Industry Voice: A market led by the large commodity stocks over the past few years has seen 'revenge of the index', making it difficult for all-cap managers to keep pace. Are we now on the precipice of a reversion of this?
The perceived concentration of the UK market has attracted a lot of debate over the years. This is not new - the bias towards the mega caps has been there for the past 20 years, but the market is dynamic and those names at the top have changed over time. Active managers had the wind in their sails through the mid part of this cycle - a time when there were pressures on the likes of oil and banking stocks and a craving for earnings growth which was hard to come by in more mature companies. It was all too easy for active managers avoiding a few large cap sectors to outperform.
Yet in the past three years we have seen the "revenge of the index", where a market narrowly led by the large commodity stocks has made it harder for all-cap managers to keep pace. Are we now on the precipice of a reversion of this? Could there be enough attractive targets within the market that are opportunities for actively managed funds - heralding the return of activism?
With the combined weight of oil and mining stocks above 20%, we believe there is a lot of money hiding there.1 Shell now accounts for 8% of the UK FTSE All-Share index, but it has not always been the largest index weight. Back in 2009 BP was 7% of the market before the Deepwater Horizon incident; and in 2000 Vodafone was more than 10% of the index after it bought Mannesmann, before falling back post-tech bubble.
We don't discount large caps, indeed we have more money in large cap companies than our peers, albeit mainly outside of the mega caps. Our large pharmaceutical holdings were good contributors to fund performance in 2018. We believe they can offer up opportunities but, as with elsewhere in the market, we want to be selective. We do not obsess over index weightings, rather we want to make sure we put capital to work where we feel we have a strong investment case.
CONTINUING TO LOOK THROUGH THE NOISE
Markets have rallied at the start of the year, but the UK continues to trade at an attractive 12x price/ earnings, with a yield of more than 4.5%.2 Nevertheless, global asset allocators remain cautious about the ongoing political uncertainty.
Underneath the surface the UK has become a three-tiered market, and while commodities may have held up well, it is not only UK domestics which are trading cheaply. The weight of money that has come out of the UK market has created a large price differential between global companies listed in the UK and those listed overseas, which we believe has created areas of opportunity for active managers. The resulting valuation arbitrage opportunity has attracted record levels of inbound activist investment and should, we believe, continue to entice inbound M&A.
We hunt across the whole market for interesting opportunities, and the UK contains a wide range of global and domestic companies, which have generally been extremely out of favour since the referendum on EU registration in 2016. Active managers that don't replicate the market can provide attractive risk-adjusted returns above the market, and by not fixating on the next quarterly earnings number, instead taking a longer-term view, we can find those that are trading at depressed valuations and which can help us to outperform over time.
1, 2 Source Bloomberg at 31 December 2018.
Richard Colwell is a portfolio manager and Head of UK Equities at Columbia Threadneedle. He manages the Threadneedle UK Growth & Income Fund, Threadneedle UK Equity Income Fund and the Threadneedle UK Equity Alpha Income Fund. He also co-manages the Threadneedle Monthly Extra Income Fund and has research responsibility across all sectors.
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