Fidelity Special Values: The case for investing in UK equities

The case for the UK

With the UK having been a relatively unloved market by investors for some years, recent performance has begun to reignite interest. From a strong financial sector to ongoing M&A activity, Fidelity Special Values plc (LON:FSV) portfolio manager, Alex Wright, examines the reasons to be positive about the UK’s prospects moving forward.

The UK has been relatively unloved by investors in recent years, with many deciding to look at opportunities in the US or Europe instead. With events such as the UK mini budget at the end of 2022 bringing about financial turmoil, investors have felt that this has been indicative of the instability of UK markets in recent years. However, 2022 saw UK equities outperform both US and European markets. Does this mean that there may be opportunities to be found in UK markets?

A positive shift

In recent years we have seen a de-rating of UK-based equities due to top-down concerns around Brexit, economic uncertainty and mixed messaging from policymakers. In a global context, we believe that this de-rating makes UK equities undervalued compared to other developed markets, especially when compared to stocks in the US.

Investment in the UK is compelling when you compare current UK valuations to historic valuations. Prior to 2015, UK markets traded slightly higher than the Eurozone and only at about a 10% discount to the US. In the 5 years after that point, the valuation gap expanded with UK stocks closer to a 45 or 50% discount compared to the US. With the UK generally trading on 10.5x forward earnings currently, it is well below its 10-year average, providing a compelling case for UK equities moving forward.

This valuation narrative began to bear fruit in 2022 as we saw a more resilient performance from UK equities than European and US markets. 2022 also saw value stocks outperform and provided UK equity strategies with a broader tailwind due to the UK’s tendency towards a value bias. The start of 2023 has continued this positive trend and could signal more opportunity to come.

Banks provide opportunity

The UK has a long history within the bank and financials sector, though it has fallen out of favour in recent years. We hold large positions in banks across the spectrum for a variety of reasons. While controversial at the moment due to recent events with Credit Suisse and US-based banks, financials provide both quality and value opportunities as the sector has evolved greatly over the past 10 years.

The industry faced a plethora of headwinds following the financial crisis, with falling rates squeezing margins on deposits and increased regulations meaning shareholders faced a reduced share of profit due to fines and stronger balance sheet requirements. Now, however, we have begun to see those headwinds convert into tailwinds as tighter regulations ensured better balance sheets and strong funding. This has converted into higher levels of buybacks and greater profit sharing now that fines have been paid off. In addition, the low interest rates that followed the financial crisis have started to rise, meaning greater margins on deposits can be achieved and an additional revenue stream is re-emerging for UK banks.

These deposits have a tendency to be “stickier” than those in US banks, so present a lower risk revenue stream and banks such as top-ten holding NatWest are well placed to benefit from this higher rate environment. This stickiness and broader, low-value deposit base can also help insulate UK banks from the problems hitting those in the US.

In addition to positive sentiment around banks, we believe that there are reasons to be positive about life insurance. We view the life insurance sector as being very defensive and it has demonstrated its resilience through different cycles over the past decade. When the Covid pandemic forced the world into lockdowns, many businesses saw their earnings negatively affected, but earnings of those in the life insurance sector, such as Legal & General, Phoenix and Aviva, did not fall. In addition, attractive valuations, high dividend yields and compelling earnings supported by annuity products providing longer term cash generation give encouragement for longer term returns from this sector.

Consolidation can bring upside

While there are longer term value opportunities to be found, these lower valuations also provide the prospect of mergers and acquisitions. UK M&A activity has been unprecedented in recent years, driven primarily by private equity and US-based corporates who are willing to pay prices based on US valuations. Special Values has been able to take advantage of this interest in 2022 with M&A activity having taken place across the market cap spectrum.

While rising rates have dulled the ability of private equity groups to borrow, we expect to continue to see bids from corporates and we see potential for our holdings to continue to benefit. In the first few months of 2023, already three of our holdings have been bid for.

The outlook looks bright

The relative attractiveness of UK valuations versus other markets and the large divergence in performance between different parts of the market continue to create good opportunities for attractive returns from UK stocks on a three-to-five-year view. In our opinion, the UK market with its higher dividends offers a better prospective return than many other asset classes, including global equities.

