City of London: the UK shares still offering value

Job Curtis, manager of the City of London Ord (LSE:CTY) portfolio, talks about a part of the UK market offering value even after strong gains.

He also looks at what could finally lure big investors back to UK shares.

City of London is one of ii’s Super 60 investment ideas. 

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Dave Baxter, senior fund content specialist at interactive investor: Hello and a very warm welcome to this Insider Interview. My name’s Dave Baxter, and joining me today is Job Curtis, manager of City of London Investment Trust. Job, thank you for coming in today.

Job Curtis, manager of City of London Investment Trust: It’s a pleasure.

Dave Baxter: So, UK markets have really roared back to life this year in particular. But the picture is definitely a bit murkier when it comes to the UK economy. I should note that we’re recording this before the Bank of England’s December interest rate decision. But the last decision, they decided to hold rates at 4%, but they said that they believed UK inflation had peaked. What’s your view on the UK economy now?

Job Curtis: Yes, so obviously the UK economy is important, but it’s just worth mentioning that if you look at City of London’s portfolio, which is predominantly in the UK stock market, some 60% of the underlying sales of our companies come from overseas, and that’s typical of the UK stock market. You’ve got big global companies.

But to come to your question on the UK economy, obviously inflation in the UK has been more persistent than in many other countries. But there are signs that it has peaked and is beginning to come back down again.

In particular, wage increases have been quite pronounced, with some quite generous public sector increases in the last couple of years, and also the living wage, the minimum wage, has gone up well above inflation, and that puts pressure at the lower end of the whole pay structure.

So, the Bank of England, I think understandably, is treading quite cautiously because the CPI rate is still well above the 2% target. But I think there are enough signs of a slowdown in the economy, in particular, the labour market, with signs of unemployment beginning to tick up a bit and wage increases plateauing.

I would expect interest rates to be on a downward path. They’ve already fallen to 4% from, I think, 5.25% some 18 months ago. But our interest rates are quite elevated still compared to most of the other G7 countries, and I would expect our interest rates to be on a downward path. But the Bank of England, as I say, tread cautiously.

In terms of growth, we’ve obviously had much stronger growth in the first half of this year when actually the UK - admittedly it wasn’t tough competition - was, I think, among the fastest growing of the G7. Then we’ve actually slowed down in the second half of the year.

But I think, overall, I would expect growth. Obviously, we’re beholden a bit to the global economy as well, but I would expect, overall, growth to carry on at a lowish level. I don’t foresee a recession at the moment.

The savings ratio is quite high. If you look at personal savings, that ratio is actually relatively high and also businesses are quite strong, the bit that’s in debt is the government.

I think that’s quite a good buffer. I think consumers have been quite cautious, which means there is something in reserve. So, I think when people get a bit more confident, and maybe when interest rates start to come down, there is scope for parts of the economy to improve. The housing market has been quite depressed and yet we know there’s quite a latent demand for new homes out there.

So, as interest rates start to kick in, and as bank lending becomes less restricted, which I think it will do, I think there’s scope for the economic growth to pick up a bit from where it is at the moment.

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Dave Baxter: So, plenty of sectors very closely associated with the FTSE 100, to give one example, financials have run really hard this year, delivered some enormous returns. In that context, where are you still finding value?

Job Curtis: I actually still think there’s a lot of value in the UK banks. They’ve had a very good year. We went overweight some two years ago, having been underweight since before the financial crisis.

In particular they’re benefiting from a tailwind from the structural hedge, which are hedges they took out when interest rates were ultra low, and as they roll over after five to seven years, they’re being rolled over at much better interest rates. This is a positive tailwind that’s set to persist.

In addition, I think the kind of regulatory climate has changed, and post the financial crisis, people, the regulators, and politicians were very understandably concerned to make the system safe and for the taxpayer never to be at risk again. But I think now we’ve moved on a bit.

