Q1 2018 Portfolio Discussion: Investing in the UK
The Brexit negotiations continue to be a source of great economic uncertainty for the UK. The outcome of the negotiations with the European Union will have a significant effect on the future of the UK, the value of the pound and the relative performance of different sectors.
Domestic vs. international exposure, large vs. small?
- The large-cap FTSE 100 gets most of its revenues from abroad, whereas the mid-cap FTSE 250 has a larger exposure to the domestic UK economy. Therefore, a fall in the pound should favour internationally exposed large-cap stocks, whereas a rise in the pound should favour smaller, more domestically-focused stocks.
- Mid-cap stocks have strongly outperformed large-cap stocks since the financial crisis but could be more exposed were the UK economy to slow further.
- The average UK equity fund has far more exposure to mid and small cap stocks than the FTSE All-Share.
Guide to the Markets - UK, page 43
Attractive income and commodity exposure
- In a world where income is still hard to come by, UK equities offer a very attractive dividend yield relative to other equity markets.
- UK listed companies have a higher proportion of commodity producers and refiners. For five years, the fall in commodity prices had depressed earnings expectations. As commodity prices have recovered from their lows, earnings expectations have also improved.
- UK equities stand to benefit more than most other developed markets from any further improvement in commodity prices.
Guide to the Markets - UK, page 42
UK valuations are relatively attractive
- UK equities are neither cheap nor expensive relative to their historical average price-to-earnings (P/E) ratio, but relative to government bonds, the dividend yield available on UK equities looks attractive.
- UK earnings have plenty of room for recovery after their poor performance in recent years. As a result, the cyclically-adjusted P/E, which takes into account our position in the earnings cycle, leaves UK equities looking cheap relative to their long-term average.
Guide to the Markets - UK, page 44
- Undemanding cyclically-adjusted valuations and a high dividend yield, could provide support for UK equities.
- Large-cap equities are less exposed to potential domestic economic weakness than mid- and small-cap companies.
- That said, the uncertainty created by the Brexit negotiations argues for taking relatively small active sector and size bets relative to the benchmark.
Our innovative UK Equity Core Fund’s low cost, low active risk approach aims to produce consistent returns from the UK stock market by taking many small active stock positions, while reducing risk at the sector level.
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