Even ignoring the FTSE 100’s lurches lower in the past week, as a headline index it is not the best advert for the UK as an investment market.
It’s choc-a-block with companies that either don’t look particularly exhilarating from the point of view of sustainability or earnings growth, with heavy representations from oil, mining, airlines, cigarette makers, banks, insurers, cardboard box makers and water companies.
What’s more, the UK’s attractiveness for global investors has also been heavily muddied by the difficulties and ongoing uncertainty of Brexit.
But, as Alexandra Jackson, manager of the Rathbone UK Opportunities Fund, says, if you ignore the whole blue-chip index and indeed the whole of the London market for these reasons you would miss out on some companies with fantastic growth records and considerable potential.
“The UK has many game-changing, world-leading companies that are as good or better than their global peers,” Jackson says.
“And at the moment the UK is very, very cheap.”
The London stock market is in fact currently trading at around a 30-year low on the basis of its average price/earnings multiple versus the P/E of the rest of the world.
And the last two times that the UK was this cheap, she points out, it went on to beat the global benchmark over the next 12 months.
“The political instability and uncertainty that we've had in recent years has kept people on the sidelines,” Jackson says. “Global investors have thought, ‘I've got the whole world to look at, so why bother with this unstable place?’
“But I think that's actually provided an amazing opportunity, if you know the right places to look.”
Last year, as US corporations awoke to the value available for takeovers of UK companies, we were given a flash of the sort of powerful re-rating that Jackson predicts could be around the corner when some of the winter worries dissipate and companies return to thinking about cross-border deals again.
“I think the M&A surge last year really highlighted to global investors how cheap the UK market is, which is helped by people getting a bit nervous about valuation multiples in the States.”
Some investors have clearly been tempted by the previously depressed high street banks and the high street retailers, but Jackson argued that these investments, and high yield mining or energy companies, might make some money over a quarter or two.
“In three to five years when you look back, I think you’d struggle to imagine how those cyclical names have generated long-term alpha and are going to be multiples of where they are now.”
As Jackson says, her fund’s aim is to get in on the ground floor or the first floor with a mid-sized UK company as they grow, while also giving access to “the full potential” of the UK stock market, with the team finding plenty of value down the market cap scale.
Over the five years to the end of December, the fund was up 46.9% versus the UK All Companies sector at 36.4% and the fund’s benchmark of the FTSE All Share index at 30.2%.
The fund is predominantly tilted to mid-caps and has around a fifth of its holdings in AIM, with this proportion having been even higher in its recent history.
Some of its holdings have shown how successful this strategy can be, with current junior market outperformers in the portfolio including legal services innovator Keystone Law Group and specialist investor Warehouse REIT.
Having worked on a special situations fund and having been assistant manager on a global growth fund before, Jackson changed the focus of her current fund from looking for recovery stocks towards picking ‘quality growth’ companies.
“We want those that generate high and rising return on capital, as that’s what tends to lead to outperformance in the UK market.”
Having a strong skew to mid- and small caps, Jackson manages liquidity in the open-ended fund by balancing the more ‘unique assets’ like Ceres, sustainable wood company Accsys Technologies or power converter specialist XP Power, with some larger cap holdings and companies that are categorised as ‘growth compounders’.
"It doesn't totally map out that all the unique assets are AIM-listed or vice versa – it’s more around thinking about how we want to think about managing the risk in the fund.
“We want to own these very interesting, potentially game-changing, very high growth companies. The idiosyncratic names we definitely want to own those – that's exactly what this fund was built for.
“But in the same breath, it wasn't built for huge volatility either, that's not what our clients want so we try to keep these unusual little business at around 25%.
Another point about these AIM rarities is that it's that they do not necessarily trade on macro events or the same valuation metrics like those on the FTSE 100, meaning it requires more of a stock-picker’s instinct on when to buy, hold and sell.
As Jackson says, “these companies generally trade around market sentiment or the theme that they are exposed to, or they trade around newsflow, so a lot of the time you're waiting for a big contract agreement or signing up a massive partner.
The smattering of FTSE 100 holdings might bestride one or both categories, such as Ocado, Croda, Halma and SEGRO, while examples of growth compounders include Dechra Pharmaceuticals, the provider of treatments for ‘companion animals’ that is expected to see good earnings growth for some time after an acceleration in pet ownership; with property website Rightmove PLC and Unite Group both in the portfolio for many years and online publishing marvel Future one of the biggest holdings.
“We are finding UK mid-caps that can take their place on the world stage, and at the moment we are able to buy them on a postcode discount.”
As the stock market roils in shock as central banks begin to end the era of cheap money, this could recreate the ideal conditions for global investors to open their eyes to the discount that UK shares are trading on.
“With rising interest rates, that is going to potentially hurt the US stock market in particular, with its big tech skew and from a position where valuations there are certainly not cheap,” says Jackson.
“So it does feel like this is a great time to start looking at the UK again.”