352. Are we on the brink of a UK consumer boom?

27 March 2025 (pre-recorded 18 March 2025)

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[INTRODUCTION]

Staci West (SW): Welcome back to the Investing on the go podcast brought to you by FundCalibre. The UK stock market has faced challenges in recent years, but is sentiment starting to shift? This week’s guest discusses why international investors are showing renewed interest in UK equities and gives his insights on finding reliable income in a low-growth economy.

Darius McDermott (DM): I’m Darius McDermott from FundCalibre and today I’m joined by Jeremy Smith, who is the fund manager of the CT UK Equity Income fund. Jeremy, good morning.

Jeremy Smith (JS): Good morning, hi.

[INTERVIEW]

DM: So let’s jump straight in. UK equities having a slightly better time of it year to date so far not a bad return last year, but they’ve genuinely been shunned over the last, near enough for a decade now post Brexit voting, et cetera, do you think international investors are starting to look at the UK for value again?

JS: Yeah. There’s been more and more interest from international investors. Mostly I have to say in the last sort of 12 months European investors that are looking a bit further afield from their own economies, which are clearly struggling in the largest economies in Europe, like France and Germany. And they’re really attracted by the 10-year low valuation of the UK market against not only their own market, but most particularly well the world market where I think we were trading at a 40-year low. So yes, there’s definitely more interest not just from institutional investors, but also of course we’ve got activist investors, we’ve got private individuals looking to make money outta buying very cheap UK shares.

DM: Yeah, yeah, no, there’s definitely a lot of interest in the UK stock market from overseas, which is picking up, which is great. So let’s dive into the funds. Pick a couple of sectors that have either worked or not. Industrials has been a key contributor to the fund returns. What is attractive about that and and where do you see the further opportunities ahead?

JS: Yeah, it’s a good question to ask. It’s been a structural overweight for the fund for many years. Our belief philosophically is that industrial companies have the same sort of exposure to global GDP as commodity companies. So miners and oils, but have much greater control over their ability to influence profitability than commodity companies do. So, you know, the oil price, the iron ore price in the short term will have a much greater bearing on the profits of Rio Tinto and BP than in industrial companies that have much more diverse in markets geographically and also from a divisional basis, and therefore have much greater control over their end profitability. So we get exposure to recruitment, to building products, to business services but they’re all exposed to global GDP in the same way over the long term. So we think it’s a much more risk averse approach and gives us better protection across an economic cycle.

DM: And I take it then from those comments, maybe that you are underweight some of those commodity linked sectors where, as you’ve already described, the price of the commodity maybe drives profitability rather than the company?

JS: Yes. I mean, we’re very focused on the long term sustainability of dividend income. Pretty much all of those companies now in the mining and energy sectors are on fixed payout ratios. So the dividend is a proportion of the earnings earned that year. So can vary quite a lot, clearly dependent on what end pricing is for those particular commodities. Of course in terms of putting a portfolio together, it’s gonna give year on year growth in dividend income and give you a yield tilt to the portfolio level to trade at a yield premium to the benchmark, which is the London stock market. We take careful consideration over those individual names in the portfolio. So philosophically we tend not to invest in them and we tend to prefer other names that give us the same sort of exposure, but better protection on that year on year sustainability or dividend income.

DM: Yeah. And of course this is an income fund and you’ve got a target at a premium income. So I suppose that that aspect of a company’s ability to pay the dividend and a growing dividend is important. What then is your thinking on the banks, because banks have been a very strong performing sector over the last whatever, it’s 12, 18 months you know, the UK’s got lots of larger banks that have now returned to paying dividends post the sort of covid blip. What’s your view on those and their ability to continue to pay those dividends and the outlook for the banks generally?

JS: Yeah, I mean, you’re right. I mean, they’ve been very good cash returners. It’s been a headwind in terms of relative performance for the fund most particularly last year where you saw share prices like NatWest and Barclays pretty much double over the course of the year. I mean we still outperformed the index last year because of the other contributors within the portfolio. But we would’ve done a lot better if we’d had some banks as well.

