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Are UK stocks still being treated like riskier emerging markets?

21 January 2020

With the FTSE 100 index having significantly underperformed its international peers until recently, Trustnet asks whether have UK stocks are still priced too cheaply?

By Eve Maddock-Jones,

Reporter, Trustnet

UK stocks are currently being valued and viewed as if they were an emerging market rather than as one of the bigger and more developed markets, but could things now be about to change following the Conservative general election victory?

Kleinwort Hambros chief investment officer Mouhammed Choukeir said that until recently the UK market has been treated like an emerging market in terms of its pricing and investor outlook.

“If you think of investing in emerging markets, it’s typically investing in countries that have big geopolitical uncertainty,” Choukeir said. “It's typically investing in countries that have high risk premium.

“You think of emerging markets you think of places that are largely unloved or people are fearful of them. People don't want to be investing there because it just feels too risky.”

However, if you take those three dynamics – geopolitical uncertainty, low valuations and unloved sentiment – said Choukeir, a picture of the UK begins to emerge.

The UK has been an in-and-out of favour with investors since the 2016 EU referendum where the unexpected ‘Leave’ result caused some investors to eschew the UK market.

The uncertainty that has persisted around Brexit has been enough to keep many international investors away.

Performance of the FTSE 100 versus S&P 500 since the 2016 Referendum

 

Source: FE Analytics

Whilst the UK could be seen by some as an emerging market on some measures, investors do not have to worry about some of the structural weaknesses of a real emerging market.

Instead, investors get the upside of what is essentially an emerging market trade, said Choukeir, but with the structural elements of a developed market such as rule of law and strong corporate governance.

“The UK market is one of our favourite themes for this year, specifically the mid-caps within the UK, partly for those reasons,” he said. “You get an unloved asset that has a lot of uncertainty but with attractive valuations.

“So that's really, the way to think about investing in emerging markets is if you're getting the valuations right then you're getting compensated for the risk and the UK presents that value right now in the global space.”

One global equity investor who decided to take on emerging market UK last year was David Harrison, manager of the £11.1m Rathbone Global Sustainability fund.

Harrison (pictured) said: “From a financial point of view it hurt over the last summer having a big UK overweight.

“Compared to some of the other global managers, I was a lot more overweight [domestic stocks] and they just had nothing in the UK.”

Almost doubling his UK exposure from 6 per cent to 11 per cent in August. Harrison said he moved overweight at a time when “everyone had thrown the towel in, and I just thought ‘it’s too cheap’.”

This UK overweight and US exposure helped drive the fund’s performance last year, said Harrison, as it went from being a third quartile performer to one in the top quartile.

Performance of fund vs sector & benchmark since launch

 

Source: FE Analytics

“I hear other global managers saying ‘I wouldn’t touch the UK’,” added Harrison. “But we just saw that the value was there and I still think that the value is there.

“I think that this year the UK could be really interesting.”

Indeed, the tide of anti-UK sentiment may now be about to change in the wake of the “Boris Bounce” according to Rob Morgan, pensions & investment analyst at Charles Stanley.

The Conservative party landslide victory in the 2019 general election removed the risk of a less market-friendly, Jeremy Corbyn-led government while also providing some clarification over Brexit, according to Morgan.

But whilst there is still the risk that “tariffs and trade friction could still be damaging, it does mean there is the potential for uncertainty to lift further and boost the market, which remains good value on a variety of measures,” Morgan added.

“For instance, the dividend yield gap between the FTSE 100 and 10-year gilts has never been wider. UK equities are also trading at a generous valuation discount to their global equivalents – notably Europe and the US,” he said.

“Sterling has recovered some lost ground, it remains cheap on a trade-weighted basis and this is likely to be a draw for overseas investors – and for M&A.”

He added: “A combination of an uptick in business activity and the government’s sizable spending plans could support a reacceleration of growth this year and provide reason for sentiment to improve.”

One fund that Morgan said could benefit from this is the “lesser-known” GVQ UK Focus fund, a £238.1m private equity-style strategy overseen by FE fundinfo Alpha Manager Jamie Seaton and deputy manager Oliver Bazin.

Investing in up to 35 small- and medium-sized UK businesses Morgan said that the fund has a low turnover of holdings, is focused on buying high-quality companies with high and sustainable cash flows.

Performance of fund vs sector & benchmark over 3yrs

 

Source: FE Analytics

Over the past three years, the fund has underperformed both the FTSE All Share benchmark (up 46.45 per cent) and the IA UK All Companies peer group (46.64 per cent) with a total return of 41.97 per cent. The fund has a yield of 2.41 per cent and an ongoing charges figure (OCF) of 0.98 per cent.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.