Although the UK led the way in the rollout of vaccinations and Brexit was largely overshadowed by the Covid pandemic and reopening, the divorce continues to cause uncertainty among investors.
The UK was able to quickly set up a vaccination programme, allowing it to reopen the economy earlier than most European countries. The OECD revised its economic growth forecasts in May and now predicts GDP growth of 7.2 per cent in 2021 and 5.5 per cent in 2022 thanks to the faster-than-expected loosening of social constraints and continued fiscal and monetary support. The vaccination programme is a feather in Boris Johnson’s cap after years of difficult Brexit negotiations.
The island after the divorce
On 23 June 2016, a referendum was held on the role of the United Kingdom in the European Union. After a fierce campaign, the British people finally chose to leave the EU. In the twelve months that followed, the Morningstar UK Large-Cap Equity category saw an outflow of 4.9 billion euros due to European investors pulling their money out of the funds. This was truly short-lived as the category saw inflows every calendar year between 2017 and 2020, totalling €12.6 billion. However, over the first seven months of this year, European investors pulled an estimated €3.7 billion out of UK large cap stocks.
Since that historic day, from early July 2016 to the end of August 2021, the annual return of the FTSE All Share Index has been 6.2 per cent measured in euros compared with 9.4 per cent for the MSCI Europe Index and 13.5 per cent for the MSCI ACWI. It is easy to attribute this underperformance to Brexit but perhaps other factors such as market composition also play an important role.
Index dominated by traditional sectors
Indeed, the sector distribution of the FTSE All-Share Index, one of the best known indices for UK equities, looks different from the broad MSCI All-Country World Index.
The latter is made up of 59.8 per cent US stocks while the UK, with a weighting of 3.6 per cent, is less important. By far the most important component in the FTSE All-Share Index is the financial sector (22.5 per cent), while it covers only 14.1 per cent of MSCI ACWI. More traditional sectors dominate with 15 per cent in consumer goods and 13.3 per cent in industrial compared to 6.8 per cent and 9.8 per cent respectively for the MSCI ACWI. On the other hand, we see technology and telecommunications stocks holding a low importance of 2.1 per cent and 2.2 per cent respectively compared to 22.6 per cent and 9.4 per cent in the broad MSCI ACWI.
It is precisely those more technologically advanced growth companies that have performed best in recent years while value stocks and companies in more traditional sectors weighed on the performance of the market as a whole. The FTSE All-Share Index includes many household names such as AstraZeneca, Unilever and Diageo to name a few, but it is mainly the Apples, Amazons, Teslas, and Microsofts of this world that have been in demand among investors. The increased emphasis on sustainability has also been a headwind for British stocks. For example, British American Tobacco, BP, Royal Dutch Shell and Rio Tinto together account for 11.9 per cent of the index.
Attractive valuations?
Are their best days numbered, then? UK-bulls remind investors that the UK market is currently trading around the lowest price-to-earnings ratio relative to global equities in the past two decades. The relative valuation therefore seems attractive, not least because UK equities offer a relatively high dividend (around 3 per cent for the FTSE All-Share Index).
Top 5
Over the first eight months of 2021, the return of the FTSE All-Share index was 19.6 per cent compared to 26 per cent for the S&P 500 measured in euros. In contrast, the FTSE Small Cap Index rose 30.1 per cent year-to-date.
In our list of the best-performing funds within the Morningstar UK Large Cap Equity category for the first eight months of 2021, Invesco is in first place. Invesco UK Equity has been managed since June 2008 by Martin Walker, who also manages Invesco’s UK Opportunities and Pan European Equity funds alongside John Surplice and Tim Marshall.
He has been with Invesco UK based in Henley-on-Thames since 1999. The fund manager also uses a bottom-up valuation-driven approach to his stock selection, focusing on the assessment of a company as well as its valuation. As with TT UK Equity, the FTSE All-Share Index is used as a benchmark. At the end of last month the portfolio consisted of just 36 positions including AstraZeneca (6.2 per cent), BP (6.1 per cent), Royal Dutch Shell (6.0 per cent) and Barclays (5.0 per cent).
In third, we find BGF United Kingdom, which was given a Bronze rating by Morningstar analysts. Manager Nick Little, who took over from Mark Lyttleton in 2012, focuses on companies with a strong competitive advantage. This resulted in a growth bias as indicated by the Morningstar Style Box. Despite this preference, Little has room to invest part of the fund in value and recovery stocks, which gives the portfolio a bit more balance. In addition, the manager makes full use of the allowed 20 per cent allocation in foreign stocks such as PayPal and Apple.
The portfolio has generally shown a higher allocation to mid-caps than the FTSE All-Share Index and the fund can also take active sector positions. Under Little, the strategy showed overweight and underweight positions in consumer cyclicals and financials respectively.