The investment trust sectors driving UK outperformance

Certain sectors within the UK economy have demonstrated resilience as much of the rest of the global market descends into tariff-driven turmoil.

Sentiment around the UK economy has been low. In many respects that’s justified: UK public sector borrowing rose to £16.4 billion in March, £2.8 billion higher than the previous year. There has been an exodus from the London stock market as businesses bemoan the lack of appetite to invest. Fears that the UK could enter recession have eased, but still abound.

Are these fears overblown? Perhaps. UK GDP growth reached 0.7% in March, defying pessimistic expectations. Inflation is relatively under control, and as such the Bank of England has leeway to keep reducing interest rates, unlike its US counterpart the Federal Reserve.

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Increased European defence spending could prove a boon for UK aerospace and other sectors.

Research from the Association of Investment Companies (AIC) shows UK equities have been more resilient than global counterparts. In the year to 8 May, the average UK All Companies investment trust is up slightly over 10%, compared to 1% for the average Global sector trust.

“It may be that the UK market has already started its rebound after several years of underperformance,” says Annabel Brodie-Smith of the AIC. “We certainly aren’t out of the woods, but with two trade deals signed and interest rates on their way down, the stars may finally be aligning for UK companies.”

The tariff turmoil produced winners and losers, and according to trust managers surveyed by the AIC, the UK economy has good exposure to those sectors that came off best.

Which sectors have driven UK resilience?

The composition of the UK stock market, particularly the FTSE 100, is a large driver of the resilience that the UK has seen.

Large caps in the UK stock market are typically in highly defensive sectors like consumer staples, says David Smith, portfolio manager of Henderson High Income Trust (LON:HHI). In these sectors, “earnings are typically more resilient in an economic slowdown,” he adds.

With global stock markets having largely fixated on growth stocks, like the Magnificent Seven, for the past decade and more, the defensive sectors that make up much of the UK’s stock market have become relatively undervalued.

That presents an opportunity for value investors like Alex Wright, manager of Fidelity Special Values.

“We have been finding new investment opportunities in domestically orientated cyclical areas, such as industrials, advertising and staffing,” says Wright, “while also selectively adding back exposure to real estate stocks and housing related names, where demand appears to be stabilising and valuations remain attractive.”

While the retail sector is much-maligned, for contrarians like Wright now is the perfect time to buy in. He explains that FSV has been increasing its exposure to “retailers specialising in big-ticket items such as kitchens and sofas, where sales are 10% to 25% below historical volumes.” Improving growth outlooks and the prospect of falling interest rates, he says, could lift this sector in the future.

While Wright doesn’t specify any particular stocks on this front, Dunelm (LON:DNLM) could fall into this category. It is highlighted by Charles Luke, fund manager of Murray Income Trust (LON:MUT).

“We believe the company can continue to take share in a fragmented market,” says Luke. “The shares trade on a mid-teens price-earnings ratio with a dividend yield of around 4%, and this has typically been supplemented by an additional annual special dividend given the strength of the balance sheet.”

Why the UK economy is appealing across all sectors

Stepping back, there are broader structural reasons that make the UK an appealing market for investment trust managers, across all sectors.

“There are a number of reasons to invest in the UK now,” says Smith. “The starting valuation of the UK equity market is low and trading at a discount to its long-term average and other global indices, especially the US, helping to absorb negative sentiment around trade tensions.”

Smith adds that the UK is not a large exporter to the US, so the impact of tariffs is relatively lower. That is also helped by the UK-US trade agreement reached last week, which reduces the tariffs applied to some car exports to the US to 10%.

“The tariff shock is happening at a time when the outlook for UK-listed companies is improving, energy and food prices are falling, pressures on the UK consumer are easing, while the labour market remains healthy and savings are elevated,” says Luke.

“UK equities are valued attractively, especially compared to US equities, and UK equities have been consistently overlooked by international investors. It may be that, having monopolised investment returns for years, the attractions of the US equity market are beginning to wane.”