Time to look close to home?

Investors in the UK stock market haven’t had much to cheer about in recent years, with domestic equities consistently underperforming their counterparts in continental Europe and the US. However, returns have been steadily improving of late – so much so that in recent days, the blue-chip FTSE 100 Index has broken through its all-time high.

Moreover, there is good reason to hope there are even better days to come. For one thing, UK equities remain relatively undervalued compared to stocks on most other leading markets. There is some distance to go to close this gap, even versus France and Germany – and particularly compared to the US.

In addition, the top end of the UK stock market is heavily weighted towards commodity companies, which are benefitting from rising prices globally. The weakness of the pound also favours larger companies in the UK, which make most of their revenues overseas. And the UK’s economic recovery – now looking a little stronger than expected – augurs well too.

There are no guarantees, but for those now looking to increase their exposure to the UK market, investment trusts offer an interesting opportunity – both in the UK All Companies and the UK Equity Income sectors.
 

In the former, shares in the average trust currently trade on a discount to the underlying net asset value of just over 11%. In other words, these funds offer an even cheaper way into an asset class that is already priced competitively. As confidence in UK equities strengthens, investors have the potential to secure a double benefit as discounts narrow.

In the UK Equity Income sector, meanwhile, discounts don’t look quite so attractive, averaging just under 6% across all these funds. That reflects stronger demand for these funds, which have been a reliable source of income during a period of low interest rates and lacklustre yields on other assets. Indeed, City of London, the best-known fund in the sector, has been pretty much the only UK-focused vehicle to appear regularly in the list of most popular investment trusts on online platforms.

Still, while UK Equity Income funds don’t necessarily offer such an attractive pricing opportunity, they do still have plenty of appeal. Remember, investment trusts are unique among collective vehicles in being able to retain some income earned on their portfolios to pay dividends in years when income is in shorter supply. This is especially attractive in a market such as the UK, where dividend income accounts for a larger proportion of total return than in many other markets.

Indeed, one reason for City of London’s popularity is its incredible record on dividends – it has raised its pay-out to investors in each and every year for almost six decades now.

None of which is to say investors should be piling into UK equities. But it is refreshing to be once again talking about the prospects for the domestic market – and plenty of analysts are predicting it will outperform for the rest of the year.
In recent times, we have got used to talking about investment trusts in the context of the role they have to play in providing exposure to alternative and illiquid asset classes. But don’t overlook their potential in more conventional areas – including the UK market.