I think the issue now is economic growth. You don’t get growth in the economy without the banks lending. There’s much more imperative to actually encourage bank lending and to make it easier for people to get mortgages, and that sort of thing does stimulate economic growth. So, I think that’s quite a positive backdrop for the banks against a situation where the competition in the sector, if anything, has lessened somewhat.

For example, you know, Sainsbury’s and Tesco’s have sold their banking operations to Barclays and NatWest. So, overall, it’s quite well disciplined in terms of the competition in the sector, and there’s quite a scope for the banks to increase their lending profitably. 

When I look at the valuation of UK banks, they have re-rated from very cheap valuations. When you look at their profit and dividend potential, looking at the relationship with share prices to tangible book values, and the returns they make, which is one of the key relationships. I’ve seen the bank sector much more highly rated in the past, and I think there’s scope for further re-rating.

Dave Baxter: What’s the biggest risk to City of London in 2026?

Job Curtis: I think it’s global markets. We are an equity fund and City of London has a fairly defensive portfolio and we’re valuation driven and tend to focus on stocks that we think are reasonably rated relative to their prospects, and with a firm underpinning from dividend yield.

But particularly in the States, there’s been this huge boom in stocks associated with artificial intelligence (AI), with absolutely massive valuations, and the spending of unbelievable sums of money on investing in AI, which obviously people have a huge vision about what it can do. But, in the short term, are the returns going to really justify the amount of money that’s being thrown at it?

NVIDIA Corp (NASDAQ:NVDA)’s market capitalisation, for example, is worth more than the whole of the UK stock market,  the whole of every single stock in the FTSE 100, Shell (LSE:SHEL), Unilever (LSE:ULVR), all of them added together.

So, if we did see some sort of correction in the States, it would drag back everything, I think. But I would argue that given how much cheaper the UK stock market is, obviously we don’t have the same scale of technology companies that they have in the US, but if you compare our oil companies with American oil companies or our consumer staples with American ones, we’re still on a massive discounted rating.

I would argue that the UK is likely to prove quite defensive in a sell down. But I think that would be my biggest worry, that at some point we get some sort of correction, and people lose a bit of confidence in the huge optimism they’ve got about the benefits of AI, or in terms of what it will mean for shareholders at least.

Dave Baxter: Beyond AI, tariffs have been a major concern for investors, but of course the effects can vary from country to country. What do you think the impact is for the UK, and how does that affect the outlook for different sectors?

Job Curtis: I take the traditional approach that tariffs are not good news. They raise prices for consumers and they lead to inefficiencies, as the world benefits from countries specialising and more trade. But, obviously, there’s the other arguments that China’s abused the system and there are security considerations as well about certain industries.

But I think the UK overall, the tariffs apply to manufactured goods. We actually have quite a small manufacturing sector, our big sector’s really services, and that’s not really impacted nearly as much by tariffs.

In addition, the UK struck a relatively favourable trade deal with the US. Although we’re still going to be paying a much higher tariff than we did previously. So, I would argue that the UK is probably less affected than many other countries.

But yes, it’s something to watch. Obviously there’s a lot of noise and you get lots of different announcements and changes and positions on one side and then deals done, and so on and so forth. So, it’s a bit of a moving feast.

Overall, I have to say I don’t think, in my opinion, that tariffs are particularly good news for the global economy, but I think we’re learning to live with it.

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Dave Baxter: The trust is very well known for its record of dividend growth, but that growth has not actually been that substantial in recent years. What are you going to do to fix that?

Job Curtis: Yes, obviously dividend growth across the market was very impacted by Covid. In 2020, FTSE 100 dividends went down by 36% and a lot of companies at the time couldn’t grow their dividends partly because their businesses had shut down, or there were issues that the banks weren’t allowed to pay dividends. So, there were factors affecting it, and we’ve had a recovery since then.

But we’ve carried on growing our dividend throughout all that, helped by the investment trust structure, which allows us to use revenue reserves and carry on growing our year’s dividend and in difficult years for dividends.

