Early signs investors are returning to unloved UK funds

This could be the first sign of a potential reversal of investor sentiment towards UK assets.

UK equity funds ended an eight-month streak of outflows in February, which could be the first sign of a potential reversal of investor sentiment towards UK assets.

As Calastone, the global funds network, noted: “Investors tentatively dipped their toes back into UK waters”, adding £145 million to their UK equity fund holdings.

For the past few years, both international and domestic investors have generally been quite negative about UK stocks. Survey after survey showed that fund managers around the world were underweight UK stocks. Meanwhile, UK-focused equity funds experienced sustained outflows.

The risk of a no-deal Brexit kept investors away from UK assets. Related to this, sterling has generally been weak. 

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These fears were further compounded in 2020 by the pandemic. The UK’s initial response to the pandemic was seen by many as being too slow, resulting in a higher number of cases and, therefore, a longer and stricter lockdown.

The sorts of companies found in the UK also added to this. The UK stock market is dominated by energy companies and banks. Firms in these sectors fared particularly badly in the lockdown.

All this generated a lot of commentary suggesting that the UK market was cheap. Many commentators and fund managers cited statistics showing that UK equites were trading at historically low valuations and were due a strong recovery. For the most part, however, investors ignored this, instead focusing on the risks in the present.

Now, as the data from Calastone suggests, the clouds appear to be lifting. There are several reasons for this.

First, the risk of no-deal Brexit has disappeared, with the UK and EU agreeing to a trade deal at the end of 2020. Meanwhile, the end of the pandemic looks in sight, with vaccine roll-outs happening across the world. This has been positive for UK stocks in two senses.

The UK’s vaccine programme has been among the most successful in the world, especially when compared to EU countries. As a result, the relative outlook for the UK economy has improved.

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However, the broader global recovery should also benefit UK stocks. As already noted, the UK market is full of energy and banks. Both sectors are seen as cyclical, meaning their share prices often move in tandem with the broader global economy.

As Edward Glyn, head of global markets at Calastone, observes: “Sentiment on UK equity funds is also going to remain closely linked to the recovery from the pandemic and whether the cautious plan to lift lockdowns starts to slip. UK funds have been so out of favour for so long that some rotation is clearly taking place now, too.”

Data from Calastone also showed that European equity-focused funds are experienced outflows. This, they argue, was the result of having a poorer vaccine roll-out. Glyn notes: “Outflows from European funds seem more linked to the shambolic vaccine roll-out."