With UK equities trading at their cheapest valuations for decades, investors nervous about going back to the market while Brexit remains unresolved could be missing out, according to Unicorn Asset Management’s Fraser Mackersie and Simon Moon.
Since the EU referendum in June 2016, UK equities have struggled to keep pace with their international peers. Ongoing uncertainty over how Brexit will be delivered by first Theresa May and latterly Boris Johnson has seen international investors shun UK stocks.
As the below chart shows, the FTSE All Share index has risen by just 30.4 per cent as the developed markets-focused MSCI World ex UK made a return of 64.45 per cent, in sterling terms.
Performance of indices since EU referendum
Source: FE Analytics
Those companies with perceived greater exposure to the UK economy have been particularly badly hit.
But Mackersie and Moon, managers of the four FE fundinfo Crown-rated, £645.3m Unicorn UK Income fund, said that could be a mistake.
“It certainly has been fairly challenging over the past three-and-a-bit years,” said FE fundinfo Alpha Manager Mackersie. “We’re going into our third [general] election in four years. We’ve had two referenda – one on Europe and one on Scottish independence – in recent years.
“That has certainly been challenging, without question. The flip side of that, of course, is that it is a good [investment] opportunity which we – as active managers – try and take advantage of.”
More domestically focused companies have represented particularly good value over the three years since the referendum result and are somewhere the managers have been adding to more recently.
“What we try to do is look for where we see the best value that isn’t warranted and that’s why were so overweight domestic earners,” said co-manager Moon. “For the last three years that’s where we’ve seen the most value.
“It’s about 70 per cent domestic earnings at the moment. The UK market is looking as cheap as it's looked in… I couldn't tell you how many years, but decades, and you can compound weak sterling onto that as well.”
Hunting up and down the market cap scale – but with a bias to small- and mid-cap companies – Moon and Mackersie seek out high quality, dividend-paying undervalued companies that are undervalued by the rest of the market.
“When you look at the rest of the rest of the sector, the majority of it tends to be focused further up the market cap scale and we're investing heavily into those perfectly good dividend paying companies that you won’t be familiar with,” said Moon.
However, even the types of companies that the managers focus on within the portfolio haven’t been left untouched by the ongoing challenges in the UK market.
“One of the tools we use for buying and selling is equity relative valuation and we run that across the portfolios,” said Moon.
“At various points over the last 12 months, over 90 per cent of the companies within the portfolio have looked to be at a relative discount to their long-term averages which is pretty stark. It's looking marginally better now, but it's still looking very good value.”
He added: “To say that they’ve been through the mill would probably be too strong a phrase. That said, they’ve certainly seen a backdrop that’s not been as sanguine as it might’ve been.
“These are companies that are the best in their sectors offering niche products and services, so they tend to be the most resilient and – even if they’re not the biggest in their sector when they go through a tough time – they’re the best of their sector and they’ll come out of it on a stronger tangent than the rest and should take market share.”
One such example of a company held in the Unicorn UK Income fund that fits the bill for Mackersie and Moon is block-paving company Marshalls.
As the below chart shows, the company saw a significant fall in share price in the days following the referendum vote, dropping by just over 30 per cent. However, since the referendum date the company has seen its share price move 139.28 per cent higher.
Price performance of Marshalls since EU referendum
Source: FE Analytics
“Shares were trading just around £4 but intraday they fell to just under £2,” he said. “We were actively in the market trying to pick up as many as we could on that day because it’s seen as almost solely domestic.
“In a sort-of doomsday-Brexit-recession scenario Marshalls looks awful but that it is a company we’ve known for years: we know how stable they are, how cash generative they are, how high quality they are,” said Moon. “We just thought all these fears were completely overdone and [impacted] the value of the business in the blink of an eye.”
Nevertheless, while the current angst over Brexit and other political issues has been good for value-focused stock pickers, Unicorn’s Mackersie said there is one thing on his wish list for 2020.
“We can’t predict the future in terms of the political backdrop, clearly we would like to see some more certainty in the market, which would be supportive to all our strategies,” he concluded.
Performance of fund vs sector & benchmark under managers
Source: FE Analytics
Since Mackersie and Moon took over Unicorn UK Income fund in January 2014, the fund has made a total return of 42.51 per cent, compared with a 37.54 per cent gain for the FTSE All Share benchmark and a 34.62 per cent return for the average IA UK Equity Income peer.
It has a yield of 4.36 per cent and ongoing charges figure (OCF) of 0.81 per cent.