Why UK shares can keep rising despite weak economy

Temple Bar co-manager Ian Lance sits down with ii's Sam Benstead to discuss how he manages his value-focused UK portfolio.

Lance gives an overview of the strategy, and explains why the UK is an excellent place to invest today, even though the economy is under pressure. He also reveals where the 30% of the trust is invested overseas, including one Asian market that he believes is overlooked.

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Sam Benstead, fixed income lead, interactive investor: Hello and welcome to the latest Insider Interview. Our guest today is Ian Lance, co-manager of Temple Bar Ord (LSE:TMPL) investment trust. Ian, thank you very much for coming into the studio.

Ian Lance, co-manager of Temple Bar: Pleasure.

Sam Benstead: You've got 70% invested in the UK. Is that high or low by historical standards?

Ian Lance: The trust has to be 70% invested in the UK, and at the moment we are just over that. But historically, it has been higher. I suppose you could flip that around and say, actually, we are utilising nearly all the 30% to invest overseas that we're allowed.

Sam Benstead: And of that 70%, where are the best value opportunities today then in the UK?

Ian Lance: We're still seeing lots of value within financials, despite the fact that financials have performed quite well. So, banks, insurance companies, then there are some specific companies where we think that what we can see is effectively a turnaround.

We've had a company which has been struggling historically. Often there'll be management change and the new management team have got a strategy to improve earnings and we think the earnings will go up and the share price will follow.

Examples of that might be Marks & Spencer Group (LSE:MKS) would be one. Smith & Nephew (LSE:SN.) is another one, a new management team with a 12-point plan to turn that around. Johnson Matthey (LSE:JMAT) is another company where the management team are basically selling businesses to realise value, so lots of specific companies as well.

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Sam Benstead: And the UK market as a whole has generally been ignored by international investors. There'd be lots of good value opportunities there. Why do you think that is? Why is the UK such a good hunting ground if you're looking for cheap shares?

Ian Lance: It's a good hunting ground because it has been ignored. Some of this has been - you're absolutely right - international investors. Unfortunately, some of it has been our own investors.

Back in the 1990s, when I was a pension fund manager, the average pension fund would have over 50% invested in UK equities. Today, that figure is probably something like 3%. So, we've seen 20 years of selling of UK equites, irrespective of valuation.

What that's caused is lots of big wealth managers these days will benchmark themselves off global indices. When they look at a global index, they'll see that the UK is weighted at 3% and the US is weighted 70%. Now, for most of the people watching this, that shouldn't really matter to them. What should matter to them should be: where can I make money?

And the UK's offering, we think, very attractive opportunity because it's very undervalued. It's very undervalued because lots of people have been selling it.

I guess the final thing I would say is, when you've got to 3%, you're probably close to the bottom in terms of people taking money out of the UK. Anecdotally, we are starting to hear about overseas investors starting to put money back into the UK, attracted by the low levels of valuation.

Sam Benstead: Do you think that will be a catalyst for higher share prices in the UK?

Ian Lance: Yeah, I do. So that's one, hearing about overseas investors putting money into the UK.

I think the two other clear catalysts were takeovers. So, UK companies just got so cheap last year that lots of overseas companies were able to buy some very cheap businesses in what was probably a cheap currency.

Within Temple Bar, we had four takeovers last year, two of which went through, two which didn't. But even the ones that didn't, so Currys (LSE:CURY) was bid for at the start of last year at about 60p, and the share price today is £1.20. So, takeovers was one catalyst and then the other one has been companies buying back their own shares.

This has been a big driver of the performance of the banks. Companies like NatWest Group (LSE:NWG) and Barclays (LSE:BARC) have bought back a lot of their own stock at a very low level. They've effectively been creating their own demand for their shares. When you're buying very lowly valued shares, that's very positive for your earnings. So, there are definitely some interesting catalysts now.

Sam Benstead: Can the UK market continue to recover? As you said, it's done very well recently. Is there more growth ahead?

Ian Lance: It looks like it. I think people must try not to anchor off low valuations. We have a chart of UK valuations that goes back 50 years. Last year, we were close to a 50-year low in that chart.

Therefore, the fact that you tick up from that 50-year low doesn't make shares expensive. It just means that they're not quite so cheap as they were. I think there's potentially still a long way to go if you correct some of that.

Sam Benstead: When you look at the UK equity market, how much attention do you pay to the economy? All we hear is bad news about inflation and growth and government's difficulties controlling the deficit. What does that mean for the stock market?

Ian Lance: Probably not a lot, actually, which might surprise some people that I say that, because I think people probably think that the stock market and the economy go hand in hand.

