In this article published on Investment Week, Square Mile's David Holder makes the case for backing UK equities and strategies worth considering to gain market exposure.

That the UK stock market has been unloved over recent years is not in contention. Brexit, political instability and a tech-light, value-oriented market with unfashionable energy and tobacco stocks can all be blamed for consistent investor outflows. However, from our discussions with UK fund managers, many believe that the value on offer is now compelling, especially versus other regional equity markets. 

Yet, despite this, the UK stock market remains deeply out of favour. 

A re-rating could be on the cards, though. Potential catalysts for such a reversal are not only underpinned by the attractive valuations on offer, but could also include; an increase in stock market listings, continued M&A, a fresh UK government willing to implement measures designed to make the UK a more attractive destination for domestic and foreign investment.

Bearing this in mind, our research team investigate the case for investing in the UK stock market in the current political and economic climate. 

Key takeaways: 

• The UK’s political backdrop is increasingly stable, with a new Labour government potentially improving investor sentiment.
•  Any improved sentiment towards the UK could benefit funds focused on smaller UK companies, especially those invested in AIM-listed stocks.
• The Bank of England could be more comfortable cutting interest rates post-election, benefitting UK-focused portfolios with growing long-duration cash flows.

The UK’s political backdrop and corporate earnings

Currently, there is a degree of consensus around the economic policies of the major political parties. As a result, a period of relative political stability in the UK could garner a more positive attitude to UK assets. Furthermore, should an incoming Labour government provide an additional boost to investor sentiment, funds with a disproportionate level of earnings tied to the domestic economy could be well placed to outperform - a marked change for UK corporates who have experienced consistent de-ratings in recent years. 

Funds such as the Square Mile A-rated Mercantile investment trust could be well positioned if investor sentiment does pick up. The Mercantile investment trust predominantly focuses on companies that are growing on attractive valuations (outside of the largest 100 listed UK stocks) and has well over half of its underlying revenues derived from the UK via names such as Bellway, Cranswick, and Bytes. 

The UK’s smaller companies

Improving investor sentiment towards the UK may also benefit those funds with a focus on investing in UK smaller companies, especially given a seemingly “pro-business” agenda from the Labour party. So, any uptick in sentiment could provide a boost for stocks, such as those listed on the alternative investment market (AIM), which has underperformed the largest UK companies (which have themselves underperformed global peers) by around 40%¹ over the past five years. A more positive change in outlook towards the UK could thus be a catalyst for a recovery in fortunes for stocks listed on this market.

The Square Mile AA rated Liontrust UK Smaller Companies fund is managed by a well-resourced and experienced team with an impressive track record in this area. Currently, the fund has around 70% invested in AIM-listed companies via key positions such as Tatton Asset Management, GlobalData and Mortgage Advice Bureau. 

The Bank of England and UK Plc

Whilst the Bank of England is independent of the UK government, with a mandate to limit the scale and volatility of price rises, it could be more comfortable cutting interest rates post-election. This should stand to benefit those portfolios with growing long-duration cash flows such as the Square Mile A rated WS Lindsell Train UK equity fund. Unlike the previously mentioned funds, this strategy has a focus on larger companies capable of reinvesting above-average earnings over the very long term to drive investor returns. Key positions include RELX, Experian and Sage Group. Moderating interest rates could provide an additional leg of support for these companies as well as this growth-focused portfolio overall.

Investing in the UK’s future

Ultimately, despite challenges that have plagued the country in recent years, the UK’s current backdrop is supportive of a possible reversal in investor sentiment. Its stock market is loaded with attractive valuations and, with potential catalysts such as a change in government, those valuations could become even more compelling. 
 
¹Source: Refinitiv as at 30th June 2024. Past performance is not a guide to future returns. 

Important information 

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