Why the rally for UK funds and investment trusts has further to go

There’s always the danger the ship has sailed following a strong spell of performance. 

Over the past couple of months, there has been increased investor appetite for the UK market, but following a strong spell of performance since the start of November there’s always the danger the ship has sailed. 

Figures from FE Analytics show how UK equity funds and investment trusts are enjoying a purple patch of form. Investment trusts lead the way; the Association of Investment Companies (AIC) UK All Companies sector is up 53.4%, followed by returns of 51.3% and 45.9% for AIC UK Smaller Companies and AIC UK Equity Income.

Open-ended funds have lagged behind, due to investment trust discounts narrowing and their ability to gear, which has enhanced gains in a rising market. Nonetheless, funds have also been enjoying a strong run. The Investment Association (IA) UK Smaller Companies sector is up 45.2%, while IA UK Equity Income and IA UK All Companies have gained 36.1% and 34.4%.

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The vaccine announcements proved to be the catalyst for UK equity funds and trusts returning to form following a challenging period due to uncertainty over Covid-19 and Brexit. On the whole, the UK market has a bias towards cyclical companies, which have benefited from the improved outlook for the UK and global economy.

However, the question investors should be asking themselves after this strong run of performance is whether the rally has further legs.

Chris Metcalfe, investment and managing director at IBOSS, certainly thinks so. He has been increasing exposure to more adventurously positioned funds at the expense of defensive funds. Metcalfe has removed JOHCM UK Opportunities and Unicorn Outstanding British Companies in favour of Slater Growth and Artemis UK Select.

“It has been a perfect storm for the UK,” he notes. “The UK market is a proxy for value, and my view is that there has not been mean reversion yet, as when looking at three, five and 10-year performance against other regions, the UK is still lagging behind.”

Metcalfe adds that UK equity income funds have plenty of scope for a further re-rating. Among the multi-asset funds Metcalfe manages he owns Man GLG Income and Franklin UK Equity Income.

“Up until now income shares have been left behind as the dividend picture for the UK market is only starting to be rebuilt. The total return opportunity for UK equity income funds is the best it has been in years.”

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James Burns, co-manager of Smith & Williamson Investment Management’s Model Portfolio Service, agrees that the rally has further to run. He described UK equities as the “standout market for bargain hunters” as the country emerges from both Covid-19 and Brexit.

Burns says: “UK stocks still look cheap compared to virtually every other market. We are overweight the UK across our portfolios because we think the UK in particular will benefit from the global economic recovery.

“A lot of stars are aligning for the UK now. First, Brexit has gone far better than expected, and the country’s response to the pandemic has come into its own after the successful vaccine roll-out.”

Burns points out that the UK is trading on a notable discount to overseas markets. UK shares are trading on a forward price to earnings ratio of 13.4x versus 20.6x for the MSCI World Index.

“Challenges remain, but the signs are that the economy is now bouncing back, and we expect the discount the country’s equity markets are trading on to narrow from here as buyers head to the UK.”

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Nick Train, manager of Lindsell Train UK Equity and Finsbury Growth & Income Trust (LSE:FGT), is also bullish on the prospects for the UK market as a whole.

Train thinks the world may be experiencing a ‘Roaring Twenties’, driven by “roaring consumer consumption” and the “extraordinary creation of new industries”.

He adds that global investors seem to be underestimating the UK as an investment destination to profit from this, which is why the UK market’s resurgence could continue. 

Train notes: “I feel energised by the much-improved performance of the UK equity market in 2021. How realistic is it that it will continue? We wonder whether global investors are still underestimating a technology upsurge in innovation across the UK corporate sector.”