The UK equity market has been a laggard among global peers since Brexit, but bargain-hunting investors have been showing renewed interest. Dina Ting, Franklin Templeton ETFs’ head of global index portfolio management, explores the positive trends that are making a case for holding UK equities.

Having endured many plot twists since the United Kingdom voted to leave the European Union in 2016, Dina Ting (pictured) at California-based Franklin Templeton believes that the UK stock market has been a laggard among global peers.

“As of the end of July 2023, US-listed UK mutual funds and exchange-traded funds continued to see year-to-date outflows of $560 million,” Ting said in a statement. “For the past 12 months, UK equity outflows totalled $1.1 billion, making the market particularly unattractive amid the outperformance of US and European stocks over the same timeframe,” she continued.  

“But with a flagging US stock market, investors are again eyeing the UK’s undervalued and long-unloved market. Outflows have recently slowed in the United Kingdom as investors have been signalling a return of some optimism for the economy’s enticingly cheap investment prospects,” she said. Falling energy and stabilising food prices helped cool Britain’s annualised consumer price inflation rate from June’s 7.9 per cent to July’s 6.8 per cent. While the UK’s inflation rate is still far higher than the Bank of England’s 2 per cent target, she believes that its recent downturn could suggest a turning point. The Conservative Government – trailing significantly in polls ahead of a general election expected in late 2024 or early 2025 – has made bringing down inflation one of its campaign priorities.

Compelling valuations
“Undervalued in absolute terms, relative to their own history and compared to other developed markets, British stocks remain in the bargain bin,” she said. In her analysis, they appear particularly cheap against equities in the United States and Japan, whose weightings dominated the FTSE Developed Index at the end of July with 67 per cent and nearly 7 per cent, respectively. The United Kingdom held a 4.3 per cent weighting in the index.

Corporate fundamentals
“The FTSE UK Capped Index’s top holdings – banking and financial services group HSBC Holdings and energy and health care giants Shell, BP, Astrazeneca and GSK – target revenue from foreign customers and sales abroad, which presents investors with the opportunity to gain global exposure without overpaying for it,” Ting continued. Also, the index has slightly more than a 30 per cent weighting to defensive sectors, such as healthcare and consumer staples, which may help it weather market volatility.

UK economy  
“Recent news about the UK’s economy still shows some headwinds, but the International Monetary Fund (IMF) announced in May that it no longer anticipates a recession this year,” she said. July saw upward revisions to its previous estimate of gross domestic product (GDP), which means that the UK’s debt ratio for recent months saw an encouraging improvement. Public sector debt at the end of July 2023 was estimated at 98.5 per cent of GDP – signalling improving debt.

“But there’s more to the UK’s economic picture. The UK Department for Business, Energy & Industrial Strategy together with the UK Space Agency announced the allocation of its largest-ever research and development budget, worth $50.2 billion, to drive forward the government’s ambitions as a science superpower. Allocations will deliver on the government’s “Innovation Strategy,” including its ambition to increase total research and development investment to 2.4 per cent of GDP by 2027,” Ting said.

“Should the Labour party win the next general election, Labour politician Rachel Reeves recently ruled out any version of a wealth tax on the richest in society,” she continued.

Government measures to boost the UK’s growth potential also include agreements to restore a smooth flow of trade within the UK internal market known as the “Windsor Framework,” in addition to an expansion in the range of businesses able to benefit from them. “IMF officials have also recently stated that a more measured approach to reviewing retained EU laws will help reduce Brexit-related uncertainty (while) . . . enhanced childcare support and tax relief on investment in plant and machinery introduced in the spring budget should support labour participation and business investment, respectively,” she said.

Taken together, Ting believes that these points make for an appealing case for investors to hold UK companies that seem to be showing good prospects and perhaps a recognition of undervalued stocks amid a slew of buybacks across several sectors to boost shareholder returns. Consider that BP, Diageo and Unilever are among the FTSE UK Index companies that launched buybacks in 2023. While Shell (the largest holding in the index) reported lower-than-expected second quarter earnings, it also launched a $3 billion share buyback programme. In addition, Lloyds Banking Group and Reckitt Benckiser both announced plans in July to raise dividends.

For those implementing global asset allocation, Ting often touts the benefits of single-country and regional exchange-traded funds (ETFs) as tools that can help investors create differentiated outcomes. In her opinion, selecting cost-effective investment vehicles, such as single-country ETFs that are tailored for precise implementation, can make sense in this environment for many investors.

Ting believes that investors should think about country allocation, taking into account the companies and sectors that represent each country, GDP growth, monetary policy, geopolitical, demographics and more transient trends that favour select countries. See other articles favouring UK equities here.