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2nd September, 2015

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Simon Brazier, fund manager, Investec UK Alpha

Investec UK Alpha was awarded an Elite Rating in September 2015. Here, the manager, Simon Brazier, discusses why he believes UK equities should have a prominent place in an investment portfolio.

“UK equities have enjoyed a steady upward trajectory since the lows of the global financial crisis in March 2009, as companies’ profits have recovered, valuations have risen and central bank quantitative easing (QE) has provided liquidity support.

“Admittedly, returns have been subdued over the past 12 months, as UK markets have had to contend with falling energy and materials prices, anaemic global growth, Grexit woes, political uncertainty in the run up to the UK General Election and the recent volatility in China. However, taking a longer-term view, I feel the backdrop from here is a positive one and supportive of future growth. While there is no denying that very real exogenous risks remain, I will outline five key reasons why I firmly believe that UK equities should have a prominent place in any portfolio seeking to achieve strong, long-term risk adjusted returns.”

1) Stable political & regulatory environment

“Although the majority Conservative party victory was a surprise, I believe the political environment is now set fair for many years to come. The Conservative party has been supportive of investment and job creation thus far, not least through their bold move to reduce corporation tax rate from 28% when the coalition government was formed in 2010 to 20% today. This is now moving even lower to 18% in 2020, as announced in the recent Budget. The Conservative majority win will give confidence to businesses that they can plan for the future and invest for the longer-term.

“The Conservative party’s commitment to fiscal consolidation provides further stability to the economic and political environment in the UK. While the current UK budget deficit of 5.5% is still relatively large by historical and international standards, this is forecast to be eliminated by 2019/20 on the back of continued government spending cuts and structural reform. This is in stark contrast to the US which is forecast by the IMF to run a wider deficit for the foreseeable future. This ‘cut less, grow more’ strategy is contingent on the US economy outperforming and effectively outgrowing its debt obligations. The UK’s approach to cut the deficit more now offers greater reassurance and economic growth potential over the medium term and is more conducive to increased business investment and confidence.

“The strong regulatory framework associated with investing in the UK is also a key benefit for investors, especially those who are looking for a more secure means of investing in emerging markets where controls might not be as strict or adhered to. In addition to the legal responsibility faced by UK companies, there is also a strong sense of corporate governance and ethics, as well as high levels of disclosure and transparency with regards to business activity and financial accounts.”

2) Strengthening UK economic outlook

“While UK GDP has pointed to slowing economic growth over the past few quarters, there have been recent signs that the economy is improving. Growth has been affected by UK election uncertainty, the future of Greece in the euro zone, widespread disinflationary pressures and uncertainty over the growth outlook for China. However, the latest IMF World Economic Outlook, published in July 2015, has forecasted much-improved full-year growth for 2015 of 2.4%, second only to the US in the G7 group of developed economies.

“Business investment growth remains strong and household real incomes have started to realise the benefit of lower energy and food prices which should see a rebound in consumption over the coming months. This should help inflation tick higher, back towards the Bank of England’s 2% inflation target, although this is likely to be a gradual process with record-low rates likely to be maintained. Other bright spots for the UK economy include the labour market, which has been consistently performing well. Unemployment dipped to 5.5% earlier this year – the second lowest in the EU after Germany – against a backdrop of improving real wage growth.”

3) UK corporates in good health

“UK corporate balance sheets are in much better shape than they were prior to the global financial crisis as years of deleveraging have seen companies restructure cost bases, drive down working capital and refinance debt at very low levels. This has left companies with much leaner capital structures from which they can build for the future – the capital strength of UK banks in particular has improved in recent years.

“The general improvement in cash balances has given companies options in terms of reinvesting for future growth or returning capital to shareholders. There is already evidence of a strong increase in M&A activity in the first half of this year relative to last. Data from Thomson Reuters shows that inbound foreign M&A in to British companies had jumped by 231% from US$49.3 billion to US$163.3 billion, as acquirers look to take advantage of strong balance sheets, low borrowing rates and attractive relative valuations. In the UK Alpha Fund we continue to focus on companies who are able to generate cash and whose management teams we believe have the ability to re-invest that cash, either organically or inorganically through acquisitions, to compound long-term shareholder wealth.”

4) Attractive relative valuations

“Although the UK market has enjoyed a rally in recent years, there is still a strong relative valuation case for UK equities when compared to both global equities and other asset classes. In the US, several years of QE and the strong performance of US equities have stretched valuations, leaving a lot of stocks looking very expensive. UK equities have lagged behind their US and global peers, and are currently cheaper. In addition, UK equities also offer one of the most attractive dividend yields relative to other countries and regions. The steady appreciation in the US dollar has made US corporates who sell goods and services abroad more expensive and less competitive, in addition to diluting any overseas earnings which are repatriated back into US dollars. Moreover, the US is likely to be the first to raise interest rates later this year, which will further diminish the equity risk premium on US equities and cause investors to look at other options overseas. The relative argument also holds up against other asset classes, including UK Gilts or even European sovereign bonds. Yields have fallen substantially across the bond market spectrum over the past few years and equities continue to offer a more attractive yield, even relative to corporate bonds.”

5) Too big to ignore

“The UK equity market (London Stock Exchange) is the third largest domestic equity market in the world and offers a broad and diverse range of investment opportunities. The market is highly liquid, and in addition to offering well over 2,000 listed stocks, is the most open market in the world outside of the US. UK equities are seen as more defensive compared to other equity markets, given its larger allocation to less economically-sensitive sectors such as healthcare, consumer staples and telecommunications, while at the same time offering global exposure to investors, with over 70% of UK corporate revenues generated overseas. Many of the top-listed companies are strong global leaders with global operations, which can be seen as a better way for investors to gain exposure to emerging markets.”

Conclusion

“Investors are increasingly on the search for total return and yield through global exposure, but within a controlled, transparent and regulated framework. The UK equity market offers an attractive dividend yield and compelling valuation opportunities relative to other developed markets. The government’s commitment to supporting business activity and investment provides a strong platform for businesses to reinvest for future growth. When we couple this with the likelihood that interest rates in the UK will remain low for some time, and while I do expect further volatility in the short-term, the outlook for UK equities remains compelling.”


Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Simon's views are his own and do not constitute financial advice


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