The valuation of the UK stock market relative to its global peers has reached a three-decade low following years of lacklustre investor sentiment, according to Man GLG’s Henry Dixon. 
However, FE Alpha Manager Dixon – who runs the £827.4m Man GLG UK Income fund – argued that this could have left the UK market primed for a rebound given the low starting valuations and relatively robust economic situation.
Investors have avoided the UK since the country voted in the summer of 2016 to depart the EU, leading to around three years of challenging performance and fund outflows.
Net of % that are over/underweight UK equities
Source: Bank of America Merrill Lynch Global Fund Manager
The latest edition of the Bank of America Merrill Lynch Global Fund Manager Survey showed that a net 25 per cent of asset allocators are running an underweight to UK equities. The country has been the survey’s consensus underweight since February 2016.
Dixon (pictured) said: “By looking at fund flows we can observe an unprecedented exodus from UK assets and the relative value of the UK is now close to 30-year lows.
“It means valuations and sentiment towards the UK look extreme.”
The combination of Brexit-induced nervousness and more global concerns such as tighter monetary policy and the US-China trade tensions means that the FTSE All Share has just gone through a difficult year.
As the chart below shows, the FTSE All Share’s 12.95 per cent fall (in price terms) during 2018 was significant worse that the 4.87 per cent decline in the MSCI World index.
Dixon noted that the index has just gone through a 23.6 per cent fall in P/E (price-to-earnings) ratios. This is the third worst de-rating in its history – it only fell faster in 2002 and 2008 – and has left the market’s valuations relative to the MSCI World
He added that 2018 was the year when the index had achieved the most earnings growth (which was up by 15 per cent last year) for a negative return.
“The key question now is whether this de-rating and starting valuation provides us with enough of a margin of safety for the year ahead,” the manager said.
Price performance of indices in 2018
Source: FE Analytics
Dixon argued that there is some statistical history that suggests optimism for the year ahead, although it must be remembered that past performance is no guide to future returns.
“As we look at the major de-ratings since 1990, we would note that all have been greeted by a re-rating of 18 per cent on average in the following year and an average total return of 24 per cent,” he explained.
The FE Alpha Manager also said that “all is far from lost” when it comes to good news about the UK economy. Record job vacancies, rising wages and falling inflation suggest to him that the UK consumer is in relatively good shape.
These three factors suggest that there could be a “meaningful improvement” in income available for discretionary spend. This is forecast to return to levels not seen since 2014 and 2015, a period when the UK would be the fastest growing G7 economy.
That said, the issue of Brexit continues to hang heavy over the UK market, despite the recent development of a ‘no deal’ exit seemingly being taken off the table. However, Dixon believes investors need to consider Brexit in a wider context.
“While Brexit could provide us with a painful ‘left tail’ event, the damage done to domestic valuations looks extreme to us, and the balance sheet in some of the sectors that might be worst affected looks to be extremely strong,” he said.
“What is more valuable, in our view, is to try to gauge both the sentiment towards the UK as well as the value opportunity.”
Performance of fund vs sector and index under Dixon
Source: FE Analytics
Since Dixon took over the Man GLG UK Income fund in November 2013, it has generated a 65.41 per cent total return, which is the highest in the IA UK Equity Income sector and significantly above the FTSE All Share index.
FE Invest, which has the fund on its Approved List, said: “Dixon uses a disciplined investment approach to UK equities, focused on valuations. The manager uses a valuation screening in order to identify undervalued companies with the potential to recover in the long term.
“The recovery process takes time to come to fruition and then it needs to be acknowledged by the market – therefore, it is a strategy that requires patience. The discipline in the approach means that despite being out of favour, the manager has generated strong relative performance.”
Man GLG UK Income has an ongoing charges figure (OCF) of 0.90 per cent and is yielding 4.11 per cent.