Changing minds on value investing: How UK markets are delivering resilient investment opportunities
The UK has faced significant political and economic challenges over the last decade, but its economy is proving more resilient than many realise. This article explores how value-driven investments, like those managed by The Merchants Trust, are uncovering promising opportunities in UK equities, where undervalued companies could offer solid returns in a recovering market.
Key takeaways
- The UK’s political environment finally appears to be stabilising, while the economic background is also improving.
- Yet UK share prices continue to trade at a significant discount to other markets, providing fertile pickings for The Merchants Trust plc, which focuses on ‘value’ investments.
- While interest rates may continue to ease, they are unlikely to return to the very low levels that overly favoured ‘growth’ stocks.
The UK Economy has performed better than you may think
Unsurprisingly, against this background, UK equities have underperformed global markets significantly over the past 10 years or so. But looking forward, it does seem as if the UK is entering calmer political waters. Indeed, the UK political scene seems less polarised now than is the case in other areas of the globe, including the US and parts of Europe . During the election campaign, for example, little real difference emerged between the economic policies of the Conservative and Labour parties. Market forces should also limit the Labour government’s ability to pursue unconventional or radical measures in the coming years.
Of course, politics hasn’t been the only issue affecting UK stocks, with concerns about inflation and economic growth in the UK also looming large. However, the image of the UK as ‘the sick man of Europe’ bears little resemblance to reality. Indeed, in terms of growth, the UK economy has performed in line with the average of the large economies over the last six or seven years. The trajectory of inflation also looks very similar to that seen elsewhere.
The very latest figures confirm the UK’s improving economic background. The economy expanded at a quarterly pace of 0.6% in the second three months of 2024 – the fastest in the G7 group of leading economies, having grown by 0.7% in the first quarter and continuing the recovery from the recession at the end of last year.1,2
UK investment opportunities
So, the fact that UK share prices continue to trade at a significant discount to other markets, particularly in the US, is noteworthy. The Merchants Trust managed by Allianz Global Investors certainly continues to find many opportunities when investing in UK equities. Not only do valuations appear attractive, but the spread between the cheapest and most expensive UK stocks is very wide. Consequently, companies at the bottom end of the market are trading at historic lows, while those at the upper end are on similar valuations to more highly priced US companies.
That situation should provide fertile pickings for The Merchants Trust plc, which focuses on value investments, i.e., targeting companies that are well established and are delivering stable revenues and consistent profits but that have undervalued share prices. Investors may, for example, overreact to an adverse development so that the share price does not accurately depict the strength of the underlying fundamentals of the company.
Value investing remains attractive
Value investing has fallen out of favour in recent years as investors have preferred to focus on what are known as “growth stocks”. These are companies that are growing much faster than the overall market, usually because they have a competitive advantage such as those in the high-profile technology sector. The businesses tend to pay low or zero dividends and investors are focused on the capital gains potential of these stocks.
Yet while the value-driven investments approach may target traditional businesses – compared with those in the glamorous tech sector – it has outperformed over the very long term,3 delivering solid capital growth and dividend yields to discerning investors in high-yield investment trusts.
In addition, many of these ‘boring’ value stocks in the UK not only trade at a deep discount to history but also to their international counterparts. UK energy companies, for example, trade at a significant discount to the US-listed energy companies, even though they’re all global businesses and have a very similar end-market exposure.
Reliable investment opportunities
The latter point highlights another feature of the UK market that those investors still concerned about the UK’s economic and political outlook should bear in mind: namely, the international nature of the market. That’s because around 70% of sales and profits of UK-listed companies come from abroad, so the direct impact of the UK economy on many of the larger companies listed on the London stock market is limited.
It’s also worth remembering that value stocks tend to be composed of reliable businesses in predictable sectors that could deliver steady earnings growth year in, year out. So, they may prove far less volatile than many of the much-hyped growth stocks.
Favourable background for value investing?
Finally, the era of ultra-low interest rates that the world entered after the global financial crisis, and that continued until inflation took off globally following the Russian invasion of Ukraine in February 2022, may be over. Interest rates may ease in the coming years as inflation ebbs, but they are unlikely to go back to the extraordinary lows that overly favoured ‘growth’ stocks.
That’s important, because ‘growth’ stocks were huge beneficiaries of low interest rates as investors focused on companies whose cash flows were further in the future, at the expense of value companies, which tend to generate earnings earlier. So, going forward, the economic background may prove less of a barrier to the value approach. That augurs well for value investment trusts and their knowledge of how to find undervalued stocks.
