We have seen a very attractive investment opportunity emerging over the course of the last two years, in domestically-exposed stocks, such as housebuilders, construction and commercial property companies. These have been increasingly out-of-favour since the UK voted to leave the European Union in June 2016.
As the negotiations with Europe have progressed, uncertainty about the path of the UK’s future relationship with Europe has increased. Within the UK stock market, a significant gap has, in turn, opened up between the performance and valuation of international-facing stocks and domestically-exposed stocks. The fund has progressively increased its exposure to the latter, selectively focusing on stocks which are pricing in an overly bleak scenario for the UK’s economic future.
The market’s persistent antipathy towards UK-exposed stocks means this part of the strategy has not yet paid off. Indeed, these stocks have been another key cause of the fund’s underperformance, particularly over the last few months. The companies themselves have done very little wrong during this period – some of them have delivered excellent operational results – but this has counted for nothing given the continued negativity towards UK-exposed stocks.
By way of example, we point to the current valuation of the housebuilder, Taylor Wimpey, which released a strong set of full year financial results in February. It has reiterated its commitment to a £600m dividend return this year, which compares to a market cap of £5.8bn. That’s a yield of more than 10%, which means the share price could double from here and still look cheap. The same or similar applies to the share prices of many housebuilders and other companies that derive the majority of their revenues in the UK economy and that are held in the portfolio.
In many respects, the momentum behind the index and the domestic opportunity that the fund is positioned to exploit, are two sides of the same coin. In running towards the global-facing, dollar-earners, market participants have been running away from domestic exposure at increasing speed. This has created a compelling valuation opportunity and, although it has been painful for performance as this valuation gap has widened, we remain convinced that the fund will ultimately be significantly rewarded for this element of the strategy.