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Coming home?

Date: 16 July 2021

With all the attention on the home nations in recent weeks, we take a look at the UK Equity sector, including whether the assets are ‘coming home’? Whilst it has proved a fruitful ground for stock pickers, the long term trend continues to be for investors to look more globally, although a recent survey from our colleagues at Quilter Investors produced some interesting results in terms of how much the average investor still holds in the UK.

Well what a week! Given the excitement and ultimate disappointment for England, I thought I’d take the opportunity to draw some parallels and spend this week’s podcast talking about the UK equity fund sector. Are the assets coming home?

It’s been a fairly unloved sector in recent years, with the long-term trend being to invest globally at the expense of the home market. That hasn’t been helped by the outperformance of growth areas such as technology, which the UK index lacks, being a more value-biased index as a whole, given its exposure to areas such as financials and energy. The shifting focus towards sustainable investing, for which again the UK market is perhaps not best placed, must also have had some impact. Looking at ETF flows this year, the UK has seen positive numbers year to date according to data from State Street for EMEA listed ETFs. That said, equities generally have all had inflows, and all regions are in positive territory. Conversely, Numis reported data to end May that suggested continued outflow within the open-ended space for All Companies and UK equity income funds, with UK smaller companies funds being the only bright spot with net inflows consistently throughout 2021.

So how have UK equity funds fared of late? The answer is that they have generally done pretty well. Over the last 12 months the average UK All Companies fund is around 6% ahead of the UK market as a whole, using the IA peer group average. Over 3 years that number is just under 5%. UK equity income funds have also done well shorter term, 4% ahead over 12 months. Given the natural value bias of most of these funds, they have struggled longer term, but over the last three years that group is on average just under 1% behind the market. Lastly, smaller companies funds continue to produce stellar relative performance, with the peer group around 12% ahead of the Numis Smaller Companies index over 3 years, although over one year there is little difference in the returns of the average fund and the index, but that amounts to around a 50% return, so I suspect most investors will be pretty happy with that result.

This all sets the UK out from other major markets as one where active stock pickers have had most success, whilst other regions have generally seen the average fund returning roughly in line with their respective indices. Of course that is what we would generally expect to be the norm, although that hasn’t necessarily been the case over some periods in recent years, with active managers struggling. In the case of the UK, to some extent active managers have benefited from weaker performance over the last 3 years from some of the largest holdings, notably HSBC and Royal Dutch Shell, almost the opposite of the US experience, where the largest index holdings have led the market up.

Looking a bit more closely, the dispersion among the UK All Companies funds has been very high in the last 12 months. The difference between the best and worst fund over that period was 72% according to. Morningstar data. It is also noticeable that the laggards in the last 12 months were some of the very best performers as we entered the crisis. As ever, a reminder to those that select funds that picking last year’s winner is always fraught with danger. Interestingly, there seem to be as many growth as value funds at the top of the list, which perhaps partly reflects the change in market environment mid-way through the period, but equally suggests that it was very much driven by stock selection. Over 3 years, that extends to 97% between the best and worst performing funds.

Surveying a group of investors with at least £60,000 in investable assets, 64% had more than 25% invested in the UK and 46% over 50%.

So, what are the key questions for the UK Equity sector going forwards? As ever there are always plenty, but on my short list, I’d include the value growth debate, and in particular whether inflation is going to play a significant role or is more transitory. There has also been a lot of activity both in terms of M&A, largely by private equity, as well as new IPOs, almost 50 already this year.How funds benefit or otherwise will clearly have an impact. More broadly, there are some very well-known managers potentially getting to the end of their careers, and how that plays out will be of interest to both holders and competitor funds. The ever increasing focus on ESG also raises the question of whether the UK sector will see a raft of sustainable focused funds launch? It has been fairly quiet in the space in the last 18 months, with just 4 launches in the All Companies space, of which only one appears to have that focus. Whilst many funds have been launched in the global sector, regional funds are often more frequently utilised for those also overlaying their own asset allocation, and perhaps this is the next step. As we said before, that is often seen as more difficult in the UK. Of course, that doesn’t mean existing funds aren’t being improved or transitioned, although I can’t say we’ve seen so many in the UK.

Lastly, there remains the bigger question of whether the trend to invest globally rather than having a much higher local UK weighting will continue unabated. It was interesting to see some research from our colleagues at Quilter Investors very recently on this topic. Surveying a group of investors with at least £60,000 in investable assets, 64% had more than 25% invested in the UK and 46% over 50%. So whilst I’ve certainly observed a move towards a more global focus within our industry, clearly there are many investors for whom the UK is still very significant.

To switch topics slightly, this has also been a bumper year for the Investment trust sector. In the most part this doesn’t relate to the UK equity part of the sector, although this group were among those issuing where the market offered the opportunity. Acriss the entire investment trust universe, that amounted to £6.7bn in new issuance in the first 6 months of this year, a record according to Numis. That was primarily in secondary issuance rather than IPOs, but interestingly it was less dominated by the alternative income space such as infrastructure and renewables than it has been. Of note, both long only equity and private equity were significant raisers of capital, albeit alternative income continued to represent over 60% of the total. All, of this is relevant to both end investors, who have a steadily expanding range of liquid options available to them, and those investing in the FTSE All-Share, where the weighting to investment trusts is over 7%.

That concludes my quick run through of the UK space today. I’m not sure assets are coming home, but UK equity fund managers have certainly performed well long term from a relative perspective, and the market remains attractive. This has been shown recently with the number of acquisitions taking place, often led by private equity. I think there are more reasons to be looking globally than locally going forward, at least with a long term lens, but perhaps short term, the relative cheapness of the market might encourage international investors.

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