The UK market has had a torrid time since the British public voted to leave the European Union (EU) in 2017 but, much like its relationship with Europe, the tide could be changing.
After the referendum, investors sold their domestic holdings as the market plummeted: the FTSE All Share index has trailed the MSCI World index of global stocks by 48.9 percentage points between 23 June and the end of 2021, failing to beat the MSCI Europe ex UK index over that time as well.
However, the ‘old school’ industries that dominate the UK market have performed well this year, while many other economies have suffered from the rotation away from growth.
Traditional industries such as energy and banks (which together account for 33% assets in the FTSE All Share index) have been a drag on returns over recent years as the rise of environmental, social and governance (ESG) and low interest rates have impacted each respectively. Yet both have performed well so far in 2022 as this has reversed.
For example, higher energy demand has boosted the FTSE 350 Oil, Gas and Coal index up 19.5% so far this year, while sharp interest rate hikes have boosted FTSE 350 Banks returns by 5.1%.
Meanwhile, the MSCI Europe and MSCI World indices have dropped 8.7% and 1.3% respectively over the period, making an appealing case for investors to put their savings into the upward moving industries found in the UK.
Total return of indices over the past year
Source: FE Analytics
This reversal of fortune has also coincided with seemingly better relationships between the UK and those on the Continent. Indeed, the UK’s role as one of Ukraine’s biggest supporters in its struggle against invading Russian forces has improved the domestic island’s reputation.
Yet while the UK market is on the charge, the European market has struggled down 12.1% so far this year, making it one of the worst performing developed markets to-date.
The war will undoubtedly have had an impact, as has a sluggish European Central Bank and rising inflation across the region.
Although relationships may be mending, the dichotomy in returns from the two major markets has been clear. This makes it an ideal pairing however, according to Ryan Hughes, head of investment partnerships at AJ Bell.
He said that, although companies in the UK and Europe may not possess the ability to dominate world markets like they do in the US, investors can find “pockets of excellence” in the region.
It’s possible to build a Europe/UK portfolio “that can combine high-quality fund managers with robust investment processes as well as allocating to funds that have a very different investment focus,” he added.
Investors have shunned both regions in favour of the high flying US market for a long time, which has led to depressed values, but the recent volatility may attract value investors looking for discounted share prices.
His top choice to invest in the UK was the Jupiter UK Special Situations fund, which has proven to be able to make the most of difficult conditions, with returns 35 percentage points ahead of the IA UK All Companies sector over the past decade (up 121.8% in total).
It not only achieved top-quartile returns over the long term, but maintained a strong performance in 2022 so far, up 2% while its peers declined a considerable 10.4%.
Total return of fund vs benchmark and sector over the past year
Source: FE Analytics
The fund also ranked within the top quartile on its Sharpe ratio, indicating that the fund delivered a decent return whilst keeping volatility low.
Hughes attributed this consistent performance to its manager, Ben Whitmore, and his contrarian stock selection that differs substantially from the benchmark.
“Whitmore is unashamedly contrarian, being perfectly comfortable investing well away from the benchmark and importantly is patient enough to wait for the value in the positions to be recognised by other market participants,” he said.
Allocations to telecommunications are at 8%, compared to the FTSE All Share’s 2.4%, and consumer discretionary assets account for 17.4% while exposure sits at 10.2% in the benchmark.
These overweight positions meant a lower allocation to several sectors, including healthcare and consumer staples, which made up 15.5% of the portfolio compared to 28.2% of the benchmark.
Across the Channel, Hughes said the Fidelity European fund would pair perfectly with the Jupiter UK Special Situations. It was up 173.1% over the past decade, beating the IA Europe Excluding UK sector by 38.3 percentage points.
Total return of fund vs sector and benchmark over the past 10 years
Source: FE Analytics
Although it declined 3.8% over the past 12 months, its losses were more subdued than most of its peers, who were down 13.8% on average over the period.
Of the 147 portfolios in the sector, only one made a positive return in the past year, so the Fidelity European fund’s decline is not unusual.
Manager, Sam Morse, invests in companies that have strong balance sheets and tested business models, which makes them more resilient to tough economic cycles, according to Hughes.
He added that the robust nature of these businesses also allows the fund to grow dividend payments over time.
Due to its focus on quality companies, its asset holdings tend to be more expensive than Jupiter UK Special Situations and it has a much higher exposure to defensive areas such as healthcare and consumer staples.
These differing investment strategies and sector allocations make the two funds a powerful pairing if held in the same portfolio, said Hughes.
He noted: “When used together, these two funds complement each other well with a low stylistic overlap and a correlation over the past 10 years of just 0.7, indicating that they are well suited to being held alongside each other.”