Could the UK stock market experience an upturn in fortunes?

Until very recently the UK equity market has lagged a long way behind global markets. A renaissance is possible, but it also may be cheap for good reason.

| 10 min read

The ‘Everything Rally’ of 2021, triggered by central bank’s creating more currency to fund government deficits, has helped the MSCI World index of global stock markets provide a third consecutive year of double-digit returns. Until very recently, the UK equity market has lagged a long way behind.

The decision to leave the EU in June 2016 was the start of a sustained period of underperformance for UK equities, but perceived political risk has only been a part of the story. The market has had a huge structural disadvantage in terms of its sectoral structure.

Quantitative easing and negative real interest rates in the 13 years since the global financial crisis has not favoured banks (the biggest sector at 20.2% of the FTSE 100 in 2007), the rise and subsequent bursting of the commodities super-cycle was terrible for miners (16.0% weight in 2011) and the coronavirus pandemic impeded energy firms (18.7% weight in February 2020).

Additionally, at the start of the pandemic, technology was a mere 0.7% weight in the FTSE 100, but in the US it was, and is, by far the dominant sector. The UK has simply not had have enough large, innovative tech stocks of sufficient size at a time when disruptive growth took over the world. It is pretty much the antithesis of the Nasdaq, the US tech and growth company index.

Table: Discrete Calendar Year Performance of UK and global indices over discrete calendar years and year to date 2022

Year Performance of UK table

Past performance is not a reliable indicator of future returns. Figures are calculated in £ on a % total return basis, bid to bid price with net income reinvested; Source: FE Analytics, data for 2022: 31/12/2021 to 24/01/2022.

Cheap and unloved

The international consensus of the UK market remains gloomy. It is widely seen as a graveyard of old fashioned companies: obsolete oil majors, polluting miners, staid banks and legacy telecoms. Even the UK’s pharmaceutical giants underperformed their global peers in another pandemic year. Valuations reflect this view. Ian Lance and Nick Purves at Temple Bar Investment Trust calculate that UK equities are still trading at the greatest discount to world equities for fifty years (around 40%) and UK value stocks are still at the greatest ever discount to growth stocks.

Many other managers we have spoken to in our recent UK sector review have highlighted the varied opportunities they are seeing. As was once famously put, “Successful investing is about having other people agree with you … later.” So, could the unpopular UK stock market experience an upturn in fortunes?

In 2022 thus far, the UK has been one of only a handful of developed markets to hold up reasonably well, as its bias towards Banks and Energy companies has benefitted performance. This is a very short period, but if inflation proves to be more than transitory, interest rates rise, supply chains become more localised and globalisation recedes, then the UK market could, at least in relative terms, sustain this outperformance. It represents an island of relatively cheap valuations and has a sector structure better equipped to cope with a rising rate environment.

Yet a continuation of the low-rate, easy money regime we have seen for the past decade would tend to favour other markets, notably the US. It is also possible that many larger UK companies in areas such as Oil & Gas and banking will, ultimately, come under renewed pressure from challenging, disruptive trends such as the pivot to green energy and digital transformation. Although the market appears cheap there may be good reasons for it.

Private buyers have taken notice

Looking beyond macro-economic considerations, there are some signs that private buyers at least see value in the UK market. Takeovers of British companies hit their highest level since 2007 during 2021, led by food seller Morrisons and aerospace company Meggitt both which were the subject to multi-billion-pound deals. According to data compiled by Refinitiv, the value of deals involving UK companies was $630.8bn, the highest number since 2007 and involved 6,926 UK companies. Perhaps we will see more of this and even businesses being taken private by founders or families too. Lindsell Train, manager of Finsbury Growth & Income IT has ended up owning 2.2% of car seller Cazoo after press baron Lord Rothermere recently took the Daily Mail and General Trust private.

