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European selectors re-thinking UK equity allocations

As parliament prepares to vote on Brexit deal, investors are warming to UK equities amid possible end to uncertainty

Brexit

European fund selectors and managers are investing in UK equities again after a year of meagre returns and despite uncertainty about the outcome of Brexit.

Janus Henderson’s head of the UK-based multi-asset team, Paul O’Connor, said UK equities were one of his big equity allocations this year as he sold some US equities and allocated towards the UK.

“The UK market has been very tricky this year and we think it’s very attractive now. It’s a market that has very negative sentiment which is the opposite to the US and you can see that in equity fund manager surveys and the positioning in sterling as well,” he said.

“Sentiment is negative which I think is a contrarian positive and it’s a market that is quite cheap. We can also find high-quality equity with decent yield.

O’Connor said the defensive stocks and commodities within the UK equities sector tended to do well late in the cycle.

According to Quilter, while sentiment towards UK equities has been in a stable low neutral position since August 2017, sentiment has started to move in an upward direction since June 2018.

Fund manager UK equities sentiment (%)

Source: Quilter

Brexit endgame in sight

VZ VermogensZentrum associate director, Michael Ausfelder, said there was still a good chance that the UK parliament would sign-off on a soft Brexit deal this month which would provide an opportunity for investors to get back into UK equities.

Parliament is scheduled to vote on the deal that prime minister Theresa May has negotiated with the EU December 11.

“The difficulty is deciding when to buy – whether it’s two hours before the House of Commons debate or the next morning but that might be too late if it is a positive outcome,” he said.

“After an agreement, equity markets will be very positive, but investors need to try and get in at a lower price. If things go south, the British economy will be the biggest hit among the trading partners within the EU.”

Ausfelder said he had been underweight UK equities for 14 months and said if he were to increase allocations towards the asset class he would reduce his eurozone positions.

However, he noted that he would only increase his UK equity positions via pan-European passive funds (that included the UK).

“[European passives] are the easiest way as we don’t want to invest specifically in certain sectors at the moment. ETFs are therefore the best vehicle to manage that over the next few weeks and months as a tactical approach rather than a strategic allocation,” he said.

O’Connor said there needed to be more confidence in the UK economy and clarity about the Brexit outcome to break his focus down into mid-cap, small cap and property investments.

“The current risks are just too substantial, so we’ve chosen to focus on buying UK big caps which are not dependent on the economy,” he said.

“UK big caps are one of the few areas – when we look across the whole multi-asset space – that we can see some absolute value to emerge.

“In most other areas you see a bit of a repricing but it’s hard to find great valuations. We’re in a world where valuation is relatively extended, and we have to expect very modest returns.”

Investing in ‘unloved’ UK stocks

For Fidelity’s portfolio manager Alex Wright, the unrelenting negativity towards UK equities is pushing him to feel more positive towards the asset class in 2019.

Wright said the UK market could be a top performer globally after Brexit and that it would be an exciting environment for a contrarian.

“My positive outlook for UK equities simply relies on some clarification in the relationship between the UK and the EU, which would act as a catalyst for investors to revisit the UK equity market as a destination for capital,” Wright said.

“It may be a cliché, but investors really do hate uncertainty, and for global asset allocators, there has been little incentive to do the work on cheap UK shares.

“Valuation discounts are just not a strong enough draw in the face of risks that are so widely discussed and absorbed into consensus thinking. The possibility of clients saying ‘I told you so’ has a real impact on investor behaviour.”

Wright noted that investors should not wait for unloved companies to have good news before investing.

“By investing when all the bad news is ‘in the price’ and no good news is expected at all, you put the odds in your favour. I think this is a situation we are in in the UK at the moment,” he said.

He added that when investing in unloved businesses, investors needed to make sure that the balance sheets could withstand a period of economic weakness and that valuation gave a margin of safety.

Top five UK equity funds v benchmark v sector returns one year to 30 November 2018

Source: FE Analytics

The top performing UK equity fund, Barclays’ GlobalAccess UK Opportunities A accumulation, over the year to 30 November 2018 returned at 6.5%, according to FE Analytics.

Liontrust’s GF Special Situations C3 Institutional Accumulation fund followed at 4.3%, Boost’s FTSE 205 1xShort Daily ETP at 1.65%, Candriam’s Equities L United Kingdom N at 0.7%, and Liontrust’s GF UK Growth C3 Institutional Accumulation at 0.3%.

All of these funds beat their benchmarks – MSCI United Kingdom at a loss of 1.3% and FTSE All Share at a loss of 2.2%.

The funds’ sector average made losses of 4.8% within the Offshore Mutual universe, and a loss of 5.1% within the FCA Recognised universe.

The worst performing fund was Merian UK Dynamic R fund that lost 13.2% during the same period.

The funds were found using FE Analytics, were domiciled in either Ireland or Luxembourg, were within the FCA Recognised or Offshore mutual universes, and were available for sale in at least three continental European countries.

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