Data that shows the appetite for UK equities is back has left analysts and investors wondering whether the asset class has pulled through its Brexit slump.
UK equity funds saw net retail sales of £114m in November, their first inflow of 2016. They had suffered £5.1bn outflows since the previous January, £3.8bn of which followed the EU referendum in June.
The last time UK equities saw inflows was in December 2015 with a £672m net gain. A total of £1.8bn flowed into the asset class in 2015.
UK equity funds account for 22 per cent of the UK asset management industry’s total funds under management and 40 per cent of equity funds under management, according to the Investment Association.
Hargreaves Lansdown senior analyst Laith Khalaf says:“[The November inflows are] the backdrop to a pretty volatile summer when a lot of people were losing their heads.”
AJ Bell investment director Russ Mould notes the trend towards greater optimism among UK investors actually began with the Brexit vote but the election of US president Donald Trump in November “accelerated that process”.
He says: “The market is going very well now so you might see more money flowing into funds anyway.
“With the FTSE 100 up, people would take more risks and pour more money into funds.”
2017 opened with the FTSE 100 reaching record levels in sterling terms, which made investors more optimistic than a year ago.
On 14 January the blue-chip index had risen for the fourteenth consecutive trading day, the index’s longest winning streak on record.
The FTSE hit an intra-day high of 7,329 points before falling back to trade at 7,314, up 22 points during the day, helped by a weaker pound, higher commodity prices and better company results.
The “currency and commodity effect” was good for mining companies, says Khalaf, although not all UK popular fund managers profited from it. This was evident from Neil Woodford’s UK Equity Income fund, whose lack of exposure to oil and gas was partly behind its underperformance over the past year.
Woodford said 2016 had been “a disappointing year” as the £9.6bn fund failed to achieve the high double-digit returns it had aimed for.
Mould says: “2016 was a difficult year, with a lot of dividend cuts from firms. Dividend cover is still lower than you expect and that will make more people put money into UK funds.”
Conversely, Mould adds the unpopularity of bond funds, given the significant drop in their yields, will also turn investors towards equities.
In November £202m came out of fixed income funds after inflows of £359m in October, marking the first outflow since February. But in Nov-ember 2015 outflows were more negative at £306m.
Khalaf believes UK equities “is still a place to be” despite all the noise in politics and currency.
He says: “If you look at performances of shares at the beginning of December, firms such as Persimmon, BT or ITV did well and these are domestic companies. Also the FTSE 250 did well, so it is not all about currency.”
Not out of the woods yet
Khalaf says while it looks like “a return to business as usual” for investors after Brexit we are not “out of the woods yet”, because of the uncertainties on the negotiation process after the triggering of Article 50. Khalaf says: “Investment sentiment is still very weak and people are still very cautious.”
His thoughts were echoed last week by Old Mutual Global Investors chief executive and manager of the £2.2bn Old Mutual UK Alpha fund Richard Buxton.
Buxton said the UK economy was “falling off a cliff” after Brexit, according to reports, while at the end of last year he told reporters the economy would slow in 2017.
According to the Office for National Statistics, the UK economy grew 0.6 per cent in third quarter of 2016, revised up from 0.5 per cent, while according to consensus forecasts UK growth in 2017 will be just 1.3 per cent, down from 2 per cent in 2016 and 2.2 per cent in 2015.
But Bank of England governor Mark Carney has told MPs the central bank is set to upgrade its forecasts for the economy, admitting that some of the risks posed by the Brexit vote have now receded.
“Dividend cover is still lower than you might expect and that will make more people put money into UK funds”
Small and mid cap march
Tilney Bestinvest managing director Jason Hollands argues with the economy faring “considerably better” than most economists have predicted, mid and small cap shares might surprise this year.
He says: “The currency benefit from the weak pound in supporting larger companies dissipates to some degree during the year if the Bank of England ends its current quantitative easing programme and sterling as a result climbs against the euro.”
Backing UK equities “for the moment”, Hollands says rather than chase FTSE 100 stocks “at these levels” investors should take a broader approach, selecting funds that have a wider remit across the market such as JO Hambro UK Opportunities, Evenlode Income and Liontrust Special Situations.
Liontrust Asset Management fund manager Victoria Stevens, who co-manages the UK Micro Cap fund, argues predictions that the UK’s vote for Brexit would dent consumer and business confidence have yet to come to fruition.
But she says: “The referendum has had other consequences which are shaping the investment outlook. One of the most significant is the fall in sterling over the last six months. Sterling weakness is a double-edged sword, negatively affecting companies that need to import goods or services but beneficial for those who export.”
She says with markets set to be unpredictable in 2017, her fund will continue to track profitable companies that enjoy pricing power and are backed by high levels of management ownership.
Khalaf says, given the uncertain political outcomes in the UK for the years to come, investors should maintain some cash “on the sideline”.
Khalaf says: “We are still in a position where interest rates are very low. There’s also a lot of cash sitting on the sideline, but as long as that’s the case, that is supportive for the market. When nobody has cash and [everybody] is fully invested, that is when you need to worry.”