Amid the general sense of doom pervading at the moment, could we be seeing a chink of light for UK markets? An interview given by BlackRock’s chief executive, Larry Fink in The Times perhaps suggests so.
Fink said that BlackRock had been busy snapping up billions of pounds worth of UK assets that it sees as undervalued. Peek through the gloom and you can certainly see why.
We’ll leave politics to one side as much as we can, but note that much of Fink’s positivity stems from BlackRock having more confidence in the outlook for the UK economy today than he did this time last year. The new government is, he said, “trying to tackle some of the hard issues”. As one can see from elsewhere in the world, stable politics is worth a lot these days.
The risks are that higher taxes on business weigh on confidence and potentially lead to job losses as UK plc tries to cut costs and maintain profit margins. Still, wage growth is chugging along, consumers have excess disposable income built up through the pandemic, corporate balance sheets are strong and interest rates are falling.
On a valuation point, too, Fink’s optimism seems on solid ground. He talked about discounts being too deep in many areas of the UK market. One can certainly see his point.
UK markets all round look cheap, whether compared to peers but also to their recent history. Indeed, on a trailing price-to-earnings (P/E) ratio of 12.5x, the UK’s blue-chip FTSE 100 index is at a c. 10% discount to its five-year average P/E of 14.1x.
Look further down the market cap spectrum and things appear even better value. The mid-cap FTSE 250 index, on a trailing P/E of 15.1x, is at a 37% discount to its five-year average. The FTSE AIM 100 Index is essentially on a half-price sale.
Of course, things might take a while to get better, but that’s okay because you’re also being paid to wait: the FTSE 250 has a dividend yield that’s broadly similar to the FTSE 100, at 3.5% and 3.8% respectively – a rare occurrence. Even the AIM 100 index yields 2.4%.
Investment companies provide the perfect way to benefit from what could be a potentially powerful recovery in UK assets for a few reasons. First, they’re mostly trading on discounts to net asset value themselves, providing a double discount. Second, as well as having plenty of equity options, you can also access the UK infrastructure, renewables and property space. Fink in particular highlighted infrastructure as a key area of focus for BlackRock.
The first point of call is the stock market, where Fink said that “so many of the UK stocks’ discounts were too deep”. He singled out the banking sector, which has bounced significantly.
Exposure to areas like this could be gained through best-of-breed trusts in the UK equity income space, such as City of London and Edinburgh Investment Trust. Both benefit from low ongoing charges, growing dividends and cheap valuations with plenty of scope for discounts to narrow.
While both are predominantly large-cap funds, Edinburgh’s manager Imran Sattar has been seeing opportunities within the mid-cap space recently, with the private rental homes provider Grainger a notable recent addition.
Moving into the small-cap space, Rockwood Strategic provides a differentiated, high-conviction approach to investing in the UK, with manager Richard Staveley hunting for overlooked companies trading at significant valuation discounts to their intrinsic value and long-term potential.
Rookwood Strategic has proven one of the best-performing trusts in the smaller companies sector and seems, in our view, one of the purest ways of attaining the valuation discount that remains within the UK market.
Another valuation-conscious strategy here is Aberforth Smaller Companies, whose six-strong management team look to identify solid firms trading at temporarily depressed valuations and hold them through their share price recovery. In particular, they have benefited from the ongoing M&A boom, which has helped realise value in several portfolio holdings.
There are plenty of opportunities outside of equities, too, with Fink suggesting that the plethora of “frightened” money sitting in bank accounts could be used to fund projects such as power grids, railways or data centres.
HICL Infrastructure and The Renewables Infrastructure Group (TRIG) each have two-thirds of their portfolios invested in the UK, with overseas diversification to boot. Both own offshore wind farms, with HICL also investing in rail operators and railways, hospitals and roads, and TRIG invests in solar parks and battery storage assets. TRIG faced operational challenges recently, but both trusts have been reducing their debt levels and committing to share buybacks to try to tackle their wide discounts.
A purer play on UK infrastructure could come from Greencoat UK Wind, the fifth-largest owner of wind farms in the UK and the largest and most liquid trust in the renewable energy infrastructure.
The dividend yields on this trio of infrastructure trusts are in the region of between 7% and 9%, providing a meaningful yield pick-up over the 10-year gilt yield, which is currently 4.4%. Indeed, Greencoat’s management team suspects that falling long-term bond yields will be one of the two main catalysts for narrowing discounts, alongside a thinning out of the wider alternative income sector.
A third and final potential play within the UK is property. We’ve already seen private equity houses taking interest in the sector, with Balanced Commercial Property and abrdn Property Income agreeing to portfolio sales last year and Assura and Warehouse REIT being targeted this year.
Picton Property Income and Schroder Real Estate have both responded to difficulties within certain property sectors, such as offices and high-street retail, in innovative ways. Picton has successfully repurposed buildings for alternative use, such as residential and student accommodation, while Schroders is attempting to harness the green premium by making its buildings more energy efficient in the hope of attracting higher rents.
Despite today’s geopolitical turmoil, opportunities abound – and heavily discounted UK assets may be ripe for a powerful bounce although, as ever, patience is warranted.
David Brenchley is an investment specialist at Kepler Trust Intelligence. The views expressed above should not be taken as investment advice.