It’s not new news that the UK is out of favour and has been since before the Brexit spanner was thrust energetically into the works back in 2016. But the unremitting distaste of investors for UK plc is remarkable.
Since 2015, net £7.3bn of UK-focused funds has been sold off and redirected into international funds, according to fund service Calastone.
Up until May this year, we saw 22 months of consecutive outflows; astonishingly, despite a rebound in sentiment and broader fund inflows in January, UK funds still endured almost £900m of outflows that month – the third level highest on record.
What’s going on?
Clearly, British political turmoil has played a part in deterring investors. Moreover, unlike the US and some Asian markets, the UK stock market cannot boast a wealth of tech exposure, so it was bound to underwhelm when the tech boom was in full swing.
Since then, of course, the economic environment has changed. From the end of 2021, as inflation took rapid hold and interest rates were hiked repeatedly, growth businesses of all descriptions were indiscriminately banished to the doghouse.
In this new world, it’s notable that the many smaller and mid-cap businesses – in the UK and globally – that had earlier jumped on the high-growth bandwagon through repeated equity issuance and the acquisition of ‘jam-tomorrow’ tech companies have not been able to maintain profitability.
That’s in marked contrast to the UK’s many high-quality growth businesses, which have been able to continue to grow structurally despite the chilly economic winds blowing. These are businesses with strong cash flow, high barriers to entry and great management, that can compound earnings over the long term through good times and bad.
To give an idea of the extent of the havoc wreaked by the sell-off, among our own top 10 holdings are Halma, a fire safety systems business and animal pharmaceuticals firm Dechra.
Both far outperformed the FTSE 100 for years up to the end of 2021, but that completely reversed with the quality-growth sell-off, leaving these stocks at their most undervalued relative to the blue-chip index for at least a decade.
Topping up on value
So, given the great value and opportunities currently in evidence across our target market, we put our money where our mouth is, and are almost fully invested in what we believe is one of the strongest portfolios we’ve held for a long time.
Although we are committed buy-and-hold investors, last year’s rotation prompted us not only to add to longstanding core holdings, but also to add some new ones that we’d been watching for years.
They include industrial equipment rental company Ashtead (which is strongly placed to benefit from the onshoring of industrial businesses in the US, where 95% of its profit is generated) and kitchen manufacturer Howden Joinery (which has continued to grow organically even during the recent housing market slump).
Importantly, all these businesses have pricing power – the capacity to pass on costs to customers without losing them and therefore to remain profitable in the face of rampant inflation.
But they don’t necessarily have to do that in order to remain profitable and we have been seeing that, in some cases, they choose not to inflict painful price hikes on their customer base but instead to raise prices at a gentler rate over time in order to preserve customer loyalty.
Indeed, some are finding that they actually gain market share versus competitors inflicting more aggressive price increases on consumers.
So how likely is it that the economic backdrop will soon revert back to the halcyon days of 2021, when money was cheap and the corporate living was easy? Pretty low, we believe, and most commentators would take a similar line.
Nonetheless, from our conversations with investors over recent months, it’s evident that many people continue to hope for just such a U-turn, and are therefore reluctant to sell out of their high-growth investments despite their recent underperformance.
Our perspective is that there is still time to rotate out of those holdings, on the grounds that there will be no return to 2% inflation or rock-bottom borrowing for some years. For us, this is absolutely the time to be patiently reinvesting into robust, high-quality UK holdings for the long term.
We don’t have a functioning crystal ball, unfortunately. But the signs are that interest rates and inflation will decline – and the UK is now so cheap that sentiment towards it is bound to improve in due course.
But by the time that happens, of course, it will be too late. A rising market rarely pauses to let suspicious investors plough their money back in – and if it did, they probably wouldn’t trust it anyway.
Fred Mahon and Rory Campbell-Lamerton are co-managers of the Church House UK Equity Growth fund. The views expressed above should not be taken as investment advice.