Investors are shunning UK stocks – but they might regret that in a year’s time

There are a number of reasons why investors aren't buying UK stocks, says John Stepek. But they may want to rethink that strategy.

Loads of banks. Loads of oil stocks. No dividends. A semi-second lockdown in process. 

Investors aren’t fond of the UK stockmarket. 

I can’t think why...

It’s not just global investors who are shunning the UK 

Ever since Britain voted to leave the European Union in 2016, overseas investors and fund managers have had a downer on the UK. 

It’s understandable. Politics is complicated enough for insiders. Outsiders don’t stand a chance. Most of the time that doesn’t really matter. Domestic politics doesn’t make big enough waves to force global investors to pay attention. Companies carry on regardless. 

However, sometimes a political event rears its ugly head above the parapet. In this particular case, global investors have to consider the impact of Britain leaving the EU. There are a lot of moving parts to grapple with, and it doesn’t help that the Davos consensus views this as a “very bad idea”. 

So global investors have a choice. Take a punt on a situation they don’t really understand, and of which their peers largely disapprove. Or take comfort in the fact that the UK equity market – while significant – is still only about 5% of global market cap, and just ignore it. 

The path of least resistance clearly points to ditching the UK (or “underweighting” it). Take the contrarian option and get it wrong, and everyone laughs at you. Go with the crowd, and get it wrong, and you’re all wrong together. It’s not a difficult choice.  

What’s interesting now is that UK investors are joining their global peers. At the end of last week, I read a piece on Citywire which highlighted that the Investment Association has found that “UK equity funds accounted for just 14% of the total funds held by British investors this year”. 

That’s the lowest level on record for this survey. It only dates back 15 years but that’s still quite an eye-opener. In 2004, UK equities accounted for 39% of British investors’ portfolios. 

Now, don’t get me wrong. It’s a good thing that British investors are shedding some of their “home bias”. “Home bias” is the tendency that all investors have to over-invest in their own stockmarkets, relative to the global importance of that market. 

Given that the UK stockmarket accounts for roughly 5% of global stockmarket capitalisation, then, in theory, a well-balanced portfolio of equities wouldn’t have much more or less than that allocated to UK stocks. 

More importantly, if you were “overweight” the UK relative to other global markets, you’d have done it deliberately, for well-considered reasons, as opposed to by default, because it’s the market you think you understand best. 

So, if this drop is largely because investors are wising up to home bias, it wouldn’t be a bad thing. I suspect that’s not what’s behind it though. 

The UK market has struggled in recent years, and it’s not just down to Brexit. There’s the dominance of two of the most hated sectors in the world right now – banking and oil. Plus the relative lack of the most loved sector in the world right now – tech. According to the Investment Association, tech makes up almost a quarter of the US market, and just 2% of the UK index.  

Toss in the great dividend massacre earlier this year – which was insult to injury for bank and oil investors in particular – and it's pretty obvious why UK investors might be fed up.

(Sadly, a lot of them appear to have switched out of UK equities and into absolute return funds, which is like pulling a bundle of sodden bank notes out of the washing machine and chucking them on your coal fire in an attempt to dry them off, but we’ll ignore that for the moment.) 

Why launch a new UK fund now? There are two good reasons

OK, so we can understand why the UK has been doing poorly. The question for investors, of course, is “will this last”?

One intriguing development is that there are now several new UK investment trusts being lined up to take advantage of opportunities in the UK market. There are launches due from Schroder, Tellworth Investments, and Buffettology. 

I must say the timing is fascinating here. Fund launches tend to come when a sector or country is in vogue and desperately expensive, not when it’s widely disliked and relatively cheap. Admittedly, investment trusts don’t have quite the same profile as their open-ended rivals once did, but this is still interesting to see. 

It suggests that in a world where active managers are increasingly competing with passive rather than each other (for more on that, check out this week’s MoneyWeek cover story), the managers of these trusts see a genuine opportunity to differentiate themselves from the index. That strikes me as a promising sign.

Is the timing sensible? Well, you have to consider two things, I think. One, by this time next year, “Brexit proper” will have happened. Whether you think it’ll be a disaster or a triumph or a great big shrug of the shoulders, the consequences will be out there – it’ll be “in the price”. So, now might be the last real opportunity to cash in on the Brexit “discount”. 

Secondly, fingers crossed, by this time next year, we’ll also be done with Covid-19. Unless something unexpected happens, we’ll be past the worst of lockdown and past the worst of infections. So again, if you have conviction that there are solid opportunities here that are being sold off amid the gloom, then it makes sense to start stock-picking now. 

So, you can see the rationale. 

Of course, if you agree with it, then you don’t have to wait for any of these new trusts to launch. You could buy into one of the many existing UK investment trusts and likely bag them at a decent discount to net asset value.

As for ideas of which trusts to buy – this is a topic we’ll be revisiting in the magazine in the near future – subscribe here to get your first six issues free

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