David Stevenson: Things are looking up for UK investors
Brits tend to be a gloomy bunch. Sometimes we overdo our natural pessimism, especially when investing in the UK. We can all recite by heart the arguments against domestic equities and, thus, UK equity investment trusts. Words and terms such as Mansion House reforms, pension fund equity allocations, sagging liquidity, poor earnings growth, downplaying the home portfolio bias, and American exceptionalism trip off the tongue, they are used so often.
The confidence of businesses and employers took a hit after the Budget and I sense a steady draining of enthusiasm for Labour and its efforts to grow the economy.
None of this is helped by think-tanks in widely read papers, such as Foundations: Why Britain has stagnated, saying the UK has effectively banned investment in infrastructure, the sector it most needs to grow.
And when the country does build housing, electricity pylons, railways, roads, data centres, nuclear reactors, tramways, and more, their prices rise to astronomical levels thanks to the regulatory, legal and administrative costs they face. With these reports circulating Whitehall, you can understand why British investors feel gloomy.
Compare that with the new world of Trumpite America, where in the last few weeks respectable investment banks such as Deutsche Bank have suggested the S&P 500 index might breeze past 6,000 on its way to 7,000 in the next few months. In November alone, the Nasdaq and the S&P 500 were up about 5%, with the FTSE All World up 3%.
Meanwhile, UK equities underperformed again: in November, the FTSE 250 was up just 1.43% and the FTSE All Share was up 1.38%. On a year-to-date basis, they’re up about 7.5% to 8% respectively, which is a long way behind the US, but it is also well behind Spain’s IBEX (up 17.2%), the Dutch AEX (up 14%) and even the German DAX (up 21%). If there’s any comfort, only the Italian indices are up less than the UK, while the French equity market is best left alone for a late-night conversation over a glass of wine.
Overdone gloom
Still, we shouldn’t get too carried away by this short-term talk. On a longer-term basis, returns from UK equities have been pretty decent. I was particularly struck by this recent comment from IDAD Funds’ Tom McGrath: ‘It might surprise you to learn that on a total return basis, the FTSE 100 is sitting close to an all-time high and that over the last 20 years of wars, banking collapses, taper tantrums and pandemics, it has delivered growth in excess of 250%. So don’t write off the UK market completely. It may yet surprise and, until then, is reasonably underpinned by a cheap valuation and an attractive dividend stream.’
Worm is turning
In this vein, I will stick my neck out and say the bearishness is overdone. Past performance has been underwhelming, but the worm might be turning. I will make four easy-to-understand positive observations on household income growth, interest rates, government spending and immigration.
The point about household spending is that, whether we like it or not, the UK is now a consumer services-led economy with an emasculated industrial sector and a feeble export sector. We depend on consumer spending and, as endless reports from the likes of the Resolution Foundation remind us, for much of the period since the global financial crash, and especially after the pandemic, household income growth has essentially been negative. That’s changed because labour costs, especially wage rates in the service sector, have risen aggressively.
That, in turn, has fed through into positive real household income growth this year and probably next. It’s precisely this big consumer-friendly trend that has led the Bank of England to slow down interest rate cuts. But governor Andrew Bailey confirmed only last week to the FT that inflation was expected to be more under control and four more interest rates were coming. That should coincide with increased government spending, which has caused angst among employers and bond investors and might bump up growth.
Last but not least, we have immigration. Across the pond, there’s ample evidence that drastically increased immigration has had a beneficial impact on economic growth – combined with negative impacts on voter anxiety and public services. If that’s true for the US, logically, it must be true for the UK, where recently revised numbers indicate an even bigger net inflow (relative to our population size). That’s not an argument for mass migration; it is just an observation that it must have had some positive impact, which might be expected to continue.
Inflows at last
Add these all up and you have a much more positive spin on the UK economy moving forward despite the post-Budget gloom. I’d also add an investment trust-specific point. Investors are showing signs of being more interested in UK equities, but too much money is allocated to frankly questionable fund structures.
One positive sign, for instance, is that last month UK equity funds recorded their first month of inflows in more than three-and-a-half years, after a period during which investors have pulled more than £25bn. According to data from Calastone, which tracks money entering and leaving funds via financial advisers, fund supermarkets and wealth managers, UK equity funds recorded net inflows of £317m in November.
Turning to the product structure point, a great deal of money is tied up in UK equity exposure in exchange-traded funds (ETFs). As regulars will know, I’m quite partial to ETFs, but buying into UK equities through an index – probably provided by FTSE – is an exercise in futility.
Our indices are not fit for purpose and do a terrible job at capturing UK economic exposure, and I include the FTSE 250 in that statement. The top five UK ETFs from Vanguard and iShare have about £21bn between them.
By contrast, all UK-listed investment trusts have only £22bn. That’s a huge chunk of UK equity capital exposed to what I regard as the wrong investment vehicles – even if just 50% of this exposure was reallocated to investment trusts, the impact on discounts could be huge!
Looking more specifically at the UK trusts space, the discounts are still quite high – the gaggle of all UK equity funds average a discount of about 10%, which isn’t far off 12-month discount highs.
For good measure, I’d also observe that the much bigger UK equity income fund sector has, on average, a fund yield running at 4-4.2%. That already equates to the two- and 10-year UK government bond yields before we get to the four interest rate cuts.
Add in the fact that UK corporate buybacks are accelerating, with estimates this could approach the £100bn mark next year, plus the point that, on average, UK pension funds have less than 4% of their allocation in UK equities, which might start to creep up under government pressure, we can make a positive argument for owning UK equity funds.
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