20th May 2022
As understatements go, the assertion that “UK equities are unloved” must be right up there. The asset class has been deeply out of favour for many years, partly as a result of significant events such as Brexit and partly as a result of index composition and the market’s heavy exposure to unfashionable energy, mining and financial stocks. Net flows out of UK equity funds have been relentless with over £25bn pulled since January 2016. Overseas institutional investors have not exactly been chomping at the bit either with the UK perennially appearing as an ‘underweight’ in Fund Manager surveys.
The latest macro concerns regarding inflation and economic growth have catalysed another wave of selling with the £6.5bn of net outflows experienced in the last 8 months, exceeding even those seen in the period after Brexit. Although the UK is the best performing major equity market so far in 2022, leadership has been incredibly narrow with the broader picture characterised by ongoing negative sentiment and indiscriminate selling.
Such an environment can create opportunities for contrarian minded, valuation conscious investors such as ourselves. We have spent the last month or so speaking to many UK equity managers and the message has been pretty much uniform. Namely – the opportunity set posed by the UK market today is as compelling as it has been in a long while. This seems somewhat at odds with the deteriorating macro data and negative headlines, but the overriding impression is that valuations – particularly for cyclicals and domestic earners – have already moved to price in a pretty dire macro scenario. Large swathes of the market are trading at cycle low multiples resulting in abundant value opportunities for active stockpickers. This is not necessarily about buying bombed out deep cyclicals where survivability and questions marks over future earnings are entirely valid. In a classic case of the baby being thrown out with the bath water, indiscriminate, macro driven selling has seen cash generative businesses with sensible balance sheets and robust profitability de-rate to unusually low multiples.
We accept that valuation is not a particularly good timing tool and that already cheap stocks could get cheaper, particularly if the economic news flow continues to disappoint. We do, however, believe that the price paid for an investment is the most important determinant of subsequent long run returns and believe that the compelling valuation support enjoyed by the actively managed UK equity funds we own leave them well set to deliver attractive positive returns over the medium term. If public market investors are not willing to grasp the valuation opportunity that exists today, it seems private equity and the companies themselves are. PE led takeovers of listed UK companies at material premiums continue to increase unabated, whilst management teams are busy deploying excess cash to buy back their own shares.
‘De-equistation’ led by sophisticated investors and companies who know their businesses best, combined with the table thumping of our most trusted managers (i.e. not the perma bulls who only ever talk their own book) helps vindicate our positive view regarding the likely future returns available from parts of the UK equity market. Valuations are attractive and offer a significant margin of safety, giving us confidence that going against the grain when it comes to UK equities will be a rewarding decision.
Ben Mackie – Fund Manager
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