The UK has been out of favour among international investors ever since 2016’s referendum on membership of the EU. But Artemis’ fund managers think this could be the year that all changes.
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With prime minister Rishi Sunak indicating he is likely to call a general election this year, but the opposition Labour party leading by about 16 points in the polls1, it looks as though 15 years of rule by the Conservatives are coming to an end. However, Artemis’ equity managers say that after years in the doldrums, the growth story for the UK market could just be getting started.
The UK had fallen out of favour with international investors long before it was hit by Covid and the subsequent rise in interest rates. Yet all the signs suggest the country is over the worst, coping with the havoc caused by these two events much better than expected.
This helps to explain why many consumer discretionary stocks performed better than expected in 2023.2
“They benefited from starting the year on low valuations, reflecting concerns around the unprecedented squeeze on UK consumer discretionary cashflow from higher inflation and mortgage rates,” said Ed Legget and Ambrose Faulks, co-managers of the Artemis UK Select Fund.
“These fears proved to be overdone. The UK consumer was more resilient than anticipated, aided by a sharp acceleration in wage growth, continued low unemployment and support from the government on energy bills.”
In addition, despite worries about the impact of rising interest rates, research from The Resolution Foundation suggested that on balance, the UK consumer has been a net beneficiary of the trend as higher rates paid on savings outweighed higher mortgage costs.
The impact of the election
Turning to this year, the upcoming election looks set to dominate headlines and may cause concern among investors if, as expected, the government changes from one traditionally regarded as pro-business to one founded on socialist ideals.
However, Henry Flockhart, co-manager of the Artemis UK Special Situations Fund, said last year’s Autumn Statement from the chancellor highlighted how quickly the two parties vying for power have moved back towards the centre ground following years of polarisation. This would make any election “a very different choice to 2019”.
“An election campaign would no doubt lead to stimulatory policies around housing and tax,” said Flockhart.
“From a market point of view, the clarity of an election result would likely be taken well.”
Despite Labour’s lead in the polls, it is possible Sunak enjoys an economic boost heading into an election, with Flockhart pointing out the average UK consumer is approaching a period of real earnings growth.
“This can be seen in the ASDA Income Tracker, which demonstrates some of the strongest increases in weekly family spending power in recent history,” he explained.
Compounding, but not as we know it
Despite the improving backdrop, the UK remains cheap relative to the rest of the world and its history and has done since the vote to leave the EU.
Fund managers have long recommended buying into the domestic market before it re-rates back to its pre-referendum levels. While this still hasn’t happened eight years on, the UK has begun to turn lowly valuations to its advantage, buying back shares “on a scale that neither I nor any of my colleagues have ever seen before”, according to Nick Shenton, co-manager of the Artemis Income Fund.
Buybacks concentrate earnings and dividends in the hands of existing shareholders. Usually, they push up valuations by making the remaining shares more attractive, but with international investors shunning the UK, there has been no response, allowing companies “to eat into their equity bases with even greater alacrity”.
“BP has reduced its share count by 16 per cent in just over 18 months,” Shenton said. “NatWest has reduced its share count by 22 per cent in less than two years.3
“These are far from isolated incidents; in the past 12 months, some 57 per cent of our portfolio by value has bought back shares.”
The return of international investors
Finally, after almost a decade of UK managers banging the drum for value in the domestic market, it is the share buybacks that seem to have done the trick, with Shenton and his colleagues on the Artemis Income Fund noticing influential international investors returning to the shareholder registers of FTSE companies in recent months.
“Fidelity bought a 5 per cent stake in RS Group in November, for example,” they said. “Whilst these increased allocations to the UK are not yet meaningful, they could be a sign of things to come, and that international investors are waking up to the value in the UK.
“The return of international investors to UK equities is likely to be the key determinant of better relative performance from UK equities.”
Whether the country ends up red or blue after the general election, it finally looks as if the grey skies hanging over it have finally begun to clear.
1https://www.reuters.com/world/uk/britains-conservatives-trail-labour-by-16-points-opinium-poll-2024-01-27/
2Artemis, as at 31 December 2023
3BP and NatWest as at November 2023
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Risks specific to the Artemis UK Select Fund
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- Currency risk: The fund’s assets may be priced in currencies other than the fund base currency. Changes in currency exchange rates can therefore affect the fund's value.
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- Charges from capital risk: Where charges are taken wholly or partly out of a fund's capital, distributable income may be increased at the expense of capital, which may constrain or erode capital growth.
Risks specific to the Artemis UK Special Situations Fund
- Market volatility risk: The value of the fund and any income from it can fall or rise because of movements in stockmarkets, currencies and interest rates, each of which can move irrationally and be affected unpredictably by diverse factors, including political and economic events.
- Currency risk: The fund’s assets may be priced in currencies other than the fund base currency. Changes in currency exchange rates can therefore affect the fund's value.
- Concentration risk: The fund may have investments concentrated in a limited number of holdings. This can be more risky than holding a wider range of investments.
- Special situations risk: The fund invests in companies that are in recovery, need re-financing or are suffering from lack of market attention (special situations). These companies are subject to higher-than-average risk of capital loss.
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