EquitiesOct 24 2019

UK equities are out of favour

Supported by
JP Morgan
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Supported by
JP Morgan
UK equities are out of favour

Sometimes they are loved; sometimes they are not. And UK equity funds are currently being shunned, according to Investment Association (IA) statistics.

The IA’s recently published figures on how savers invested in August show that UK equity funds waved goodbye to nearly £700m in net retail outflows.

They were not alone, as all regions experienced significant outflows that month, apart from the US, which enjoyed net retail sales of £70m.

But even with Europe close on its heels at £536m, the UK equity-fund outflows were considerably bigger than the others.

 

And UK equity funds’ unloved status is not a blip. So, just why are investors deserting UK equities in droves?

In the IA’s previous month’s report, Mr. Cummings alluded to the spectre of political turbulence, as he commented: “Appetite for stocks and bonds was poles apart in July 2019, as savers looked to weather the ongoing political and economic uncertainty by diversifying their investments and seeking out safe haven assets.”

 The political turmoil makes it easier for asset allocators to shun the UK Edward Park, Brooks Macdonald Asset Management

Looking at the UK in particular, Mr. Cummings added: “Investors reacted to the ratcheting up of uncertainty in the UK, triggered by the change in political leadership, by taking £1.2 bn from UK equity funds”

So, are there reasonable grounds for this UK-equity exodus, or are investors perhaps being over-fearful, in the face of the UK’s forthcoming break away from the EU?

Fear and anxiety

“It makes sense for people to be fearful,” says Edward Park, deputy chief investment officer at Brooks Macdonald Asset Management:

“And the political turmoil makes it easier for asset allocators to shun the UK. They are not being foolish; there are cheap valuations elsewhere.” 

Chartered financial planner, Keith Churchouse, of Chapters Financial also believes that anxiety is a contributing factor, as he comments: “The key word is ‘fear’.

“The majority of the UK are concerned or fearful for the future because of Brexit.”

He adds: “We believe the markets have largely factored in the Brexit position. But for the ‘man on the street’, equities have had a good run and there are profits to take, so they are taking them while they can, because the UK is going to have a tough time.

“I would also query whether there has been a ‘Woodford effect’ on UK equities and UK equity funds,” says Mr. Churchouse, reflecting on the demise of Woodford Investment Management and the impact on investors.

Summing up, he concludes: “This move away from UK equities is sentiment driven by fear.” 

However, it is possible that the focus on the UK’s woes may be considered overdone.

Iain Wells, co-manager of the Kames UK Equity Income Fund points out that there is also plenty of geopolitical and economic pain in other parts of the world.

He says: “One might question if the same investors avoiding the UK are ignoring major issues in their own backyards: the US/China trade war, weakening growth in Europe, the limits of central-bank intervention and moves to impeach President Trump are just a few.”

Contrasting these with the UK’s Brexit troubles, he emphasises: “It is not very pretty elsewhere.”

Regardless of what is happening elsewhere in the world, the outlook for UK companies is not necessarily one of unremitting doom and gloom anyway.

Tineke Frikkee, head of UK equity research at Waverton Investment Management comments: “Whilst the ultimate impact of Brexit is uncertain and may remain so for a number of years, it is highly probable that the majority of UK listed companies will get through these turbulent times.”

Buying opportunities

So, what about valuations? If these are depressed, what is the view on buying opportunities?

Ms Frikkee perceives some possibilities, as she explains: “Both large and mid-sized companies are on a price/earnings (P/E) ratio of 12x, with a 5 per cent and 3.9 per cent dividend yield respectively.

“The P/Es of the indices are not at 2008/2009 levels (7.5x), but overall look attractive. Within these indices, many domestic UK companies have become very cheap, such as retail, housebuilding, leisure, property, banking and insurance, but also global cyclical sectors such as mining and oil and gas.

“For those investors that can withstand high volatility for the next six months or so, there are very good buying opportunities of decent businesses with balance sheets that can support dividend and free cash flow yields between 8 per cent to 10 per cent.”

James Illsley, Portfolio Manager for the JPM UK Equity Core Fund & JPM UK Equity Plus Fund also sees potential opportunity, as he explains: “Brexit has created a great deal of uncertainty which has led investors to persistently reduce exposure to the UK equity market.

“We would argue that this has created a once-in-a-lifetime valuation opportunity with UK equities looking extremely cheap compared to other equity markets and other asset classes. For example, the yield gap between the yield on 10-year gilts and the dividend yield of the UK equity market has only been wider around the time of World War I.”

Mr Illsley therefore suggests that market jitters could be excessive, as they observe: “We would argue the market is being far too fearful.

"Whilst Brexit is causing uncertainty, it is hardly comparable to the World War I era and therefore we see a fantastic opportunity to invest in the UK.

“Further, the UK equity market is as cheap as it has been for 30 years when compared to the world equity market. We believe that any certainty on Brexit will lead to a reallocation to the UK and the valuation discount to close, driving strong returns for bold investors.”