UK equities: where innovation meets value

Nicholas Little
UK Equity Portfolio manager on the Emerging Companies Team

3 reasons to consider UK equities

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UK equities have been unpopular with investors for the past five years, with UK equity funds notching outflows consistently since 2016. Factors weighing on the region include the UK’s decision to divorce from the European Union and a general desire among equity investors to seek more global allocations.

We are always attuned to the macroeconomic narrative, but more important to us at BlackRock Fundamental Equities is spotting the opportunities created by company and industry change. We believe this overpowers the macro, and at this time of rapid shifts we are particularly drawn to companies that are driving the structural change in their industry. We see three key reasons why now may be a good time to invest in UK stocks:

We think this is an era of rapid change in many industries, and we see plenty of great investments in the UK – especially where technology is being used to disrupt the incumbents and gain market share.

We’re seeing an important shift in UK financial services, a sector dominated for decades by large companies with household names and ambitions to become global through acquisitions. A big brand and a big presence were once advantages. We now think that era is over. Now, being one of those large brands can be a liability. More innovative, entrepreneurial companies listed in the UK are challenging the incumbents with nimble, online-only operations. These financial technology companies aren’t particularly focused on lending. Instead, they focus on payments and foreign exchange, which are high-margin and global-facing services. These innovative companies are now able to disrupt the large incumbents and are taking profitable market share from those legacy players.

Another area where disruptive companies are making a difference is within the UK software industry. Many large and historically successful companies gained their market share in the era of on-premise software. Now, the best software solutions are cloud based. Many of the legacy incumbents have been unable or too late in making the switch to the cloud and are facing levels of competition they have not faced in 30 years. The shifts in market share here create huge opportunities for investors who can spot the best-in-class cloud solutions companies replacing the on-premise providers.

Five years since the Brexit referendum, we believe the UK remains cheap compared to global indices. MSCI data tracks the relative value of the UK market and is shown below. While the UK has regularly traded at some level of discount, that discount widened after the Brexit referendum in 2016 and reached its widest valuation gap at the end of 2020 as Brexit deal uncertainty reached its most extreme. After the Brexit deal was made, that valuation gap started to close. But it remains large and we believe it is set to narrow further. This provides an attractive entry point for investors. Indeed, a sign of this is the high level of merger-and-acquisition activity (M&A) we have seen this year, with corporates and private equity bidding for UK listed companies.

The price versus the peers

Equity market valuations versus 10-year average, August 2021

Graph image

Source: Refinitiv DataStream, MSCI and BlackRock Investment Institute, August 24, 2021. Notes: The orange bars show the 12-month forward price-to-earnings (P/E) ratios of MSCI country indices. The yellow dots show the 10-year average for each market. The P/E ratios are calculated using Institutional Brokers' Estimate System earnings estimates for the next 12 months.

The relatively depressed price of UK equities has led to a flood of (M&A) activity, aided by the start of an economic recovery and record-low global borrowing costs. We believe this makes it a great time to own UK assets, as cash-rich corporations and private equity companies launch multi-billion-dollar bids at a premium to the share price. And away from the mega-cap area, M&A may be driven by large companies looking to grow through smaller acquisitions, and private equity seeking opportunities to buy and restructure companies. Good companies with a large global presence make particularly attractive targets at this time because – since they are listed in London – they are available at a large discount to global peers.

In the same vein, initial public offerings (IPOs) essentially ceased for four years after the Brexit vote. Since the start of the year companies are once again looking to list in the UK – an indication of the health of UK financial markets. We saw several high-quality IPOs in the first quarter of this year, presenting attractive opportunities for investors in UK equities to buy innovative companies at an early stage. 

We believe the opportunity favours active stock pickers, particularly those equipped to fully assess the landscape and capitalize on these three powerful dynamics, which are spotlighting UK equities on the global stage after years in the dark.