And we’ve tended to focus again outside of the banking sector on other financials. Again, a bit like the industrials where banks ultimately are recipients of income based on the 10-year yield curve, which is determined by governments and currencies, et cetera, and views on economies. Again, in the short term, there’s not a lot of that banks can do if yields change dramatically or even slightly in short end or the long end that materially influences their P&Ls. They’ve been locked into this hedging which they’ve taken out in the last few years, which has given them quite a good buffer. But that will start to roll off as we head into the future.

We think they’re quite fairly priced now. But they are good cash. They are cash, good cash returners to shareholders. The real time to invest in them was in Q4 2020, which is sort of pre-vaccine. And you know, they were trading on very low valuations to book at the time. We looked at them a lot, and in the end we decided we would average down in our existing exposures to the UK economy shares like Marks and Spencer’s actually at the same at the time were 90p just like NatWest was. And again, you know, we’ve made sort of four or five times our money from doing that, so we’ve not lost out but we didn’t own the banks.

DM: That I suppose is the the job of the fund manager is to decide which of these opportunities presents the greatest opportunity for s some capital growth as well as that dividend.

JS: Exactly.

DM: So you know, we know you can’t win them all and you can’t lose them all either.

JS: Exactly.

DM: So, I do want to come on to the outlook for your outlook for the UK economy, but let’s, I think we’ve just touched on it well in the earlier part of our conversation, there are others now finding act, you know, real value in the UK market. We’ve seen a number of takeovers in the investment trust world and activism an area that I’m very familiar with, but M&A is picking up, and it’s not just that sort of side. What’s your view on how attractive UK companies are to other buyers, whether it be private equity or private companies or private individuals?

JS: Yeah, I mean, I think we’re in the 39th month of consecutive outflows from the domestic wealth management industry from their UK exposures. So, you know, that forced selling has had a much more material impact lower down the index. So mid-caps, small-caps have seen valuations change really quite well, quite materially because on the other, there’s just been effectively more sellers than buyers. And in that vacuum, as I said, you know, we’ve had some institutional buying from European investors and some US value funds. So the likes of Travis Perkins, for example, I think half their shareholder registries US domiciled funds now. But, you’re right. I mean, within the last year was an absolute boom for M&A in the UK corporates and private equity.

And you know, of I think of the 14 largest transactions we had, we were involved in nine of them. So, you know, our focus on intrinsic value or fundamental value or however you want to call it, you know, what is it worth someone else? Never mind what it’s worth today. We, we have a very strict three to five year investment horizon. And so no matter how much noise there is today in terms of short-term earnings changes, we stay very focused on that long-term value. And that gives us, in this particular environment, quite a competitive edge in terms of having our more than our fair share of bid approaches, some of which, to be honest with you, are not welcome. We rejected the bid for Royal Mail. We rejected the bid for Hargraves Lansdown.

I mean, they still went through, but, you know, we don’t want our best ideas going out at the wrong price. And with, with so many shares trading at such abject valuations, you know, we continue to act very much as active owners with boards where we’ve got significant holdings to, you know, and to say to boards, so, you know, you’re gonna go out at the wrong price. You don’t want to lose this great business off our exchange at the wrong level. And boards are finding themselves in very difficult positions because of the very low share prices.

DM: Yeah, I suppose when they covered a noticeable, if not significant premium to the share price, some investors are gonna want to take that uplift. And I slightly wonder about the de-equitisation. You know, you say big parts of our market are cheap, and it is now starting to be spotted and well done for having an interest in so many of those large m and a opportunities last year. So let’s just talk a little bit about the UK economy. What your view is and how you go about searching for that reliable income in a low growth UK economy. Because other things, I think the January figures came out, which were negative recently. You know, it’s not like the UK is booming at an economic level.

