Thrifty Britain Offers Both Affordability and Growth Momentum

Thrifty Britain Offers Both Affordability and Growth Momentum

In an interview, Ian Lance, the manager of Temple Bar Investment Trust, provided insights into the fund and the current state of the UK market. Established a century ago with a market value of around £900 million, the equity-income fund has been under Redwheel's management since October 2020. Since the announcement of Pfizer's vaccine in November 2020, the trust has experienced excellent returns.

When asked about the UK market being perceived as cheap, Lance emphasized the substantial discount of the UK market's valuation relative to the MSCI World Index over the past 50 years, with the current discount standing at 45%. He explained that the skew towards the old economy compared to the US technology-heavy sector justifies the typical 17% discount.

Investors' diminished interest in UK stocks during the past two decades is due to several factors, Lance explained. One key development was the introduction of IAS 19, an accounting standard for pension funds, in 2000. The new standard introduced mark-to-market accounting for pension funds, resulting in funds unable to tolerate stock market volatility. As a result, over the next 20 years, pension funds reduced their equity exposure. In 2000, they held around 53% of their total assets in British stocks, but that figure has since dropped to 3%.

A global approach to investment by pension funds has also been a contributing factor. With the US weighting at 73% in the MSCI World Index and Britain's weighting at just 3%, many pension funds now see their reference point as the world index rather than the UK market. Mergers and acquisitions among wealth managers reinforcing this trend.

Lance suggested that the UK market's weakness over an extended period has created a self-fulfilling prophecy, making investors hesitant to buy into the market due to perceived risk. Nevertheless, he highlighted two catalysts that could help crystallize the value in the market:

1. Takeovers: In recent years, foreign companies and private equity firms have seized opportunities to buy undervalued UK firms, signaling confidence in the UK market.
2. Share buybacks: While companies with flourishing businesses but low valuations have started to use share buybacks to advantage their shareholders, the practice was less common in the UK than in the US. Last year, many British companies initiated significant share buyback programs. Banks such as NatWest and Barclays experienced spectacular gains, with shares increasing by 80%, despite remaining on price/earnings (P/E) ratios of eight.

Lance believes that the recovery in the UK market has already begun, with foreign buyers, private equity funds, and companies themselves buying back shares. Furthermore, investors appear to be shifting their focus from overpriced American markets, as evidenced by the performance decline of the Magnificent Seven in the US.

For shareholders, the shift towards buybacks in the UK market should result in positive returns. Historically, the US has been considered the main market for buybacks, but the trend is changing. Lance believes that a greater percentage of UK companies are engaging in responsible buybacks, and fewer US buybacks are detrimental to shareholders compared to their counterparts in the US.

While the UK market recovery has shown progress, structural changes may be necessary to ensure its lasting success. Addressing Structural issues, such as pension funds' underweighting of the market and decreasing liquidity, could help cement the market's recovery.

Access to funding is a crucial element in making the UK market more appealing. Lance highlighted the case of an AI start-up in the UK that struggled to secure funding and eventually listed in the US, illustrating the need for improved funding opportunities for innovative UK businesses.

In conclusion, the extraordinary value available in the UK market should gradually feed through to improved returns due to low starting valuations. The Temple Bar Investment Trust has a focus on large-cap stocks, but the fund manager sees value in medium-sized and smaller firms, provided they offer strong yield potential. The fund primarily invests in financials and energy companies, with a yield of around 4%. As the UK market recovers, more value-oriented investors may consider shifting their focus to this undervalued market.

1. Ian Lance, the manager of Temple Bar Investment Trust, highlighted that a primary factor leading to diminished interest in UK stocks by investors over the past two decades has been the introduction of IAS 19, an accounting standard for pension funds, which introduced mark-to-market accounting, making funds sensitive to stock market volatility.
2. In the current state of the UK market, investors are at the start of a potential recovery, as evidenced by foreign buyers, private equity funds, and companies themselves buying back shares, signaling confidence in the market.
3. Lance believes that the shift towards share buybacks in the UK market, combined with a decline in performance of overpriced American markets, will result in positive returns for shareholders, particularly those who invest in value-oriented firms, such as the ones managed by Temple Bar Investment Trust.
4. To ensure the lasting success of the recovering UK market, Lance suggests addressing structural issues, such as pension funds' underweighting of the market and issues related to decreasing liquidity, as well as making improvements in funding opportunities for innovative UK businesses, in order to make the market more appealing to a wider range of investors.

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