Investment – Value will out
6 April 2021
Andrew Millington, head of UK equities, Aberdeen Standard Investments asks whether it is time to increase exposure to domestic equities
2020 was certainly a rollercoaster year for investors. And looking ahead to the rest of 2021 and beyond, investors could be forgiven for feeling inclined to sit on their hands and watch from the side lines. But it’s at times of uncertainty and change that investors who are able to block out the noise and take an evidence-based, long-term view of fundamental value, can make the decisions that have the biggest impact on their long-term returns.
So let’s take a look at the UK equity market through that lens. UK equities have lagged most global equity indices for several years now and buying today is still the counter-consensus call. I like that as a place to start; it’s precisely when the received wisdom is to avoid an asset class that we believe the most exciting relative and absolute returns can be made.
We all know why UK equities have been out of favour. Since 2016, Brexit has been an ever present spectre whenever UK assets are discussed, and more recently, Covid-19 has sadly hit the UK worse than almost any other large economy.
But looking backwards isn’t going to help us to understand what will drive the market from here. Brexit has happened, we know the detail of the trade deal the UK and EU have signed; any change from here is likely to be in the form of further sector by sector deals, particularly on the services side, which investors would welcome.
As for Covid-19, we believe the UK can bounce back strongly from the crisis. After the huge economic hit in 2020, there’s significant pent-up demand that the reopening of the economy will release – from everyday things like the post-lockdown haircut I’m looking forward to, to bigger ticket items like the holidays we’re all so keen to go on.
Of course for many, loss of earnings over the last year will mean a continued period of difficulty even after restrictions lift, and it’s crucial that government support schemes taper in a way that smooths the return to normality. But in aggregate, there has been a huge spike in household savings in the UK which will be unleashed through the second half of this year. Crucially, that bounce back in economic activity is likely to happen meaningfully sooner in the UK than in other countries, given the impressive pace of the UK’s vaccine rollout so far.
All of a sudden, you’ve got a tailwind for UK domestic stocks rather than the headwind we’ve been facing for the last five years. That’s a hugely significant shift which could drive a sustained turn in their relative performance.
But UK domestics only represent less than a third of the revenue of the UK equity market. In fact, many UK-listed companies provide access to growth across the world. The UK market’s valuation, however, reflects very little of this.
Ever since that 2016 referendum UK stocks have traded at a discount to their peers listed elsewhere even when you adjust for the sectors they operate in, and even where those sectors are truly global. Depending on the sector, the discount on some UK stocks range from 10% to as much as 50% compared to peers listed in the US. The fact is, markets aren’t as efficient as we’re sometimes led to believe; international investors have likely looked at what’s been happening in the UK and decided to allocate their capital to other markets.
But over time, value will out. And in the current world of low interest rates and low returns, the UK’s 3.5% market dividend yield with growth will attract investor flows.
There’s one more consideration investors need to think about before allocating to an asset class, beyond the fact it might be cheap and with improving fundamentals. And that’s the governance framework you’re investing within. The UK’s corporate governance standards, and in particular the protections that are afforded to minority shareholders in the UK, are world leading. Principals like one share, one vote, a binding remuneration vote, and free float limits mean that, as fund managers, we can engage with the companies in which we invest on our clients’ behalf and exert real influence to make sure clients’ rights are respected and their interests prioritised.
There are many aspects aligning nicely at the moment for the UK equities market. It’s cheap, it’s under-owned and the news flow is improving. Furthermore, it offers access not just to UK domestic recovery but to global growth, and with some of the best shareholders protections around.
So, while the rest of the investment world may be looking in the rear-view mirror and allocating elsewhere, now could be an opportune time to increase exposure to UK equities.
This article was first published in the April 2021 issue of Professional Paraplanner.
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