- UK equity funds continue to take outflows but performance has been strong
- Which names stand out for 2025?
The past decade has been something of a sour period for UK equities, with a combination of economic uncertainties and political drama helping drain away confidence. That’s reflected clearly enough when it comes to fund flows: open-ended UK funds have not, as a cohort, enjoyed an annual net inflow since 2015. Retail investors pulled more than £13bn from UK funds in 2024 alone, with a similar volume of money leaving the sector in 2023. The market itself has also shrunk notably thanks to advanced acquisition activity on the back of low valuations.
All of that suggests that investors, like UK companies themselves, could simply look overseas for better fortunes. The S&P 500 continues to look almost unbeatable and leads the pack with a sterling total return of nearly 90 per cent over a five-year period.
But it’s easy to miss the fact that the FTSE 100 beats most other rival markets over this period too, with a return of around 41 per cent. Sectors such as financials have powered ahead; buybacks and M&A have generated some rich gains in recent history, and yet the market continues to look pretty cheap versus the likes of the US. Recent pronouncements also suggest the UK may be less vulnerable in a trade war than other regions, although this is clearly subject to change.
As Rory McPherson, chief investment officer at fund management company Magnus, suggests, the UK market simply offers investors “something different”.
“It has a relatively high weighting to energy and materials at 15 per cent, just over twice the weighting found in a global developed stock index,” he says. “Hence we believe it’s an attractive market to own when combined with a core global holding. Added to this, it’s the cheapest market among developed peers on 12 times forward earnings and is benefiting from buybacks, bid activity and companies that are beginning to generate positive earnings [growth].”
Investors’ Chronicle readers might need little persuading of the merits of their domestic market, and may already take advantage of the many bargains on offer via their individual stock picks. But those who prefer funds might feel overwhelmed by the choice: even after a decade dominated by outflows, there are still 225 funds in the Investment Association’s UK All Companies sector alone.
Once investors also factor in decisions such as whether to go for a passive or active fund, back a trust or an open-ended vehicle, favour growth or income and whether to pick one investment style over another, there is much to mull over.
As Charles Stanley chief analyst Rob Morgan puts it: “Investors are spoilt for choice for UK funds and trusts; there’s really rather too many given the diminishing size and importance of the UK market over the past couple of decades. But it means there is a manager and strategy for all tastes, as well as some stand-out names that I think are worth owning for the long term.”
Some options
We’ve noted in recent weeks that value funds in the UK, from Artemis UK Select (GB00B2PLJG05) to Law Debenture Corporation (LWDB), have been on something of a hot streak, thanks to factors including their allocations to the likes of financials and the big gains made by certain recovery stories. However, Morgan believes that those investment teams erring on the side of caution may be most worthy of backing, given the uncertain economic backdrop.
“The economic challenges are well versed and largely accounted for in valuations, but I think a quality bias, or at least some regard for balance sheet strength, is necessary,” he explains. “The going could be tough for many domestically oriented businesses with significant debts and doubtful growth opportunities.”
As such, he believes that Man Undervalued Assets (GB00BFH3NC99) could be worth combining with a FTSE 100 or FTSE All-Share tracker in a portfolio. As its name suggests, this is a value fund, and Morgan believes the team takes a “disciplined” approach here thanks to an emphasis on the financial strength of investee companies.
“By focusing more on the current shape of the balance sheet, as well as cash generation and positive operating momentum, the managers target companies whose share prices do not fully reflect their ‘intrinsic’ value and those whose profit streams are undervalued by the market,” he says. “Importantly, this should weed out companies likely to fall victim to shaky balance sheets.”
As some might expect given these criteria, the fund has big allocations to the financials, industrials and materials sectors, which often prove a rich hunting ground for value investors. Unlike the broader market, it has very little exposure to consumer staples stocks.
A sense of caution is also notable in other commentators’ fund picks. McPherson points to Artemis Income (GB00B5N99561), which, as we noted last week, has actually outpaced plenty of more growth-minded funds in terms of its five-year total returns.
McPherson likes that the investment team “focuses heavily on sustainable cash flows, which we believe helps drive superior returns and, importantly, less variable returns”. It’s worth noting that McPherson regards Artemis Income as a core UK position, and that Redwheel UK Equity Income (GB00BG342939) and Fidelity Special Situations (GB0003875100) could be held alongside it. Both of these options adhere to a value approach, and the Redwheel fund has had a notable focus on banks.
Small wins
Bargain hunters may, of course, prefer to look further down the market cap spectrum, where sentiment appears more depressed and the gains could be greater were the UK economy to perform better than expected. As the chart shows, small and mid-cap companies have trailed the FTSE 100 in terms of their recent recovery.
Morgan likes Mercantile (MRC) as one option here, given it balances quality and value in its investment process. The trust’s shares trade at a reasonable discount to net asset value of around 9 per cent and the team does use some modest gearing, which could amplify any gains or losses made in the portfolio.
Morgan also rates Gresham House UK Smaller Companies (GB00BH416G53) as a dedicated play on small caps.
“Gresham House applies a private equity perspective to public markets, with the managers taking a hands-on approach with investee companies to provide input into strategic decisions and maximise shareholder return,” he says. “The manager has a good record, and holdings often become M&A targets.”