Nothing is certain about the UK political and economic outlook, but portfolio manager Adam Avigdori explains there is still plenty for active investors to get excited about.
The UK political and economic landscape is about to change. As Brexit negotiations continue nothing is certain but we do know that the future will be different from the past.
Last year’s globally synchronised growth has so far continued in 2018 but the G20 notes a series of risks that threaten to undermine this positive environment (g20.org, March 2018). Rising financial vulnerabilities, heightened trade and geopolitical tensions, global imbalances and inequality are all contributing to a likely slowdown in growth.
The UK stock market is not only facing these Global challenges, but is also toying with uncertainty within its own borders as a result of Brexit. The stock market has priced in a great deal of this uncertainty which seems logical since investors are unsure about the future for domestic companies. However, while some businesses will be affected negatively by the UK’s withdrawal from the European Union, this will not be true for all UK listed companies and indeed, many UK companies earn most of their revenues internationally.
At times of significant political shifts, the market tries to identify businesses that will experience an adverse impact. Since it is unclear which ones will suffer or for how long, the response has been for stock prices to fall collectively.
As a result, the UK market is not an expensive market to invest in and has only been cheaper twice in the last 100 years; during WWI and WWII[i]. The UK is trading at a 29%[ii] discount to the MSCI World and is at a 15-year valuation low relative to Europe, whilst still offering higher expected returns over the next 5 years than many of these markets, and indeed than other asset classes:
BlackRock’s 5 Year Asset Class Beta Return Assumptions
31 August 2018
Source: BlackRock Capital Markets Assumptions in GBP over the next 5 years. Data as at 31 August 2018
Over the longer term, we expect investor interest in the UK market to increase as political uncertainty diminishes and investors recognise the importance to their portfolios of an asset class that is attractively valued, expected to deliver strong risk-adjusted returns and that traditionally performs well in the late stage of the cycle. In the meantime, we believe the stock market reaction has been too broad in some respects and this creates an opportunity to buy certain stocks relatively cheaply. The BlackRock Income and Growth Investment Trust, for example, targets companies with strong management teams with a vision aligned to shareholders. These businesses have robust balance sheets with good free cashflow that can be passed back to investors through dividends or reinvested in the business to drive growth.
Rising interest rates
Importantly, we look for businesses that have low levels of debt. This year, we have started a return to interest rate rises which means that, going forward, borrowing conditions will not look as favourable.
The UK is also entering its first real return to inflation for a decade and successful companies need to be able to absorb rising costs of labour and energy, for example. We invest in businesses able to withstand price rises without damaging their margins or affecting their position in the market. Our portfolio contains companies with unique technology, products or services that allow them to price ahead of inflation and remain resilient to competition.
We are also interested in firms that can endure disruption. Much is made of the rise of new technology that has upset traditional industries. The growth of online retail, for example, has caused problems for some high-street retailers. We look for businesses that are driving this disruption and those best able to adapt and respond. Fears about disruption – like fears about political change – also create pricing anomalies. We believe the market overreacts to disruption and de-rates some companies unnecessarily. This creates opportunities for us to invest in those businesses we believe are more resilient to changing conditions than their share price might suggest.
The UK market also continues to benefit from high levels of M&A activity not seen since before the financial crisis. UK M&A totalled $120bn and 681 deals, which is more than twice the overall value of transactions in Q4 2017 (EY, April 2018).
Much of the activity came from abroad. A fall in the pound’s value, alongside the UK’s sound legal infrastructure, robust accounting system and limited government protectionism, maintains Britain’s position as an attractive destination for foreign investors.
Clearly, UK plc has its challenges. Those businesses exposed to the domestic economy, ones with a heavy reliance on EU labour and those that import will be hampered. And the ongoing uncertainty makes strategizing difficult.
That said, the UK boasts some excellent companies with long-term growth potential. We remain committed to seeking those out.
There is no guarantee that any forecasts made will come to pass.
Trust specific risks
Overseas investment will be affected by movements in currency exchange rates. Emerging market investments are usually associated with higher investment risk than developed market investments. Therefore, the value of these investments may be unpredictable and subject to greater variation. Investment strategies, such as borrowing, used by the Company can result in even larger losses suffered when the value of the underlying investments fall.
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[i] Citi Research, UK in Focus September 2018.
[ii] Across P/E, P/B and Dividend Yield measures. Morgan Stanley Research September 2018
At BlackRock we see investment trusts differently. The world is undergoing political, economic and demographic change. For some, change means challenges but at BlackRock we see opportunity. We have a range of 9 investment trusts, from multi-asset to specialist. We use leading systems and experts to invest in the fastest growing countries and most successful companies across the world.