The UK equity market has been seen as the place to avoid since the Brexit vote of 2016. The asset class has been unloved and out of favour, with uncertainty around the vote – and the knock-on implications of this – meaning that many global asset allocators have steered well clear.
But now that Brexit is firmly yesterday’s news, and within the UK we have made great strides in terms of the vaccine rollout to tackle the pandemic, UK equities now look to present a very different proposition.
We expect the areas that will prove most popular will be value and economically sensitive companies, being likely to reap the greatest benefit from any potential domestic economic recovery.
Within the UK equity market, we have had two speeds. On the macro side, UK equities have been left off the table by many investors, but within the asset class there has been a strong preference in the market for growth and defensive areas of the market versus value and cyclicals.
The dominance of ‘bond proxies’ peaked with outright risk aversion in March 2020, but today the growing belief that economic recovery is coming will be accompanied by rising risk appetite. This should favour more economically sensitive parts of the market.
UK equities look cheap in aggregate versus their history and compared to other equity regions. In February, we reduced our US equity exposure to underweight, and reallocated the capital into UK equities.
The attractiveness of UK equities is being highlighted in the corporate world, with nearly 20 M&A deals being announced since August last year, totalling around £34bn, and spanning the market-cap spectrum within the UK market.
Examples include offers for William Hill and RSA. UK companies have remained strategically and financially attractive to industrial buyers.
In order to gain exposure to domestic recovery, we believe the best way to play this is through a multi-cap approach, which is where many of these types of companies reside.
The rotation we saw in February is a good example of this. Many small- and mid-cap equities are viewed as recovery candidates, and should benefit when we return to normality.
Many FTSE 100 names, which have high overseas earnings, suffered with the recovery of sterling, putting pressure on profit margins. But increasing optimism about the prospects for a revival in economic activity, perceived inflationary forces and a steepening yield curve, meant that stocks generally grouped in the classic value baskets were heavily favoured.
Over the past few years with interest rates, yields and inflation falling, the market has favoured growth stocks in a low growth world.
However, if the tide is turning and inflation is picking up and growth is starting to spread wider, with economic recovery on the horizon there is the potential for a rotation into value and cyclical areas of the market to continue.
As an asset class, this should favour the UK market in relation to say the US, which is more growth orientated.
The potential for higher long-term interest rates and inflation could provide headwinds to stocks and parts of the market that are looking fully valued, and in some instances almost priced to perfection.
On a broader, global level, we believe an increasing number of asset allocators will start reconsidering their underweight positioning towards the asset class.
The uncertainty of Brexit has been eliminated, the path to economic recovery looks strong and the asset class still looks cheap.
In the current environment, looking for select value and cyclical opportunities within the UK equity market to take advantage of the recovery story could be a route worth considering.
Richard Warne is a fund manager at Beaufort Investment