27 Sep 2023
In the second article of this 2-part series, the Artemis equity income team explore why UK equities deserve much greater consideration amid a new investment and economic landscape taking shape.
The age of historically low interest rates and easy money saw investors plough funds into growth companies, most of them tech-centric and US-based. That era is now at an end. In the second of a two-part series, Nick Shenton, Andy Marsh and Adrian Frost explore why UK equities deserve much greater consideration amid a new investment and economic landscape.
As we explained in the first article of this series, more than a decade of ultra-low interest rates propelled many investors towards ‘growth’ companies, the vast majority of which are in the US.
Yet quantitative easing has given way to quantitative tightening, with rising interest rates putting pressure on businesses with elevated valuations. This has put the attractions of UK equities into sharper focus as investors recognise that shovelling ever more money into Big Tech may no longer be the most sensible ploy and that it could be prudent to look elsewhere – this side of the Atlantic included.
As we remarked in our previous article, the UK equity market has more than its fair share of ‘traditional’ businesses. These are often perceived to be less than fleet-footed – even dinosaur-like – and about as fashionable as a novelty Christmas jumper.
Look closer, however, and you will find many UK companies – industry incumbents among them – have skilfully embraced the innovator’s dilemma. Having invested significantly and sensibly in their technology and data capabilities over a number of years, they are well placed not only to consolidate their competitive position through their brand, heritage, scale and customer relationships, but to become better and more profitable businesses.
Take Next, which in recent years has quietly built a capability for ‘capex-free growth’ by providing end-to-end online logistics and distribution services. It is set to become less a retailer and more a facilitator, allowing its partner brands to concentrate on products that please consumers.
Another of our holdings, ITV, has invested materially in two platforms that are likely to be central to its future. The first, ITVX, provides streaming, while the second, Planet V, delivers digital advertising. Both have been successful to date.
Initiatives such as these remain largely underappreciated and even ignored by the wider market. We believe they could go on to generate plentiful cashflows soon enough and deliver sustainably over the long term.
The UK is also home to high-quality global businesses. While the price of such opportunities still tends to be steep in the US, in the UK it is possible to find value in companies that are genuine world leaders – although it is ultimately long-term potential, not the short-term gains inherent in valuation anomalies, that captures our attention.
Crucially, a characteristic of many of these businesses is a willingness to move with the times. Many date back well over a century – hence the perception of a market awash with unhealthily conventional and even outmoded constituents – yet their policies and practices are far from rooted in the past.
Smiths Group is an interesting example. Founded in 1851, it started out making precision watches for the Admiralty. Today, it is a multinational industrial technology company with a portfolio that embraces seal technologies for the energy industry and advanced industrial heating elements. We believe Smiths is as well placed as any business to benefit from the energy transition.
RELX also has quite the history. Formed from the merger of British trade book and magazine publisher Reed International, which was founded in 1894, and Dutch scientific publisher Elsevier, which was founded in 1880, it is has built a position as a major digital information and analytics company. Its customers include governments, universities, insurance businesses and law firms, while telematics – a blend of telecommunications and information processing – is among its cutting-edge specialisms.
LSE, the London Stock Exchange, is another company that now makes the bulk of its money from data, deriving 70% of its revenues from subscription-based services in this area and analytics. The digitisation of financial markets data is still in its early stages and presents long-term opportunities amid increasing demand from wealth managers, asset managers and banks.
Speaking of banks, the banking system has again made headlines for the wrong reasons of late. The collapse of Silicon Valley Bank in the US and Credit Suisse in Europe raised fresh questions about capitalisation, risk management and oversight.
Yet UK banks are now among the best-capitalised (and most robustly regulated) globally. Despite more than a decade of quantitative easing, they have managed to strengthen capital while also paying redress, funding pension liabilities and adapting to digitisation. Profits are normalising and fear of the past need no longer trump the future fundamentals.
Meanwhile, another breed of supposed dinosaur, resource companies, are sitting on long-dated consented assets, many of which are likely to be important to the unfolding energy transition, particularly since the timeline for developing a new mine could be something in the order of 15 to 20 years.
More broadly, UK balance sheets are strong. British companies are generally also less leveraged than their US counterparts. The UK market’s free cashflow yield is roughly twice that of the US and many businesses have used these flows wisely in investing for the future and buying back shares at attractive valuations. Despite a challenging macroeconomic environment, the quality of cashflows covering company dividends may never have been better. Governance standards are high, too.
You might think all this sounds very unlike the UK equity market that many investors were so quick to dismiss during the age of low interest rates and easy money – and you may well be right. But the reality today, at least in one important respect, is the same as it has always been: no market has a monopoly on the world’s best companies, and many of them are to be found in the UK – if, that is, investors would care to look.
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