Two discounts in one with UK Equity

What could be better than buying something on the cheap? Well, how about an extra discount on the first bargain? This double whammy, suggests the investment companies team at analyst Stifel, is what UK Equity investment companies may be offering right now.

The first valuation opportunity lies in the fact that UK equities have underperformed other global stock markets by a substantial margin so far in 2020. The FTSE 100 Index has lagged the S&P 500 Index by a remarkable 30 percentage points since the beginning of the year; it is around 20 percentage points down on European markets. On this basis, now might just be the time to think about increasing exposure to UK equities.

How, though, to do that? Well, Stifel points out that shares in several investment companies in the UK Equity sector are currently trading at unusually wide discounts to the value of the underlying assets. Herein lies the extra savings. It cites the examples of JPM Claverhouse, currently on a 5% discount compared to a 12-month average of 1%, and Fidelity Special Values, where today’s 7% discount compares to an average of 3%.

In other words, these funds potentially offer the opportunity to access a market that may already be cheap at an unusually discounted price. The key word here, of course, is potentially. It is one thing to spot a bargain, but quite another to get the timing right – investors will only benefit if and when these valuation gaps begin to unwind.

Stifel thinks there are several possible catalysts for that. A last-minute trade deal with the European Union, for example, might provide a fillip for UK equities after months of interminable negotiations that have appeared to be heading towards a damaging impasse. Better Covid-19 news – and above all, a vaccine – would be another positive boost.

Equally, stronger performance from UK corporates – and particularly those that pay decent dividends – would also help the UK market. One reason for the underperformance of UK equities this year has been that this is a stock market that offers unusually high levels of yield; with this yield under threat as companies’ trading performance during the pandemic has forced them to pull dividends, UK equities have taken more of a battering than less yield-dependent stocks elsewhere.

Still, none of these outcomes are guaranteed. In fact, there is plenty of room for disappointment on the downside. Most obviously, the surging second wave of Covid-19 cases in recent weeks, which has already forced the reintroduction of tough restrictions across much of the UK, will put many businesses under pressure. Nor is this solely a domestic issue – with countries around the world facing similar problems, the UK’s large international businesses are suffering too.

It is possible that the situation may get worse before it gets better. That might mean the valuation opportunity in the UK Equity sector becomes even more compelling, though it is difficult to see the gap between the UK stock market and its international counterparts widening much further in the coming months.

Long-term investors and their advisers should not worry too much about this debate; they will sensibly be sticking to their plans and trying to ignore the short-term volatility. Still for investors making more tactical decisions about where to invest, Stifel’s analysis makes interesting reading. And above all, it is a reminder of how the structure of investment companies, sometimes criticised as over-complex, can often be used to investors’ advantage.