Christopher Johnson: The U.K. equity market has been unloved for many years. But with the recent market sell-off in the U.S., the U.K. now having a new government and the fact that there is going to be a thawing of relations with the European Union, it’s now the time for investors to take a second look at the U.K. equity market. To discuss all of this and more, I’m joined by Guy Anderson of J.P. Morgan Asset Management.
Guy, thank you so much for being here with me. So, my first question to you is, is now the time for investors to dive into the U.K. equity market?
Guy Anderson: So, I am biased, I’ll accept that, but I do think now is a really interesting time. And I think actually we’re at the early stages of a potential recovery. So, as you say, we’ve been through a pretty torrid period for a number of factors – some of them external, of course, related to the pandemic and Russia invading Ukraine, but some of them potentially internally generated. And there has been a certain amount of instability in the U.K.
Where we are today, though, I think some of the external factors are becoming less relevant in terms of the weight of inflation and how the economy is now actually beginning to recover. We’re back into real wage growth. A lot of the soft lead indicators are looking pretty promising. But also, we’re in a position where there is the potential for greater political stability going forwards. Of course, we can’t say with any certainty that that will happen. But I think there is the potential for greater stability. So, I think some of the risk premia associated with the perception of instability can gradually fade. And you set that against a market where the valuation, as everyone knows, is looking extremely cheap, both relative to its own history, but also relative to alternative equity markets. I think that’s an interesting setup.
The most important thing for us, though, when we look at the portfolio is how are the underlying companies performing. And here I take reassurance because, of course, there are always ups and downs in any portfolio. But in aggregate, the portfolio of companies in which we’re investing have been outperforming our expectations. In other words, the reality on the ground is that things are gently, not too hastily, but are gently getting better. And I think that’s the best litmus test.
CJ: Do you also think that with the turbulence that we see in the U.S. markets, that the U.K. equity market can benefit from that?
GA: To a certain extent, yes, simply because certainly I’ve found over the last year or so when talking to our investors and our clients, there’s a certain amount of reluctance to step away from something when it is performing so well and so potentially just a little bit of a shudder could make people reassess their exposure and potentially think, ah, maybe now is the time to consider an alternative.
CJ: I’m also interested to get your perspective on kind of the impact of Brexit on the U.K. equity market. What needs to happen for U.K. equities for their valuations to return to their pre-Brexit levels? What needs to be done, do you think?
GA: Sure. So, I guess to put some numbers around that — so, if we think about before — if we think back to say four or five years ago, the U.K. market was on sort of low to mid-teens type P/E ratio, so call it, 13, 14, 15 times. Whereas where we’re sitting today, we’re back at around maybe 11 times earnings, having got down to below 10 times at the nadir a year or so ago. So clearly the market has re-rated quite substantially.
A lot of that will be, in my opinion, due to both the sector makeup of the U.K. and then also the risk premia that’s been added because of the perception of instability, as well as of course the economic outlook where we sit today. Of course, we can’t control all of those factors, but clearly, the economic outlook is improving. The risk premia associated with the uncertainty, some of which of course is due to Brexit, I would hope would diminish, particularly with the potential for a new government to potentially reset relations. Of course, they’re not going to go back and start renegotiating, but potentially a reset of relations. So, I think that’s a risk premia that can gradually diminish over time.
So, I don’t think this is something that suddenly changes overnight. And then of course, if the companies can perform well, so if the sectors that are in our market start to be ones that do well, but most importantly, the individual companies start to do well, then I think that can focus investors’ attention on the opportunity.
CJ: And on to the fund, so according to Morningstar data year-to-date, the JPMorgan UK Equity Growth Fund achieved 11.53%, beating the Morningstar UK Index. So, what do you put the outperformance down to?
GA: So, the portfolio is built very much on bottom-up stock selection. So, it always comes down to the individual companies in the portfolio. And as I said, there are always pluses and always minuses within that. But what has been quite pleasing is some of the breadth of winners, if that makes sense. But to pick a couple, one of our best-performing companies this year has actually been an investment in Rolls-Royce. So, this is a company that has obviously had a relatively turbulent history, has been through a number of turnaround attempts. But what we’ve seen over the course of the last year is actually the current restructuring plan genuinely yielding improvements in the financials. And we’ve seen – I think when I look back over the last 12 months, I think earnings estimates have been increased by 80% for Rolls-Royce. And that’s really important metric for us. So, we’re looking for – obviously, we’re looking for companies that are growing, but we’re also very much thinking about, are they growing relative to expectations? So, it’s about, are they beating or missing the market expectations? And Rolls, I think, is a really good example of once it’s got that positive operational momentum, really smashing market expectations. And we see that opportunity continuing ahead of them as the turnaround continues.
CJ: Shell and BP are two of your top holdings. But can they really be considered as U.K. growth companies?
GA: So that’s a great question. And actually, that comes back to the point about the growth relative to expectations. So, what we’re looking for is absolute growth, but then also the unanticipated growth. And Shell and BP were, I think, two good examples of this, particularly if we look back to late 2021: so, at the end of 2021, we didn’t hold either of those companies in the portfolio, but we bought both of them at the start of 2022 or early in 2022 when the outlook for the (quality) price massively increased. So, in other words, when Russia invaded Ukraine, and actually oil and gas went from being — or energy more broadly, went from being one of the largest underweights in the portfolio to the largest overweight in a six-month window. Where we sit today, I think it’s fair to say the outlook is clearly more challenging. And so those companies are significantly smaller in the portfolio and are actually sitting as underweights.
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