For the past decade, there has only really been one show in town for investors - US equities. The S&P 500 has been the best performing equity market among its global peers in six of the past 10 calendar years* and, even when it hasn’t topped the table, it has still managed to produce positive returns of between 6-26%*.
This has resulted in cumulative returns of 337% over the decade**, with its nearest rival Europe posting returns of 238%**. The UK, emerging markets and China have returned far less at 99%, 89% and 68% respectively**.
Perhaps unsurprisingly, this resulted in investors flocking to the US stock market and in 2021 inflows into US funds were more than the total invested in the previous 19 years!
According to Ian Lance, co-manager of TM Redwheel UK Equity Income fund, this was caused by monetary policy. “The Federal Reserve was founded in 1913,” he said. “It took them over a hundred years to put the first $4 trillion of debt on its balance sheet and 18 months to do the next $4 trillion.
“The zero interest rate policy and quantitative easing caused an epic bubble in equities and the party only stopped when inflation reared its head.”
Now monetary policies are reversing, Ian believes that it is an excellent opportunity for UK value.
“There are five reasons for my optimism,” he said. “Firstly, value performed well in the last period of inflation in the 1970s and growth did badly.
“Secondly the UK market is still a very cheap market - it is now around a 38% discount to the MSCI World index, when a 17% discount is the long run average.”
Hugh Sergeant, manager of ES R&M UK Recovery agrees with this point. “UK shares are really very cheap now,” he said in a recent update. “UK small and mid-cap stocks are on bargain basements valuations and any equity that has uncertainty associated with it is very depressed.”
And Michael Stiasny, head of UK equities at M&G Investments, is also of the same mind saying that “the recent strong performance of the FTSE 100 index is only just turning the dial on the multi-year valuation discount between the UK and the rest of the world.”
“UK equities still look historically cheap on a relative basis to global peers and, even with the headwinds, we continue to see excellent relative value across the UK with the mid-cap part of the market hit particularly hard but masked by the strong performance of their largest peers,” he said.
This brings us nicely onto Ian’s third reason: “The UK tends to outperform in risk off periods. Over the last 20 years, the UK has had the highest probability of outperforming when global stocks were falling.”
And this fact is borne out by a chart shared by Luke Newman, co-manager of Janus Henderson Absolute Return fund, in his quarterly update. In it you can see quite clearly that UK equities have been the strongest performers year-to-date as stock markets have struggled and the US has been the worst.
Source: Refinitiv Datastream, Janus Henderson Investors, year to date to 25 May 2022. China: Shanghai SE Composite Index, France: CAC 40, Germany: Dax, Italy: FTSE MIB Index, South Korea: KOSPI, Spain: IBEX 35, UK: FTSE 100 Index, US: S&P 500 Composite Index, Japan: Nikkei 225 Index. Past performance does not predict future returns.
Ian’s fourth reason is that UK stock market performance is correlated with value because it is a value market, while the final reason is that income has once again become a crucial factor for total returns and the UK stock market has the highest yield at 4% today.
There are several funds investors can consider if they want to invest in UK value. Here, we give four examples:
The first example is Man GLG Income, which is on the Chelsea Core Selection. It has a value-driven approach, and its flexible mandate allows the manager to find value in parts of the income market many other managers may ignore, such as smaller companies. We also like the fact that the manager can, and will, invest in a company's bond, rather than its equity, if he feels the risk/reward characteristics are more favourable.
Next up is CT UK Equity Income (previously called Threadneedle UK Equity Income), a contrarian value fund managed by the highly experienced Richard Colwell, who looks for unloved companies with the ability to sustainably grow their dividends. Richard is a proper stock picker and will own what he likes and not simply what is popular. He will hold a combination of solid cash generative companies, and some recovery stocks to deliver income and capital growth for investors.
Another option is Schroder Income, a deep value-driven fund that invests in companies valued at less than their 'true' worth and waits for a correction. It has little correlation with other income funds, tending to avoid the big income producers in favour of more niche names, where both capital as well as income can grow significantly.
And finally, there is GAM UK Equity Income. It invests in companies of all sizes – from the very small and those listed on the AIM stock market, through to the FTSE 100. The manager believes dividends are the most important driver of total returns and while he is targeting a yield higher than that given by the UK stock market, he is also looking for steady dividend growth. The manager can invest some money in a company's bond if he feels the opportunity is better.
*Source: FE fundinfo, total returns in sterling, calendar years 2012 to 2021, comparing the FTSE All Share, MSCI Asia ex Japan, MSCI China, MSCO Emerging Markets, MSCI Europe ex UK, S&P 500 and the TOPIX.
**Source: FE fundinfo, total returns in sterling, ten years to 2 August 2022.
***Source: Redwheel, Bank of America, 25 November 2021
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the fund managers and author and do not constitute financial advice.