Is the current view on UK equities more than a little familiar?
Jon Hudson, manager of the Premier Miton UK Growth fund, takes a step back in time and finds a lack of love for a specific equity market is nothing new amongst investors.
For information purposes only. The views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
A foreign romance
‘’The romance with foreign stocks continues. What started in the mutual funds has spread to the pension funds. The California Public Employee Retirement System poured $7.3 billion into foreign stocks in 1991, and not to be left out, the New York State Teachers’ Retirement System invested $750 million in 1992. Our largest 200 pension funds now have $75.6 billion invested abroad – more than seven times as much as they did in 1985.’’
The above extract was written in 1993 by the legendary investor Peter Lynch, fund manager of the Fidelity Magellan Fund between 1977 and 1990. He put pen to paper here to explain why he thought the American stock market wasn’t a basket case, highlighting lots of great companies. As was often the case, he was right. Over the following 5 years the US stock market returned on average 17% compared to 10.5% for global equities.
The vapour trail of past experience?
As a UK equity fund manager, it all feels remarkably familiar when considering the UK stock market today. Pension Funds have long allocated away from UK equities as an asset class as their members reach retirement age – a natural part of the derisking process – but individual asset allocators continue to withdraw money out of UK equity funds. Why is this?
Brexit and political disarray often top the list but is the UK’s prospects so gloomy compared to the rest of the developed world? I don’t think so. The latest ONS statistics show that since the start of the pandemic, and therefore Brexit, the UK economy has grown faster than Germany and not far behind both France and Italy.
Prospects for the US economy may look more promising in the short-term, but this is hardly surprising with the Federal budget deficit forecast to hit 6% next year. To put this into context, Liz Truss’ mini budget, which almost brought down the UK pension industry, was proposing to increase the projected budget deficit from 2.5% to 5%. Perhaps the UK will be rewarded for its greater fiscal prudence one day.
Herding instinct and FOMO
I believe the real reason for the mass exodus from UK equities has little to do with the UK’s economic prospects, after all, two-thirds of the FTSE 100’s revenue is derived from overseas. Instead, I think this comes down to behavioural psychology or herding to be specific. We have seen this story before. Many investment bubbles and depressions in history have been the result of it.
FOMO or ‘fear of missing out’ is part of this ‘group think’ phenomenon. Many people have never used Bitcoin, let alone know how to value it. Yet after hearing how their neighbour or hairdresser was making easy money, they couldn’t resist investing. Eventually the bubble pops and people sell in panic. Humans like to herd for the same reason as antelope: perceived safety in numbers.
Yet many professional investors will tell you that need to think differently to outperform. “Be fearful when others are greedy and greedy when others are fearful” was Warren Buffett’s famous quote. In this respect a case could be made for UK equities to become a contrarian investment. While I’m not arguing that the UK equity market deserves to trade at a premium to other G7 stock markets, the valuation discount today is now, in my view, at extreme levels it is hard to ignore.
A positive view from the ground up
I honestly find it hard not to be positive about the prospects for the UK companies that I screen, research, meet and invest in. JD Sports is an excellent example. Many may still think of JD as a UK retailer, but over the past decade it has created a global side to its business. Over half of the products that JD sells are manufactured by Nike and this relationship has gone from strength to strength over the past decade, allowing JD to take market share. This has allowed JD to grow its earnings on average by nearly 30% per annum over the past 10 years while Nike averaged 9% growth over the same period. Despite this, Nike trades on a multiple of 25 times its earnings compared to a lowly 10 times for JD.
Games Workshop is another very interesting company. It sells fantasy figurines to a highly passionate and niche set of hobbyists. The hobby used to be very UK centric but it’s taking off globally with the US now the largest market. An upcoming series with Amazon will introduce its Warhammer product to Amazon Prime’s 200m global subscribers. Companies that dominate niche areas cam make high returns on capital because competition is discouraged from entering. Asset-financing software developer Alfa Financial Software is another example of this. Both companies frequently distribute surplus capital back to shareholders.
Elsewhere Flutter Entertainment owns gambling brands globally, including Fanduel, a US gambling platform, where sports betting has only recently been legalised, opening a new market and a potential growth opportunity.
The final word
Present day UK can clearly draw a comparison with Peter Lynch’s observations around US equities in 1993. For now, it may be the home of the contrarian investor, but sooner or later UK equities will be back in view of the herd.