Interactive Investor

Why UK funds and trusts could go from zero to hero in 2021

We explain why there is more optimism about the outlook for UK funds and investment trusts.

15th December 2020 11:51

Hannah Smith from interactive investor

We explain why there is more optimism about the outlook for UK funds and investment trusts. 

The UK stock market has been a global pariah for some time, shunned by both domestic and international investors even with valuations at historic lows. But, with a Brexit deal or no-deal by the end of this year and a Covid-19 vaccination programme under way, will retail investors return to UK equity funds in 2021?

The UK market is still languishing in negative territory so far this year, held back by its high weighting to economically sensitive sectors such as banks, energy and materials, and its low tech exposure. But since November’s vaccine news, “the FTSE 100 has led the rally as investors have started to feel more optimistic about a recovery in earnings of the more beleaguered areas of the market”, says Shauna Bevan, director at RiverPeak Wealth. 

At the fund level, some UK equity funds have notably outperformed, with JO Hambro UK Equity Income, for example, up 24% since Pfizer’s vaccine announcement on 6 November, although Bevan notes that “it still has quite a lot of ground to make up for its investors”. Another comeback kid is Man GLG Undervalued Assets up 20%, while Artemis UK Select has gained 19% over the month. 

UK stocks ‘from a different planet’

The UK market has underperformed for the last five years, notes Tom Becket, chief investment officer at Punter Southall Wealth. During this time, his firm has had a bias to global stocks versus the UK in portfolios, despite its usual “unashamedly” UK-focused approach, but next year its “biggest decision” will be whether to go overweight UK stocks. 

Becket is optimistic on the outlook, arguing that the structural reasons the UK has lagged could now drive better performance. “UK equities look like they’re from a different planet compared to the performance of global equities,” he says, highlighting three big drivers of this divergence. One is the chaos that has surrounded Brexit since 2016, another is the severity of the UK’s pandemic experience, while a third is the prolonged outperformance of growth stocks, especially tech, which are thin on the ground in the UK. But, with its bias towards cyclical recovery value stocks, the UK could be well placed to benefit from the reopening of the economy, Becket says.

Fidelity’s Alex Wright argues that changes happening in all three of these scenarios could entice investors back to the UK. The manager of the Fidelity Special Situations and Fidelity Special Values (LSE:FSV) says the end of Brexit negotiations and the vaccine roll-out should “lift some of the uncertainty that has plagued UK equities”. Wright argues that even a no-deal Brexit, while not a great outcome, would still mean a resolution to five years of uncertainty, and robust UK supply chains during the pandemic have proven that companies are well prepared. 

While growth investments have outperformed value by 30% between July 2018 and November this year, Wright notes that in the last month value has made a welcome comeback. Value stocks remain cheap, and a return of investor confidence could lead them to broaden their horizons away from a “narrow range of secular growth stocks” and seek out these unloved companies once more, he suggests. 

The other clue which could point to a UK recovery story is a recent spike in M&A activity. Typically, when foreign buyers start showing interest in snapping up UK businesses, that means they see irresistible value there. Where private equity and venture capital firms lead, retail investors may eventually follow. “We have recently seen a pick-up in M&A activity, a sign that foreign corporates and private equity investors are recognising the value on offer,” says Wright.

Failure to launch

Although many signs look good, Bevan notes that “not everyone seems convinced” about the outlook for the UK market. She points out that two UK-focused investment trusts that were due to be launched this autumn failed to meet their minimum fundraising targets, while a third, Schroders, just scraped through with its new Schroder British Opportunities (LSE:SBO).

“Brexit negotiations have continued to dominate the headlines, impacting sentiment, and I think many investors are enjoying the returns that they have made in more global-focused investments and are not yet brave enough to take their profits and put them into the UK,” says Bevan.

“This is understandable since many of the areas that have done well, such as big technology firms, possess structural tailwinds which will benefit these areas for many years to come. However, those who have maintained exposure to the UK and follow a disciplined approach with regular rebalancing will naturally be drip-feeding more money into the UK, which I think will have a positive impact on their portfolio returns next year.”

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