HUB EXCLUSIVES PANEL DISCUSSION
Panel discussion, hosted by Cherry Reynard, with:
Gervais Williams, Head of Equities, Premier Miton Investors
Anna Farmbrough, Portfolio Manager, Ninety One
It has been a long road for investors in UK stock markets. Without a glamorous technology sector to excite international investors, and with its fair share of domestic troubles, the UK equity market has haemorrhaged capital. However, in the last few months, there have been signs of a reversal.
The pick-up has been broad-based. Anna Farmbrough, portfolio manager at Ninety One, says: “Some domestic areas have done very well, such as banks and construction materials. In general, businesses that have delivered on expectations have performed well, and re-rated. At the other end, any companies that have missed a beat on earnings have been punished. It’s been very volatile and polarised.”
Gervais Williams, head of equities at Premier Miton Investors, adds: “We’ve seen areas such as commodities and financials doing very well, plus manufacturing and defence. The consumer has held up much better than we expected.” It has been a good environment for active investors, with companies rewarded for strong performance.
Compelling valuations
In spite of recent rises, valuations in the UK market remain appealing. The UK has experienced a decade of poor relative performance, with the MSCI UK delivering around half the annualised returns for the MSCI World . While the sector composition of the UK indices means that the UK tends to trade on a discount to its international peers, that discount is still unusually wide.
Nevertheless, investors still need to be careful. Farmbrough says: “Some of those businesses that have performed well are on very high multiples and no longer compare as favourably to their international peers. Unilever used to be at a big discount to Nestle for example, but that gap has narrowed. At the large end, there has been more interest from international investors and the valuation gaps have closed.”
“However, there are plenty of businesses that you can compare on a like-for-like basis and they still look very cheap.” She gives the example of Rentokil, which has recently acquired Terminix to create one of the biggest pest control businesses in the US. While the business faces some integration challenges, which will take time to work through, it is trading on a multiple of less than half of its peer Rollins. She adds: “The market is very short term, which creates a lot of opportunity for investors who are prepared to be patient.”
She believes that there is an inherent gap between the quality of UK companies and their valuations: “The UK market is at a wider discount and yet the quality of British companies – in terms of their balance sheets and profitability - is higher than it has been.”
Shrinking market?
The shrinkage of the UK market remains a problem. Global companies and private equity have spotted the opportunity in the UK market and are cherry-picking high quality companies to buy. Share buybacks have helped support valuations, but also shrink the market. There are signs of life from the IPO market, but it has been a lacklustre period.
Williams believes this problem will resolve as the era of cheap debt comes to an end and the relative advantages of raising capital from equity markets increase. He adds: “It has not just been a UK phenomenon. The US market has been exceptionally buoyant and has also seen a shrinkage in the number of companies. It’s been about the cost of debt being very cheap. Private equity has had advantages. Lots of companies have chosen that as a route to raise capital.” His view is that the number of quoted companies in the UK could double in the next 10 years.
However, in the meantime, a reversal of the outflows that have weighed on the UK market would be welcome. There are no signs of this in the current Investment Association data, but there are anecdotal reports of increasing interest in the UK market. The most recent Bank of America Global Fund Manager survey, for example, showed investor sentiment improving for the UK.
Farmbrough says that the UK doesn’t necessarily need inflows to perform well. She adds: “There's been a pick-up in M&A and activism with a bid for Hargreaves and activist shareholders taking stakes in Rentokil and Smith and Nephew, for example. There has also been a pick up in retail trading volumes.”
Williams says that it would only take a small reversal for UK equities to start performing well. He adds: “Lots of companies are doing buybacks and they are now overwhelming local sellers. International investors are starting to look again. If we saw local investors selling a little less, the UK market would go up even faster. There could be significant upside to come.”
