Is now a good time to invest in UK equities?

April 23, 2014

Interestingly, some studies suggest that there is no direct link between GDP growth and the performance of the market. 2012 illustrates that point, when the UK equity market delivered double-digit returns alongside a GDP growth close to flat.

But having said that, emerging signs of economic growth should boost corporate profitability and cash flow generation, and the impact of these will work their way through to stock valuations thereafter.

Investing in the UK market means exposure to a wide variety of countries. Around half of the business done by companies in the FTSE 100 is done overseas, so optimistic prospects for the US, Asia and emerging markets should translate to good opportunities for UK businesses and their stocks.

How can investors gain exposure to the UK's housing boom?

The most direct way to play the housing theme is through construction companies and UK property stocks. These stocks have had a terrific run in recent years, following their lows in 2009.

But if you look at the UK more broadly, an improving housing market leads to a pick-up in consumer confidence, and the best way to play UK consumer confidence is through investing in smaller and mid-sized companies, since these tend to have more of a domestic bias. Again, these types of stock have performed well, but there are still pockets of value to be found, so look for a fund managed by a strong active stock-picker, who can spot opportunities among companies.

Since equities have performed so well, is there still value in the UK market?

My view is that the market is priced at around fair value: not expensive, but not cheap either. Over the last couple of years, we've seen market valuations rising steadily without seeing a pick-up in earnings growth. If the market continues to rise from here, we'll need to see this earnings growth to support it.

Have so called 'safe haven' stocks become too expensive?

Six months ago, these perceived safe haven stocks - mostly defensive companies with quality growth, strong cash flows and high dividend yields - were performing very well relative to more cyclical, economically-exposed stocks in the index. But as the economic data has improved over recent months, more cyclical stocks have performed better than their defensive counterparts.

A number of defensive stocks have hit bumps in the road: Unilever is a good example. Its share price has tailed off in the last couple of months, primarily due to a message from management that emerging markets are beginning to slow down in the short term. Looking at defensive stocks overall, I think we've seen a correction in their valuations. For investors with a three or five-year time horizon, they are now offering better value.

Have profit margins in UK companies reached a peak?

The share of economic outlook represented by corporate profitability is high by historical standards. Some investors see this as a cyclical phenomenon - and expect the pendulum of company profit margins to swing in the other direction in future - but I think there are a number of factors that could mean margins continue to increase.

First, increases in the supply of labour have stalled wage rises, which benefits margins. Second, globalisation means companies are increasingly able to enter new markets, which also supports profitability. Third, technology has allowed companies to become far more efficient, keeping costs low and contributing to margins overall.

In addition, many companies currently have very strong balance sheets, which they can use to acquire smaller competitors and boost their margins that way. So overall, there's a reasonable chance that we'll see margins continuing to progress from here.

Which active UK equity funds should be on your radar?

The following funds can be found on Fidelity's Select List. The Select List contains around 140 funds chosen from our fund supermarket's range of over 2,000 investment options that we believe stand out from their peers.

Axa Framlington UK Select Opportunities

Axa Framlington UK Select Opportunities is run by Nigel Thomas, who joined Axa Framlington in 2002. He has more than 30 years investment experience. His objective is to achieve capital growth by investing in companies where he believes above-average returns can be realised.

In order to assess a company's growth prospects, he looks at the quality of its management and financial position, the industry in which it operates and its competitive position. The fund typically has a growth bias, and is expected to deliver an annualised excess return versus the benchmark of 2 per cent-3 per cent gross of fees over more than a three-year rolling period.

Ecclesiastical Amity UK

The suitability of investments into the Ecclesiastical Amity UK fund is considered by an in-house team of analysts and fund managers. They will review company fundamentals, valuation and apply an ethical screen.

This fund seeks to avoid investment in certain areas such as companies which have a material involvement in alcohol, tobacco and weapon production, gambling or the publication of violent or explicit materials.

Additionally, the team look to invest in companies that make a positive contribution, both environmentally and socially.

Fidelity UK Select

Aruna Karunathilake has managed the Fidelity UK Select fund since 2007. His investment process looks to take advantage of points when negative market sentiment leads to attractive buying opportunities in strong, well-managed franchises. Aruna is heavily reliant on the well-resourced team of equity analysts for their input on the true value of a company.

Each company is then ranked by the manager on five characteristics: fundamentals, franchise, change, sentiment, valuation. He will invest in the highest-ranking stocks taking into consideration the risk parameters of the fund. The fund has a list of 40-55 stocks.

Jupiter UK Special Situations

Jupiter UK Special Situations is managed by Ben Whitmore, who built a successful career at Schroders before joining Jupiter in 2006. Whitmore is one of the highest conviction contrarian managers in the UK equity universe.

He seeks stocks that are cheap on specific metrics, and those with a combination of high return on operating assets and low valuations.

The portfolio will reflect an amalgamation of Whitmore's best ideas and is not constrained in terms of number of stocks or risk against the benchmark.

Kames Ethical Equity

The Kames Ethical Equity fund is managed by Audrey Ryan who has more than 15 years investment experience. The fund holds no banking, tobacco or pharmaceutical stocks as these are excluded from the ethical investable universe. The fund also has limited exposure to oil and mining stocks.

The fund manager works closely with other members of the UK equity team to identify good-quality companies within her investable universe. Alongside the fundamentals, the team will also consider valuation and technical measures including directors buying.

The fund has a bias towards growth companies and is skewed towards medium and small-sized companies. The fund manager can hold up to 20 per cent of the fund in cash.

Liontrust UK Growth

Anthony Cross and Julian Fosh are joint managers of the Liontrust UK Growth fund and creators of the economic advantage investment process on which the fund is managed. Both managers have more than 20 years' investment experience and took over management of the growth fund in 2009.

The managers seek to identify companies that have a durable competitive edge (economic advantage) that enables them to sustain a higher level of profitability for longer than the market expects and has priced in. Turnover of ideas is very low as this approach inevitably leads to a long-term investment horizon.

Nick Peters is portfolio manager at Fidelity Solutions.

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