JS: Not at the headline levels. No, that’s true. I mean, you know, this sounds very outrageous, but we could be on the cusp of a consumer boom in the UK, which I’m sure most people would laugh at. Look, given the recent headlines, all of the foundations are there for a 1980s style consumer boom. You know, the housing transactions are running at very low levels. So I think sort of the builders merchants building volumes of 40% below their 10-year average the savings ratio is more than double the long-term average debt to GDP for households is at 2000 level, so 20 year lows. So, you know, we’ve had nine months of consecutive double digit growth in disposable incomes as measured by the, as as their income tracker.

So the average person in the UK, regardless of the Daily Mail headlines, is in a much better position than they’ve been for donkeys years. And courtesy of covid, courtesy of inflation and certainly double digit national wage rises every year. The bulk of the population of the UK is in pretty good shape. The main issue at the moment is consumer confidence because that people are very affected by headlines. You know, the budget in November had a fairly catastrophic impact on people’s willingness to want to spend on big ticket items. So I think, you know, new car sales are at five year lows, but people are spending like bill on going away on holidays, restaurants, clothing. So, there are avenues where people are spending money.

We use the macro to inform us rather than to decide the stock selection. But, there are pockets, where because of Brexit, because of covid, because of cost of living, those companies that have survived that are listed are in a much better place today than they were 15, sorry, 10 years ago. So, you know, the likes of Tesco, Marks and Spencers, they’ve poured ahead mainly because a lot of competition has really struggled in real, we’ve invested into real estate for the first time in 10 years. Those listed players there have got very low leverage versus their, their net asset values. And there’s been a real survivor bias, you know, in terms of retail, in terms of retail centres.

There used to be 200 quite well attended shopping centres in the UK. There is now 30, you know, and land securities that we own. There’s nine of them. So, you know, and rents are going up in all of them because if you are prime market and you want a bigger site, or you are next and you want a bigger site, I’m afraid it’s gonna cost you a lot more money because no one’s built a new shopping centre in the last 15 years. So there’s a real survivor bias and the bigger companies have come out much stronger and are in much better competitive positions. So we’re still finding some good ideas out there.

DM: Brilliant. Well, it’s nice to hear somebody actually cheery on the UK rather than the opposite side. So very, very interested in that. So maybe finally, what’s the one part of the UK equity market that you think is still being unfairly overlooked by investors right now, and where might you see best opportunities for income and growth over the next year, 18 months?

JS: Well, I mean, the glib answer to that is pretty much everything below the top 30 stocks in the index. To be honest with you.

DM: I thought you were gonna say the mid-caps. I thought that was the answer.

JS: I mean, through our quite strict criteria, looking for a new idea, we’ve found ourselves double weighted in mid-caps is certainly not only is UK market trading at a 10-year low against the world MSCI benchmark with mid-caps to trading at a 10-year low against FTSE 100. So, you know, it’s basically cheap on cheap on cheap. And we have got some absolutely excellent businesses that are listed there. You know, through no fault of their own, they’re listed on the London stock market. Many of them have got absolutely nothing to do with the UK economy. You know, they’re world leaders in what they do. So we’ve got some good niche companies doing extremely well. And you know, ultimately we are a fundamental bottom up valuation sensitive strategy. And so, you know, all of those characteristics have led us towards the mid-caps, which we think are very cheap.

DM: Brilliant. Jeremy, thank you very much for that. Interesting discussion on your fund and of course the UK and as I say, nice to hear a little bit of optimism rather than maybe some of the gloom that the headlines lead us to.

SW: Jeremy looks for unloved companies with the ability to sustainably grow their dividends. The fund is unconstrained and has a ‘contrarian value’ bias. Jeremy is looking for hidden gems and businesses with long-term potential.To learn more about the CT UK Equity Income fund visit fundcalibre.com – and don’t forget to subscribe to the Investing on the go podcast, available wherever you get your podcasts.