Has UK PLC become uninvestable?

It details the significant events of the character over seven days of his life, with a major life event taking place on each day.

It comes to mind because, at the time of writing, it has been seven days since the UK’s "mini" Budget was announced by chancellor Kwasi Kwarteng.

Since then, we have seen the UK economy spiral downwards as a wave of sweeping tax cuts to promote growth in the country’s spluttering economy have been met by concern from all quarters. This includes a stinging rebuke from the International Monetary Fund, which raised concerns the moves will increase inequality and counteract the Bank of England’s monetary policy.

Much like Solomon’s life, every day has been a new drama. We have had anarchy in the bond market; the pound slide to record lows versus the dollar; fears that house prices could fall as much as 15 per cent; predictions that interest rates could hit 6 per cent; fixed rate mortgages withdrawn at unprecedented speed; and the BoE stepping in to buy huge amounts of debt to shore up prices amid fears of insolvencies in pension funds. 

The only difference is, seven days later Solomon was dead and buried while this “attempt to promote growth” is still being pushed hard by the UK government.

How has this impacted the UK economy?

A lot of column inches have been dedicated to this fiasco, but I think the one that stood out to me was the comparison of the UK economy to an emerging market.

As Schroders senior European economist and strategist Azad Zangana points out, it is very rare – and incredibly negative – that we see interest rates coming up in markets and the currency falling at the same time, especially in a developed market. 

Those that worry the UK has become too much of a horror show to invest in are wide of the mark.

He says the uncertainty around the pound obviously puts off a lot of international investors. However, at the same time, the government has taken some significant steps to try to make the UK a more attractive place to invest, by cancelling the rise in corporation tax and by getting rid of the additional rate of income tax.

From an economic point of view the UK does not look good today – to say the fiscal stimulus has been poorly received by the market would be an understatement. That is not just the stock market, which has actually been quite resilient, but the bond and currency markets too. I was staggered by some of the substantial losses in the former, particularly long-dated gilts.

Value in UK equities

But I do feel those that worry the UK has become too much of a horror show to invest in are wide of the mark. We must remember the UK is still home to great companies, as well as huge amount of overseas and dollar earners.

As Alex Savvides, JOHCM UK Dynamic fund manager, points out, the FTSE 100, in parts, is ludicrously cheap. There is not just value but deep value, where he targets companies with management or strategic change taking place or hidden growth.

He says the soaring inflation narrative has made an index of old-world stocks like energy, pharmaceuticals, materials, banks, insurance companies and telecom stocks look more attractive at a time when value is no longer a dirty word.

I would expect M&A activity to surge from here with a lot of US private equity investors sitting there with huge sums of cash.

He adds: “Asset managers now see large, established and highly cash-generative companies with real asset bases and real market positions being aggressively managed for change to fight the successive and often existential threats they might face.

“Regardless of the fear and mistrust with which the market is meeting the new government's economic policies, there is no doubt that the policies are hugely supportive of UK corporate profitability, UK investment and UK growth. So coupled with the record low valuations, I have no hesitation in continuing to back UK PLC.”

Vincent Ropers, TB Wise Multi-Asset Growth manager, says sterling volatility is likely to make UK companies more attractive to foreign investors; a trend that was already appearing prior to the "mini" Budget, courtesy of the valuation discount on UK equities, coupled with the strength of the US dollar.

However, he warns now is not the time to take big bets given any view on FX or bonds can be turned on its head quickly by quantitative easing.

Could mergers and acquisitions surge?

I talked in this column last month about the battering the UK small and mid-cap sectors have taken in 2022, down 28 per cent and 25 per cent respectively year-to-date. Both are now looking incredibly cheap, so I would expect M&A activity to surge from here with a lot of US private equity investors sitting there with huge sums of cash and aided by a strong dollar.

Matthew Tonge, Liontrust UK Micro-Cap co-manager, says it is understandable that the market might be concerned that mid and small-caps in aggregate might be disproportionately affected by the problems faced by the UK’s domestic economy.

Pessimists would say we have been talking about these discounted valuations since 2016, but the fact is they remain prominent.

He says while the companies they hold are not immune to the contraction, they have been re-assured by their resilience. He adds that pricing power is likely to prove critical in dealing with cost pressures, which look set to persist, with cyclical companies with low barriers to entry and weaker balance sheets set to feel the pain more than most.

We must be pragmatic on this and view UK equities over the long haul. There are major international earners, resilient UK small and mid-caps and leading dividend payers all heavily discounted due to this uncertainty.

Pessimists would say we have been talking about these discounted valuations since 2016, but the fact is they remain prominent. The game has changed, investors should not expect dramatic returns over three years, but these aforementioned benefits should be felt by those patient enough to hold UK equities for the next decade at this entry point.

Three funds to consider

Rock solid income and exposure to FTSE 100

1. Artemis Income: This fund has been a stalwart of the UK equity income sector for more than 15 years. Managers Adrian Frost, Nick Shenton and Andy Marsh focus their analysis on a company’s cash flows and how this will drive future dividends.

The stocks they will buy will have a strong franchise and offer a unique product or service. Meeting management is also an essential part of the process.

The fund, which is predominantly large-cap in focus, is an ideal all-weather fund that has consistently done its job over a long period.

The multi-cap option

2. ISFL Marlborough Multi-Cap Growth: Richard Hallett invests in the UK’s leading growth businesses, irrespective of size. He initially identifies long-term structural growth trends and then invests in the strongest market-leading businesses benefitting from them.

Despite the fund’s excellent long-term performance, it has gone under the radar of most investors. With a concentrated portfolio of 50 holdings, the portfolio has benefitted from its growth investing style, though this has become a headwind more recently.

The value play

3. JOHCM UK Dynamic: Having run this fund since 2008, manager Alex Savvides’ process is all about corporate change as he scours the market for undervalued companies that are making positive improvements to their businesses.

Savvides has historically held several mega-caps, which he says are often overlooked by other investors. We view him as a top UK manager with an excellent track record, despite facing some style headwinds.

Darius McDermott is managing director of Chelsea Financial Services & FundCalibre