But, overall, I certainly see in the banks scope for dividends to carry on growing in that particular sector. If you look at NatWest Group (LSE:NWG), for example, which is a top 10 holding for City of London, they paid out 44% of their earnings in dividends last year. They’ve targeted 50% this year, but actually this will lead to fairly decent dividend growth given the earnings going up.

But, if you look at the history of banks and banks in other jurisdictions, 50% is actually a relatively low dividend impact ratio. They could actually pay a much higher payout ratio than that.

So, I think there are pockets of the market, sections of the market which I’m confident about as ever, and there are other areas where things are more difficult. We’ve had a lot of cuts in the mining sector and also more cyclical sectors, building-related companies, and retailers have had to cut their dividends.

That’s the benefit of having a portfolio approach. By investing in a portfolio like the City of London, hopefully I can guide us to areas of the market where the dividends are growing and mitigate the areas which are more under pressure.

Dave Baxter: You, like some of your peers, have lamented the fact that institutional investors, so pension funds and the like, have really been steering clear of UK equities in the last couple of decades. What do you think could happen to draw them back in?

Job Curtis: What’s happened is, first of all, a lot of institutions have gone what we call ‘risk averse’, where they’ve got liabilities, and just want to match them in the least risky way, and they see that as going into fixed interest and just sort of matching their liabilities. Periods of fixed interest can be quite risky because of inflation, but nevertheless that’s a course they’ve taken under advice from actuaries.

In addition, [where people and institutional investors invest in equities],everyone’s gone very global, and the UK is now quite a small part - it never was particularly big - or an even smaller part of the globe. They have probably got a lot more money, say, in the American stock market than they will have in the UK market. 

To be honest, I don’t see anything particularly likely to reverse that in the short term. I think it’s kind of a bit set in stone. But I think what’s happened, what’s really encouraging, is that the companies have risen to the challenge and they’ve seen how undervalued their shares are.

So, companies have embarked on a lot of share buybacks across the stock market, and so now slightly over 2% by market cap of the UK stock market has been bought back by companies. Every day, at 4:30pm, I see the announcements of various companies buying back their shares.

For the people who remain in UK equities, such as City of London and its shareholders, this is a very virtuous circle because companies like Shell (LSE:SHEL), to give a good example, or Imperial Brands (LSE:IMB), are buying back substantial amounts of their shares, and so they are able to grow their dividend, but because they’re shrinking the number of shares in issue at such a fast rate, the actual cost of the dividend is declining despite the fact it’s being grown. And it’s very supportive to the share price.

I think this is one of the reasons why the UK stock market’s been performing very well this year and rather better than the American stock market. This share buyback is bigger as a proportion of its market cap than the US share buyback, and we’ve got a much better dividend yield. So, the companies have risen to the challenge.

For the UK institutions to come back to the UK, it’s a bit like Waiting for Godot, you know, and I’m not getting too excited about that possibility, but I think the share buyback is making up for that.

Dave Baxter: What are your biggest reasons to be cheerful and fearful in 2026?

Job Curtis: I think the valuation of the UK stock market is very supportive. It still is the cheapest rated on our calculations of the major stock markets, and it’s somewhat below its long-term average, unlike most of the other stock markets.

You’re being paid while you wait, you’ve got a dividend yield of over 3%, around 3.3%, a share buyback going on at around 2.2%. So, you’ve got what we call a total distribution yield of about 5.5%, which I think is a very strong starting point. So, you’re kind of paid to hang on in the UK stock market is one way of describing it.

In terms of my worries, I guess the geopolitical. You can’t worry about it every minute of the day, but we’ve still got a war going on in Ukraine and, obviously, we’ve still got these big tensions with China, and issues in the Middle East haven’t gone away either, really. So, I think the geopolitical could rear its ugly head at some point. I’m not predicting it will, but it’s something you can’t ignore at all.

Dave Baxter: Job, thank you for your time.

Job Curtis: It’s a pleasure.

Dave Baxter: So, that’s it from us. Many thanks for watching. Do let us know what you think in the comments. And if you enjoyed this series, do hit the like and the subscribe button. Take care.