A further sign that the UK may not be quite the global basket case that many overseas-based commentators think it is can be found in the IPO market. 2021 was a bumper year for raising equity capital via flotations. London has raised more equity capital for newly listing businesses this year than at any time since 2007. A total of 122 companies listed on the main market, raising £16.8bn, up from £9.4bn in 43 floats in 2020, according to the London Stock Exchange Group. That made London the biggest single source of capital outside the US and China.

Fund options

There is no shortage of UK equity funds available. Here is a small selection from our Preferred List compiled by our Collectives Research Team for those looking to add UK exposure.

They are provided for your information but are not a guide to how you should invest. Before investing in any fund please read the relevant Key Investor Information Document or Key Information Document, and Prospectus to ensure they meet with your objectives and risk appetite.

iShares Core FTSE 100 UCITS ETF

If you are invested in a global index tracker you won’t have much exposure to the UK – about 4% most likely. For straightforward and low cost access specifically to the UK market this ETF is highly competitive with an all-in annual cost of around 0.09%.

The objective of this fund is to track the performance of the FTSE 100 Index, representing the 100 largest UK listed companies, as closely as possible after allowing for charges. It is 'physically replicated', holding all the same stocks as the index, and has low charges and a strong record of closely following the index. Owing to its size it tends to be easy to trade with a tight trading spread between the buy and sell prices.

There is an income version for those wishing to receive dividends (paid quarterly) rather than reinvest them.

Man GLG Undervalued Assets

This fund adopts a disciplined approach to value investing with an emphasis on financial strength. By focusing more on the current shape of the balance sheet the managers target companies whose share prices they believe do not fully reflect their ‘intrinsic’ value or those whose profit streams are undervalued.

It is dynamically managed, with assets sold as they come to be priced at what the managers considers to be fair value and replaced with fresh ideas in cheap territory. To guard against buying ‘value traps’, the team also like to see good cash generation and operational momentum before investing. The portfolio currently has a tilt towards economically sensitive areas with heavy weights in the energy, materials and industrials sectors.

JOHCM UK Equity Income

This fund aims to achieve long-term capital growth and to generate a dividend yield that is above the FTSE All-Share Index average from owning a portfolio of UK equities. Managers Clive Beagles and James Lowen seek to invest in fundamentally strong companies at an attractive price, meaning growth opportunities as well as relatively high starting yields.

We like the repeatability of their process, which is always forcing the managers to look where value exists in the market, and their willingness to own both large and small companies to create a ‘best ideas’ fund that covers most of the market spectrum.

Mining remains a key plank of the strategy with 15% allocated, banks are around 13% of the fund and Oil & Gas is 11%. Whilst yield is the first criterion assessed it is by no means the only one as each position has to have capital appreciation potential. Currently the managers’ themes include ‘underappreciated’ growth companies exposed to the energy transition (mining), green energy (utilities), rising global infrastructure spend and logistics. For those looking for income, the yield is 3.9& (variable, not guaranteed). Please note ‘income’ units pay out income and ‘accumulation’ units reinvest it.

FTF Franklin UK Smaller Companies

Smaller companies are an exciting, albeit higher risk, area and one that can add important diversification to a portfolio. This smaller companies fund is managed in a pragmatic fashion and contains a good balance of smaller companies, from growth-orientated businesses to potentially under-appreciated ‘value’ names.

It’s concentrated – meaning it has a relatively small number of holdings – which increases the impact of each holding on performance and can lead to meaningful sector-beating returns if the managers get their stock selection right. Of course, the reverse is true if they don’t. In addition, we believe the fund benefits from its smaller size, which allows it to invest flexibly across the range of opportunities in the smaller company universe.

This fund has done a good job in capturing the growth and dynamism of the market, albeit with a more conservative valuation discipline than some of its peers, and has made good use of the IPO market recently. Seven out eight companies added to the portfolio over the past year were new listings.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

Could the UK stock market experience an upturn in fortunes?

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Investment decisions in fund and other collective investments should only be made after reading the Key Investor Information Document or Key Information Document, Supplementary Information Document and Prospectus.

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