Of course, that's not really the case for a couple of reasons. Number one is because the stock markets are discounting mechanisms, so the stock market is looking ahead, not back. So, the stock market probably knows and prices in all the sort of bearish news on the economy that we're hearing today. 

Point number two is you've got to realise that lots of the stocks in the UK stock market are not that exposed to the UK economy. A lot of them are big international businesses that happen to be quoted in London. So, even if the UK doesn't do very well, for many it's not really that important because it's just such a small part of their profits.

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Sam Benstead: Moving away from the UK now, where is that remaining 30% invested?

Ian Lance: It's a range of companies. So, we have some European investments. We have some Japanese investments. I think a new area that we've invested in, which I think is quite interesting, is South Korea.

So, Korea is a market that has done quite badly for quite a long period of time. Valuations look very low, and it's one of these areas [where] the story is somewhat similar to Japan a couple of years ago. In other words, you have a government now that has a clear policy to try to encourage companies to create value and to remove some of the low discounts that they're trading at. So, that is a positive catalyst.

We recently, for Temple Bar, bought two Korean banks called Hana and Woori. These are very, very high-quality banks. Actually, the Korean economy is doing very well. South Korea's economy is doing probably a lot better than the British economy. Yet they are trading at very, very low valuations. They have very good policies in terms of returning money to shareholders. So, we thought that was a really interesting area outside the UK.

Sam Benstead: And what about the US? Just how expensive is that market and are there opportunities there for value investors like yourself?

Ian Lance: There are some opportunities because the US is a big market and a big part of the overvaluation comes from the fact that, as I guess probably everyone knows, 30% of the US market is in seven technology stocks. Those seven technology stocks are probably quite expensive. But outside that, there are definitely some cheap stocks in unfashionable areas.

Overall though, I think people should be cautious about having too much money invested in the US market. I was looking at a chart yesterday made by a US fund manager called John Hussman. He has a market cap to GDP-type ratio, which goes back 100 years.

The US market has never been more expensive on that ratio, going back 100 years. Historically, when you've bought the market on that sort of return, you have lost money on an annualised basis of about 6% for the next 12 years. So, if the data holds in the future, you wouldn't really want to have too much money in a US tracker, let's put it that way.

I think, as I say, that there are pockets in the US market. Small-cap and mid-cap US stocks, there's probably plenty of value to go in that sort of area, but at the index level, I think it probably is pretty expensive.

Sam Benstead: As you said, it's these large technology stocks which have pulled up valuations and they dominate the indices. Are you worried about a bubble in AI? It's all we seem to hear about at the moment. Does that worry you a little bit?

Ian Lance: Yeah, it does. It does. I have been, believe it or not, managing money for about 34, 35 years. Therefore, I was managing money in the late 1990s and a lot of what is going on today is eerily reminiscent of what was going on there.

Back then, companies were beginning to use the internet, people were putting the dot-com label on stocks. And, probably like AI, we all know now, don't we, the internet, it was a game changer. It really, really changed the way that we all do business and the way we all interact and read the news and everything.

That didn't change the fact that some of the stocks involved in it were horrific investments. I mean, Nasdaq lost 78% of its value in two years after 2000. Some of those stocks, it took 12, 15, even 20 years to get back to your start point. I have a horrible feeling that AI might be the same.

In other words, yes, it absolutely is going to be a game changer in terms of companies' efficiency and how we all go about our business. But I suspect that is factored into a lot of these share prices and more, and in the long run, some of them can end up being very poor investments.

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Sam Benstead: Following a value investment strategy focused on the UK should insulate you if there is a big crash in that part of the investment world?

Ian Lance: Yes, it should do. I think sensible diversification is always a good policy in terms of thinking about your investments. For me, having 70% in the US doesn't sound sensible, particularly at a point when the US is very, very highly valued.

Therefore, almost from a diversification point of view, you can make the case that you probably should be spreading your investments more towards the UK, Europe, Japan, emerging markets, etc, etc. But especially so given the divergence in valuations, you're effectively switching from a very expensive US market into quite cheap assets in other geographies.

Sam Benstead: Finally, the question we ask all our guests, do you personally invest in the trust?

Ian Lance: I do. And so does Nick, and [it's] a pretty substantial amount of money.

Sam Benstead: Ian, thanks very much for coming into the studio.

Ian Lance: Pleasure.

Sam Benstead: And that's all we've got time for today. You can watch more of our Insider Interviews on our YouTube channel, where you can like, comment and subscribe. See you next time.