is arguably now undervalued relative to its peers.
Good opportunities at cheap valuations
Alexandra Jackson, manager of the Rathbone UK Opportunities fund, pointed to the exodus of capital from UK equities having had a remarkable effect on stock prices, with the UK stock market trading at a significant discount to the rest of the world. “The UK is the cheapest developed market out there,” she said. “The UK trades on around a 40% discount to global equities and I think that’s quite a nice starting point.”
And while some like to say the UK stock market is not comparable to other markets due to its heavy weight in resources and banks, even sector-adjusted the discount remains.
Alessandro Dicorrado, co-manager of Ninety One’s UK Special Situations fund, says, “these low valuations offer opportunities”, and he cautions against forgetting the UK stock market which has traditionally offered investors a disproportionate share of the investable companies to be found in Europe.
“These do not only include some solid domestic businesses, but a good number of companies that do most of their business internationally, often leaders in their sectors with significant growth prospects,” he said.
However, their UK listing today means that they are valued at a significant discount to their global peers, and Alessandro thinks this offers an opportunity to investors to buy them cheap.
Good news on a macro level
At a macro level, after a good few years’ of turmoil, the UK actually has quite a few things going for it politically right now, and Neil Veitch, manager of the SVM UK Opportunities fund, welcomed a political landscape that “for once, is relatively becalmed”.
The latest Spring Budget came and went without the market or the currency collapsing and even featured some much needed supply-side reforms, he pointed out, and the Windsor framework has helped reset relations with the EU and helped lower needlessly inflamed relations with our closest trading partners.
There are also less-heralded policies with the potential to boost the UK’s attractiveness as a place to do business. Neil noted, for example, plans to streamline clinical trial approvals in an attempt to make the UK a more attractive destination for trials.
Looking ahead, a general election in 2024 contested between parties led by Rishi Sunak and Sir Keir Starmer “is unlikely to set investor nerves jangling”, he added, meanwhile currently, “unlike the US, where regulators appear to have been somewhat asleep at the wheel in the monitoring of the funding structures of small and mid-sized banks, the UK banking sector is well-capitalised and well regulated”.
Spotlight on UK smaller companies
Throwing the spotlight onto smaller UK companies, this sector had a particularly challenging 2022, as SMEs dealt with multiple headwinds including spiking inflation, labour shortages and subdued consumer demand.
But even in this battered part of the market there are opportunities, according to Eustace Santa Barbara, co-manager of IFSL Marlborough Special Situations, which mainly invests in UK smaller companies.
“The reality is that the majority of companies we hold in the fund are continuing to trade strongly and we believe they have very strong long-term growth prospects,” he said.
He believes last year’s sell-off has created “a rare opportunity to invest in outstanding businesses at significantly lower valuations”.
Eustace is holding companies with strong long-term growth prospects that he believes look significantly undervalued at current share prices, like Cranswick, for example, a leading UK food producer, supplying meat products such as pork, sausages, and bacon.
“We like Cranswick’s strategy of long-term reinvestment in the business, with this capital used for acquisitions, expanding production facilities and diversifying into new areas,” he said. The company has steadily grown revenues, earnings and dividends and looks highly attractive for investors taking a long-term view.
Smaller companies are often a bellwether and are usually the first to benefit from an improvement in the economic climate, which, with the UK marginally avoiding entering a technical recession with GDP data beating expectations in Q4 2022, could be on the cards – despite the IMF’s gloomy predictions.
“If the economic picture does begin to brighten, we’d expect smaller companies to lead the way in an environment of improving investor confidence,” he said.
The better-than-expected GDP figures showed there is clearly some resilience within the UK economy. The next 12 months are likely to be difficult. But with the market giving that back to investors in the form of lower valuations, brave bargain hunters could pick up some good deals right now among good companies trading cheaply.
