Improving UK economic fundamentals

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We believe that the market consensus has misread the outlook for the UK, where economic fundamentals are improving, not deteriorating. Looking forward, we see UK economic health improving, with more people in work, more wage growth, less inflation, more investment spending, better public finances and a continued recovery in manufacturing and exports.

We believe the UK economy is capable of continuing to grow by annual rate of 2% or more, irrespective of the outcome of the Brexit negotiations. This is a considerably better outcome than the recession that some of the more pessimistic commentators are forecasting and what is clearly priced in to equity market valuations. It will also compare very favourably with most other major economies, many of which are rapidly losing momentum amid increased political risks and tighter monetary policy.

Overall, the data we’ve seen over the course of the last year points to a strong labour market, real wage growth and a strong banking system. In April 2018, real wage growth re-emerged as the post-referendum inflation, which was caused primarily by the decline in sterling, started to moderate – we expect this to continue going forward. Meanwhile, according to ONS data, the unemployment rate is the lowest since 1975, and, with more than 800,000 job vacancies waiting to be filled, we think the UK economy will benefit from further employment growth.

Additionally, the UK has a healthy banking system that is very well placed to continue to provide growth-enabling credit to businesses and consumers. This, coupled with all the other positive trends in the domestic economy that we are seeing and the disappointing data elsewhere, leads us to believe that the UK will be one of the fastest growing OECD economies in 2019.

Neil's view

As we have been anticipating, with inflation moderating and wage growth picking up, we now have real wage growth again in the UK. This should become more meaningful as the year progresses.

View chart
21 March 2018

An upbeat assessment of the UK economic outlook from Chancellor Hammond yesterday. Somewhat surprising therefore, to see the OBR become incrementally more negative, whilst at the same time acknowledging that manufacturing is growing more strongly, inflation is falling, the labour market is setting records, and real wage growth returns to the UK this quarter. I remain positive on the UK economic outlook.

View chart
14 March 2018

In essence, my relatively positive view of the outlook for the UK economy stands in stark contrast to a very bearish market consensus. I’m not expecting rampant growth from the UK economy but 2% GDP growth in 2018 looks eminently achievable. Many commentators are talking about recession and that appears to be reflected in valuations – hence the opportunity.2 January 2018

I’ve rarely witnessed such an overwhelming consensus view — which I believe to be profoundly wrong — that the UK economy is going to hell in a handcart. People have become so extreme in their view that Brexit is a pre-determined disaster for the UK economy, that the share prices are discounting literally economic Armageddon for the UK economy.

Read full article
1 December 2017

In recent months, an increasingly benign view of the UK’s economic prospects combined with the wider market’s antipathy towards domestic cyclical businesses, has created a contrarian opportunity. From our perspective, UK housebuilders and the construction industry more broadly, now look poised to benefit from structurally positive fundamental dynamics and a long-term opportunity which is underpinned by the public sector.

Read full blog
29 June 2017

UK domestic stocks trade on decade low valuations relative to globally-exposed stocks

Source: UBS, Woodford

UK-focused stocks trade on very attractive valuation levels not seen in years. Our funds are positioned to capture this long-term opportunity.

We now have real wage growth in the UK

Source: Lazarus Partnership, Bloomberg, Woodford

OBR forecasts for UK growth have become more negative - we believe this is wrong

Source: Office for Budget Responsibility, Lazarus Research, Woodford

Relationship between global PMI data and FTSE 100 performance has broken down

Source: Datastream, Haver, Goldman Sachs Global Investment Research, Woodford

Sales weighted PMI = global Purchasing Manager’s Index survey data weighted by the geographic sales exposure of the FTSE 100 index.

Pessimism towards UK equities is close to post financial crisis lows

Source: BofA Merrill Lynch Global Fund Manager Survey, Woodford

Net overweight/underweight (100 = 02.18) UK index vs World index performance Fund managers overweight UK (Net %) 16015014013012011010090 403020100-10-20-30-40 98 00 02 04 06 08 10 12 14 16 18 Big short

The UK stock market has underperformed other regional markets since the Brexit vote

Source: Bloomberg, Woodford

Global-facing UK stocks have outperformed domestic-focused UK businesses since Brexit

Source: Bloomberg, Bats Indices, Woodford

The Bats 100 index tracks the top 100 UK listed companies based on market capitalisation. The BATS UK Brexit high / low 50 indices represent the 50 companies in the BATS 100 index which derive the largest / smallest proportion of their revenues from the domestic economy.

UK economy continues to defy expectations of a slowdown

Source: Bloomberg, Woodford

UK domestic stocks trade at a rare valuation discount to UK exporters

Source: Morgan Stanley, Woodford

UK job vacancies at record level

Source: Lazarus Partnership, Woodford

How the funds will benefit

If the UK economy performs better than people think, then by extension, it is logical to expect that some companies which are exposed to the UK economy, will also perform much better than people think. Herein lies an opportunity which we have positioned the funds to exploit. The valuations of many housebuilders, construction businesses and retailers are simply too cheap and growth expectations far too low.

