Sheridan Admans looks at some investment opportunities in "underdog" funds.
Cheering on the underdog
Cheering on the underdog is as typically British as eating fish & chips or putting on the kettle in a crisis. In this month's funds article I am going to put forward why now could be a good time to increasing your exposure to UK investments
Money leaving UK investments
In the last twelve months the Investment Association (IA), (the trade body that represents UK investment managers), highlights that the UK Equity Income funds sectors appeared 2 times as the worst selling sector by net sales and the UK All Companies appeared 5 times, collectively appearing 7 out of 12 times over the year. Looking at the data annually, over the last 10 years the UK All Companies sectors appeared 7 times. This suggests that UK investors have been diversifying their portfolios for some time away from UK equities. IA data shows that investors have pulled £5.5 billion from UK equity funds since June 2016.
Pessimism among UK and overseas investors has seen the UK become the most unloved developed market to invest in, helped in recent years by questions over Brexit, UK politics in general and its position on the world stage.
Sentiment towards the UK has got so bad that now might be a good entry point for contrarian and value investors to start increasing their stake back in UK equities.
There is now clearly obvious divergence between UK equity income and that of the rest of developed market income. Until late 2016 – early 2017 the indices highlighted showed strong correlation before the FTSE All Share (the orange line) diverged. This divergence now arguably demonstrates that investors should be, in part, compensated by income returns for the extra risk currently associated with investing in UK income stocks.
I purposely used the FTSE All Share index and not the FTSE 100, which is traditionally used to show income returns, as opportunities exist throughout the UK market cap spectrum for investors seeking income.
UK, US, Europe and Developed Market Equity Index Returns
Investing in UK companies provides investors with great exposure to overseas opportunities the FTSE 100 for example generates around 75% of its revenues from overseas operations. Also current valuations make the UK a ripe hunting ground for overseas predators. The mid-cap, FTSE 250 over the longer-term provides better growth opportunities and not only gives investors great exposure to the domestic economy but like the FTSE 100 generates a significant proportion of its revenues from overseas, approximately 50%. My point is that UK investing can still give investors a significant exposure to overseas opportunities.
There is certainly no denying that headwinds remain; wage growth is below the rate of inflation (as seen in the chart below) and has been since the end of 2016. However, it is assumed by economists and the Bank of England that inflation will fall nearer the 2% target by year end as the transitory effects of a weaker Sterling and a higher oil price fade, which should see wage growth higher than inflation once again. The effect of this should provide a boost to the UK consumer and their ability to spend has a significant impact on the health of the economy and its ability to grow.
UK CPI (inflation) v UK Wage Growth
Other reasons to be a little less pessimistic; the wheels don’t seem to have come off because of Brexit, the forward P/E on the All Share index is around 13 to 14 times earnings well below the long-run average and rates are still likely to remain below historical norms for some time to come.
While Brexit is likely to be a drag on investor confidence the economic situation has been better and more resilient than many expected. In the spring statement the chancellor raised the UK growth forecast to 1.5% up from 1.4%, borrowing expectations were revised down and a small current surplus is expected in 2018 to 19. A surplus which should leave some room to borrow to fund capital investment rather than meet day to day spending needs.
So while the underdog, in this case the UK economy is not likely to grow as fast as other economies in the near future it is still expected to grow and be pulled up by the rest of the world. Unlike some other economies equity markets UK valuations look a lot less toppy at this stage in the cycle. Given the competing factors as laid out above at this point in time active management should outweigh a passive approach. The chart below show the Royal London UK Mid-Cap Growth fund and the FTSE 250 since June 2016 and the acceleration in an active performance verses the index.
UK Mid-Cap index (FTSE 250) v An Actively Managed Fund
Funds, investment trust and an ETF you may want to consider if you are thinking about topping up your UK position:
Growth bias idea
Royal London UK Mid-Cap Growth - The fund is managed with a strong emphasis on mid cap companies with the portfolio having a minimum of 90% invested in these companies.
Value bias idea
Polar Capital UK Value Opportunities - The fund managers George Godber and Georgina Hamilton seek to identify UK companies that they believe are trading at a significant discount to their intrinsic value.
Lowland - Managed by James Henderson invests in a broad spread of predominantly UK companies of differing sizes, with normally not more than half by value coming from the largest 100 UK companies and the balance from small and medium sized companies.
Exchange Traded Fund (ETF)
DB X-Tracker FTSE 250 - The fund offers a dividend yield just below 3% with a total expense ratio of 0.35%. The fund will give a more meaningful exposure to the UK economy as the constituents are more domestic focussed than one tracking the FTSE100 index.
All information given including prices, yields and our opinion is correct at the time of publication. Our opinions on investments can change at any time and for our latest view please go to www.share.com. To understand how our Investment research team arrive at their views please read our Investment Research Policy.