UK equity managers have been arguing that their investments look very cheap, but then they tend to argue that most of the time. However, for the first time in many years, there is a good case to have a larger amount of a global equity portfolio in the UK.
Firstly, the Labour government is likely to preside over a period of healthy growth. Some will say that period has already started, that inflation seems under control and employment levels high; others will argue these are all the achievements of the new administration.
Government debt levels are high, but so are those ratios for most western countries. On the basis of debt-to-GDP ratios, international bond investors see little extra risk investing in UK gilts than Italian or French bonds, even US Treasuries.
Inflationary pressures seem to be moderating in the UK, though are not yet indicating longer term inflation below 2 per cent. The US economy seems ahead of the UK and so seems likely to reduce interest rates ahead of the Bank of England over the rest of the year.
If UK interest rates stay higher than US rates, that may be positive for sterling, which has recently risen from being worth $1.26 to $1.3. This is a healthy recovery from the getting close to the level of one pound to one dollar during the brief Liz Truss premiership.
This recovery in sterling reminds us that international investors have been given a range of reasons to avoid UK investment in recent years. Some will have taken a negative view of Brexit, some a negative view of Jeremy Corbyn’s policies (and will not be convinced the new team have convincingly renounced them), some will simply have sold an underperforming market so they can buy more US technology stocks.
Over the past 25 years, global equity funds I have managed have generally held few UK equities. That has principally been due to the composition of the index. The UK equity market is dominated by banks, oil and mining companies and pharmaceutical companies – I have generally avoided investing in these sectors.
The UK equity market also contains a number of reliable high-quality stocks with steady growth, even if inflation proves persistent.
The sectors that dominate the UK equity market could be described as ‘value sectors’, which generally trade on low price-to-earnings ratios, high yields and low price-to-book ratios. But these ‘value’ sectors often perform well when interest rates fall, which may be the background for the remainder of the year.
As interest rates fall and gilt prices rise, ‘bond proxies’ such as UK property stocks may seem attractive sources of current income. The yield on the two largest UK listed Reits is 5.5 per cent for British Land and 6.2 per cent for Land Securities (I own both).
The UK equity market also contains a number of reliable high-quality stocks with steady growth, even if inflation proves persistent.
Unilever and Diageo yield around 3 per cent a year, but their cash flows and dividends should grow ahead of inflation over the long term and so may seem reasonable valuation to international investors.
Global equity portfolios have, in recent years, become very heavily weighted towards US equities. This is mainly down to the performance of US technology shares, but also driven by strength of the US dollar. During that period, US-based investors may not have been very focused on their overseas holdings.
With the US election approaching and a second Trump presidency likely to produce surprises, having a well-balanced portfolio may seem more important.
From Wall Street looking out, which markets seem good value and with modest political risk? Japan perhaps, but within Europe the UK may now seem more predictable than many other European countries, with France taking a sudden drop down the list.
The UK equity market has been out of favour for some years and overseas investors have had few reasons to participate. Given problems in other developed markets, UK equities might attract more interest just by appearing stable and reasonable value.
Those conditions seem in place now.
Simon Edelsen was a global equity fund manager for 40 years
Leave a comment