Finding value in unloved UK equities – Fidelity International’s Alex Wright

by | Feb 1, 2024

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  • UK equities are currently pricing in a lot of pessimism and, as a result, trade at a significant discount to other markets
  • We remain cautious on companies’ prospects in near term but believe we are in the very early stages of a long-term rally in value stocks
  • UK market offers better prospective returns than many other asset classes, including global equities

Ahead of today’s Bank of England meeting and interest rate decision, Alex Wright, portfolio manager of Fidelity Special Situations & Special Values PLC, explains that there is considerable historical evidence on the impact of monetary tightening to keep him cautious on company prospects in the near term, despite increasing talk of a soft landing. However, UK equities are currently pricing in a lot of pessimism and, as a result, trade at a significant discount to other markets. This presents an investment opportunity, as he believes we are in the early stages of a long-term rally in value stocks. 

“Value stocks have outperformed growth stocks over the last three years, but they still have significant ground to catch-up. The current market environment of stickier inflation, higher interest rates and economic volatility is more aligned to the long-term pattern seen over the last 100 years. History suggests that over the long-term value tends to outperform, given generally higher discount rates and a reversion to the mean.

Value has outperformed over time 

 
 

Source: Fidelity International, Refinitiv DataStream, 31 December 2023. For illustrative purposes only. Past performance is not a reliable indicator of future returns.

“We, therefore, believe that we are in the very early stages of a long-term rally in value stocks, as we return to a more normal inflation and interest rate environment. With its high dividends and low valuations, the UK market offers better prospective returns than many other asset classes, including global equities.

Recent outperformance mostly unnoticed

 

“Interestingly, after a painful period of poor returns following the Brexit referendum in 2016, UK equities have started to outperform other markets – a fact that has gone largely unnoticed by investors. While corporate earnings have improved, valuation levels have remained largely unchanged.  

Source: Fidelity International, Refinitiv DataStream, 31 December 2023. For illustrative purposes only. Past performance is not a reliable indicator of future returns.

“The UK, which trades on 10-11 times price to earnings multiples, compares very favourably to the US market, which is trading on PE multiples of 18-20 times. And this valuation differential exists across the market capitalisation spectrum, making the UK a very attractive place to invest.

 

All areas of UK equity market at a discount versus history

Source: Fidelity International, Refinitiv DataStream, 31 December 2023. Data for FTSE 250 and FTSE Small Cap not available pre-1998. For illustrative purposes only. Past performance is not a reliable indicator of future returns.

“While the economic environment remains uncertain, it is important to recognise that the UK is a large and diverse market. To this end, we are finding overlooked companies with good upside potential across industries and the market cap spectrum. In aggregate, our holdings have significantly lower levels of debt and possess the strength and resilience to navigate a tough macro environment.

 

“The relative attractiveness of UK valuations versus other markets – as well as the large divergence in performance between different parts of the market – continues to create good opportunities for attractive returns from UK stocks on a three-to-five-year view.

“While the value in the UK market is not being recognised by investors, it is being acknowledged by other market participants, mainly US corporates and private equity firms whose bids have often been at significant premiums to prevailing share prices. The low valuations are also reflected in the substantial buyback activity among UK corporates.”

Portfolio positioning

 

“Financials is the largest sector exposure in our portfolios. Our holdings in financials are diversified from both a geographic and business model perspective. For example, our largest bank holding AIB Group not only benefits from higher interest rates but also from an improvement in Ireland’s banking industry, where the number of competing groups has recently shrunk from five to three.

“Elsewhere, we are selective about our consumer exposure. A stock we like is low-cost carrier Ryanair. The company has a strong balance sheet and mostly owns its planes outright rather than having to lease them. As its peers have seen costs rise sharply, Ryanair’s profit margins have expanded as volumes returned to historic levels. As low-cost provider it is well placed to capitalise should consumers become more cost aware, while supply remains constrained as competitors are plagued by engine issues and plane shortages.”

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