Important information

The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Overseas investments are subject to currency fluctuations.

The shares in the investment trust are listed on the London Stock Exchange and their price is affected by supply and demand. The investment trust can gain additional exposure to the market, known as gearing, potentially increasing volatility. The trust invests more heavily than others in smaller companies, which can carry a higher risk because their share prices may be more volatile than those of larger companies and the securities are often less liquid.

This trust uses financial derivative instruments for investment purposes, which may expose it to a higher degree of risk and can cause investments to experience larger than average price fluctuations. Reference in this article to specific securities should not be interpreted as a recommendation to buy or sell these securities and is only included for illustration purposes. Investors should note that the views expressed may no longer be current and may have already been acted upon. This information is not a personal recommendation for any particular investment.  If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

The latest annual reports, key information document (KID) and factsheets can be obtained from our website at www.fidelity.co.uk/its or by calling 0800 41 41 10. The full prospectus may also be obtained from Fidelity. The Alternative Investment Fund Manager (AIFM) of Fidelity Investment Trusts is FIL Investment Services (UK) Limited. Issued by Financial Administration Services Limited, authorised and regulated by the Financial Conduct Authority. Fidelity, Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited. 

UKM0422/381525/ISSCSO00120/NA

Fidelity Special Values PLC (LON:FSV) aims to seek out underappreciated companies primarily listed in the UK and is an actively managed contrarian Investment Trust that thrives on volatility and uncertainty.

Click to view all articles for the EPIC:
Or click to view the full company profile:
Facebook
X
LinkedIn
Fidelity International

More articles like this

Fidelity Special Values

London regains status as Europe’s biggest stock market

London has reclaimed its position as Europe’s biggest stock market, just two years after losing the title to Paris. This resurgence comes amidst significant turmoil in French markets following the surprise election called by President Emmanuel

Fidelity Special Values

British equities rise amid rate cut anticipation

On Thursday, British equities experienced a lift as investors looked forward to a widely anticipated rate cut by the European Central Bank (ECB), although gains were tempered by companies trading ex-dividend. The FTSE 100, a blue-chip

Fidelity Special Values

London equities start the week on a high note

London equities kicked off the week positively, buoyed by a rally in metal miners and defence stocks. Investors are now awaiting comments from the Bank of England for hints on the central bank’s interest rate trajectory.

Fidelity Special Values

London stocks rise on strong wage growth data

London stocks gained some ground on Tuesday led by advances in the personal goods sector amid labour market data that showed wages grew stronger-than-expected, though a basket of mixed corporate updates kept investor optimism in check.

Fidelity Special Values

FTSE 100 hits Record High on Glencore approach

Britain’s FTSE 100 hit a record high on Friday, boosted by Anglo-American after Reuters reported Glencore is exploring an approach for the miner, while Diageo advanced after naming a new chief financial officer. The blue-chip FTSE

Fidelity Special Values

FTSE 100 hits record high on positive corporate updates

Britain’s FTSE 100 extended its record rally on Monday, helped by a slew of positive corporate updates including a report that said mining giant BHP Group was considering a better buyout proposal for Anglo American. The

Fidelity Special Values

FTSE 100 hits record high on Anglo American buyout offer

Britain’s benchmark FTSE 100 stock index touched a record high on Thursday led by miner Anglo American on a buyout offer from BHP Group, while investors cheered earnings from several blue-chip firms including Unilever, AstraZeneca and

Fidelity Special Values

FTSE 100 rebounds led by commodity stocks

The FTSE 100 index, which lost 1.8% by last night’s close in its worst performance for nine months, put back 34.58 points to 7854.94. Commodity stocks drove the improvement, with gold miner Fresnillo the best performer

Fidelity Special Values

FTSE 100 hits 8,000 mark, nearing all-time high

The FTSE 100 breached the 8,000 mark this morning and briefly eclipsed its previous record closing price as it inched closer and closer to its all-time high. The capital’s premier index was up 0.69 per cent

Fidelity Special Values

FTSE 100 on track for positive March quarter end

UK’s FTSE 100 was set for a positive end to the March quarter and touched fresh highs on Thursday after a rally last week, bolstered broadly by miner and bank stocks on the last trading day