We believe that the share prices of many domestically-focused businesses will stage an impressive recovery from here and the funds are positioned to benefit from this.

LF Woodford Equity Income Fund (as at 31 August 2019)

Geographical allocation
Country Fund (%)
United Kingdom 84.50
United States 11.58
Switzerland 0.98
Norway 0.78
Luxembourg 0.73
Ireland 0.64
Sector allocation
Industry Fund (%) Benchmark (%)
Financials 29.81 25.30
Consumer Goods 26.89 14.71
Health Care 22.64 9.52
Industrials 8.09 11.64
Technology 5.72 1.07
Telecommunications 3.17 2.61
Consumer Services 2.18 11.81
Utilities 0.70 2.62
Oil & Gas 0.00 13.38
Basic Materials 0.00 7.32
Cash and near cash 0.79 0.00
Total 100.00 100.00

We have positioned the fund to capture a contrarian opportunity that has emerged in domestic cyclical companies where valuations are too low and future growth expectations far too modest and therefore, the portfolio has an increased bias towards UK revenues. Back in September 2015, we estimated that 41.9% of the portfolio’s revenues came from the UK. Now that number has risen to 55.5%.

LF Woodford Equity Income Fund's geographical exposure based on underlying revenues

Source: Bloomberg, Woodford (as at 30th September 2018)

What are the risks?

  • The value of investments and any income from them may go down as well as up, so you may get back less than you invested
  • Past performance cannot be relied upon as a guide to future performance
  • The ongoing charges figure is charged to capital, so the income of the funds may be higher but capital growth may be restricted or capital may be eroded
  • The funds may invest in other transferable securities, money market instruments, warrants, collective investment schemes and deposits – some of these security types could increase the funds’ volatility and increase the level of indirect charges to which the funds are exposed
  • The funds and trust may invest in overseas securities and be exposed to currencies other than pound sterling – as a result, exchange rate movements may cause the sterling value of these investments and the income from them, to fluctuate
  • The LF Woodford Income Focus Fund will be invested in a concentrated portfolio of securities – the fund is not restricted by reference to any geographical region, sector or market capitalisation
  • The LF Woodford Equity Income Fund and the Woodford Patient Capital Trust may invest in unquoted securities, which may be less liquid and more difficult to value, because they are generally not publicly traded – the lack of an open market may also make it more difficult to establish fair value
  • The price of shares in the Woodford Patient Capital Trust is determined by market supply and demand, and this may be different to the net asset value of the trust. This means the price may be volatile in response to changes in demand
  • Long-term outcomes are more binary – extremely attractive rewards for success but some businesses will inevitably fail to fulfil their potential and this may expose investors to the risk of capital losses
  • Young businesses have a different risk profile to mature blue-chip companies – risks are much more stock-specific, which implies a lower correlation with equity markets and the wider economy – it can take years for young businesses to fulfil their potential, this investment requires patience

Important information

Before investing, you should read the Key Investor Information Document (KIID) for the fund – or Key Information Document (KID) for the trust – and the Prospectus which, along with our terms and conditions, can be obtained from the downloads page or from our registered office. If you have a financial adviser, you should seek their advice before investing. Woodford Investment Management Ltd is not authorised to provide investment advice.

The Woodford Patient Capital Trust currently intends to conduct its affairs so that its securities can be recommended by IFAs to ordinary retail investors in accordance with the FCA’s rules in relation to non-mainstream investment products and intends to continue to do so for the foreseeable future. The securities are excluded from the FCA’s restrictions which apply to non-mainstream investment products because they are shares in an investment trust.

The Woodford Funds (Ireland) ICAV (the “Fund”) has appointed as Swiss Representative Oligo Swiss Fund Services SA, Av. Villamont 17, 1005 Lausanne, Switzerland. The Fund’s Swiss paying agent is Neue Helvetische Bank AG. All fund documentation including, Prospectus, Key Investor Information Documents, Instrument of Incorporation and financial reports may be obtained free of charge from the Swiss Representative in Lausanne. The place of performance and jurisdiction for all shares distributed in or from Switzerland is at the registered office of the Swiss Representative. Fund prices can be found at www.fundinfo.com.

 

Woodford Investment Management Ltd is authorised and regulated by the Financial Conduct Authority (firm reference number 745433). Incorporated in England and Wales, company number 10118169. Registered address 9400 Garsington Road, Oxford OX4 2HN.

Woodford Patient Capital Trust plc is incorporated in England and Wales, company number 09405653. Registered as an investment company under section 833 of the Companies Act 2006. Registered address Beaufort House, 51 New North Road, Exeter, EX4 4EP.

© 2019 Woodford Investment Management Ltd.
All rights reserved.

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