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What will it take for investors to return to UK equities in a meaningful way? The UK market’s relative underperformance in recent months hasn’t inspired confidence: many DFMs have been pruning positions all year.
At the very least, allocators have been content to let their domestic positions – historically the bulwark of a balanced portfolio – drift lower amid the rally seen elsewhere.
Latest statistics from the Investment Association today confirm that this isn’t an isolated trend. Net retail sales for July show another £900m was yanked from UK funds on the month, following on from £1.1bn in June. It’s not been an auspicious summer for the asset class – particularly when you consider most other equity regions saw inflows over the period.
The underwhelming performance of the main UK indices mean the market now trades on a price to book ratio of just 1.4 times, according to Bank of America. As we discussed yesterday, that’s in no small part because of the likes of financials (0.7x) and energy (0.6x).
But as a postscript to that analysis, let’s note that Capital Economics thinks a brighter path could lie ahead for UK indices even if financials continue to struggle. Putting the sector aside, some 40 per cent of the MSCI UK index is in sectors that have underperformed since the start of the pandemic. That implies a healthy upside if – if – economic recoveries can continue in the coming months.
And the problem is a pressing one for wealth managers. Their preferred UK growth funds have done a good job at beating benchmarks (and peers) again this year. But they’re all well behind the MSCI World on a one, three and five-year view. Whether or not a UK rally materialises, some selectors may start to wonder whether better options lie elsewhere.
Covid-19 isn’t the only hurdle for equity markets this autumn. Brexit is starting to occupy thoughts once again. And so, too, is US politics. Betting markets are increasingly pondering the prospect of a second term for the Trump administration, despite the latest round of data suggesting the president’s polling bounce is over for now.
Either way, there’s anticipation that bumpier times are nearing. October Vix futures are now back above the highs reached in March. And it’s not just politics causing concerns. When compared with its S&P 500 equivalent, the Nasdaq volatility index is particularly elevated. That, and recent price action for shares like Apple and Tesla, indicates more nervousness over the outlook for tech shares.
The pace of August’s rally perhaps made a reaction inevitable. Baillie Gifford’s own rules on holdings limits have prompted the fund house to cut its Tesla stake last month.
The question for allocators, then, is whether equities and volatility can keep moving higher in unison. This isn’t a common phenomenon, but the lessons of recent years suggest shares can rise in tandem with most other metrics you might care to consider.
SocGen’s equity derivatives team note that most of the recent rise in US volatility is down to a rise in the price of call options. Put option contributions have remained relatively stable - implying the volatility increases are more to do with investor FOMO than concern about a sharp reversal. But whether that’s any healthier for the market’s short to medium-term prospects is debatable, at best.
Returning to the fray
Absolute return fund blow-ups have been a regular feature of Asset Allocator since our launch almost two years ago. Problems have been around long before that – it was 2016 when net outflows first began to soar for Gars – but the sector’s travails have become more widespread over the past 24 months.
So it’s perhaps notable that July saw net outflows for the sector as a whole dip below the £100m mark for the first time since June 2018. Redemptions stood at a mere £5m on the month. This drop is likely to indicate a simple exhaustion of outflows, rather than faith being restored. But that’s the first step on the path to recovery. For those strategies whose reputations haven’t yet been irredeemably damaged, renewed sell-off concerns represent another chance to prove there’s life in the sector yet.