Merchants Trust (MRCH ) manager Simon Gergel believes there are encouraging signs that ‘stubbornly negative’ investment flows out of UK equities could be reversing as the government takes action to restore the domestic stock market.

The UK equity income manager noted that the Financial Conduct Authority had introduced changes to the UK listing rules to attract more companies to list and that the government was looking at ways to encourage UK pension funds to allocate more money to domestic equities, such as mandating disclosure of their current exposure.

‘Even a small change in allocation from the large UK pension funds could make a meaningful difference to the demand-supply balance in the market. There have also been tentative signs of returning retail investor interest, although these flows can be fickle,’ Gergel (pictured at last month’s Citywire event) said. 

He added that the UK stock market had had a positive six months to the end of July and there were still reasons to be optimistic about the future outlook, given the political stability, inflation nearing the Bank of England’s target, economic growth picking up, while interest rates have started to come down.

‘This will moderate mortgage bills and corporate debt costs in due course. The UK stock market remains lowly priced, especially compared to other leading markets and we are seeing a large number of share buybacks from companies, as well as a high level of takeover activity,’ he said. 

The £847m trust’s interim results showed net asset value total returns of 13.5% beat the FTSE All-Share index benchmark’s 12.3% gain over the half-year period.  

A large weighting towards construction and materials sectors was ‘particularly helpful’ in keeping it ahead of its benchmark as manager Gergel turned his attention to banks.

Geotechnical engineering services group Keller (KLR) was the largest contributor. The shares were ‘heavily discounted’ owing to downbeat trading conditions and operational issues, but the management team significantly strengthened the commercial execution and operational processes in the business, while a recovery in the key US market also helped, sending the shares up 75%. 

Housing products business Tyman (TYMN) also rallied on the back of a takeover bid, one of three portfolio holdings that received offers in the period, with housebuilder Redrow (RDW) agreeing a merger with Barratt Developments (BDEV) and power supply manufacturer XP Power (XPP) rejecting an ‘opportunistic bid in the wake of recent profit warnings’.

The growth in building materials led Gergel to sell CRH (CRH) as the share price, which had doubled since he first bought the company in 2022, fully reflecting the high quality and good prospects of the business.

Barclays (BARC) and Lloyds (LLOY) were among the top 10 performers in the half year, and Gergel added to his exposure to banks with the purchase of Bank of Ireland.

Gergel has been building exposure to banks after the restructuring of the industry since the global financial crisis. It is also benefiting from interest rate recovery, boosting margins.

He bought components and powdered metals supplier to the automotive sector Dowlais (DWL) after concerns about the transition from combustion engines to electric vehicles depressed the shares.

Unite Group (UTG) was also added on the strength of the student accommodation provider’s strong development pipeline. Beleaguered Burberry (BRBY) also made it into the portfolio despite profit warnings, and a general downturn in the luxury goods sector.

The shares have lost around two-thirds of their value over the past year but Gergel says ‘strong potential’ remains and the share price drop provided an opportunity to make a ‘modest’ investment.

‘Whilst we did not expect an immediate dividend cut, it was a possibility we had considered before investing,’ he said. ‘We are prepared to hold strong business franchises through a restructuring period, where we can see significant value.’

The AIC ‘dividend hero’ paid out a quarterly dividend of 7.3p per share, meaning the payout for the first half of the year totals 14.5p, marking a 2.1% increase year-on-year. This was fully covered by earnings of 17.1p. 

Over five years, the 4.9%-yielding trust has delivered shareholder returns of 58%, which is well ahead of the benchmark’s 32% and the Deutsche Numis UK equity income sector average of 33%.