The outlook for UK equities

Richard Hallett, head of our UK equities investment team, provides an overview on the outlook for UK equities.

UK companies still face considerable headwinds, with high inflation, rising interest rates, slowing economic growth and weaker consumer confidence.

However, investors are growing more confident that central banks are bringing inflation under control and many expect that over the next year it could fall to around 3% in the UK and to between 3% and 4% in the US.

While further interest rates increases are expected, we may now be approaching the end of the rate-hiking cycle. Last year bond yields were rising fast, which resulted in a derating of many growth stocks, because their future profits suddenly looked less attractive when investors could earn healthy yields on bonds.

This year bond yields have been more range-bound, which could help to herald an end to what has been a particularly challenging period for growth stocks.

Our view is that company fundamentals are beginning to reassert themselves in valuations, which should be positive for stock-pickers, as investors begin to once more focus on companies’ long-term growth potential.

At the same time, we have seen a flurry of merger and acquisition activity, with Deutsche Bank agreeing to buy investment bank and broker Numis (held in Marlborough Multi Cap Income) and private equity houses in talks, at the time of writing, with companies including veterinary drug maker Dechra Pharmaceuticals and payments processor Network International (both of which we hold in Marlborough Multi-Cap Growth and Dechra is also held in Marlborough Special Situations).

We believe this highlights the fact that UK equities are looking fundamentally undervalued, in part because international investors remain concerned about political uncertainty and the lingering effects of Brexit.

Simon French, Chief Economist at broker Panmure Gordon, calculates that valuations of UK companies are on an average discount of 18% to comparable businesses in other developed markets. Our view is that this discount, which increases as you move down the market-cap spectrum into smaller companies, will not last indefinitely.

In the meantime, it is enabling the managers of our UK equity funds to invest in high-quality UK-listed companies, many of which are global players, at valuations significantly lower than if they were listed in other developed markets.

We believe that confidence is beginning to return among investors and that, at current share prices, UK equities represent a particularly attractive long-term opportunity.

Sector outlooks

UK Smaller Companies

Eustace Santa Barbara, Co-Manager of Marlborough Special Situations, Marlborough UK Micro-Cap Growth and Marlborough Nano-Cap Growth

The worst of the economic forecasts for the early part of this year appear to have been avoided, consumer and business demand has held up better than many predicted and most of the companies in our three funds have continued to trade in line with expectations and, in a number of cases, exceeded them.

The value available has not gone unnoticed by private equity houses and trade buyers. In recent weeks we have seen three companies we hold in our funds targeted for acquisition: Dechra Pharmaceuticals, Sureserve and Fulham Shore. All three bids were at substantial premiums.

We have a core investment team of five on our three funds and we work closely with the rest of the large UK and European equities team. This enables us to conduct our own primary research, using analysis of fundamentals to identify the most attractive opportunities among thousands of companies and in almost all cases engaging with management teams before investing.

The companies we favour have strong long-term growth prospects, high-calibre management and robust balance sheets, with relatively low levels of debt, which means they are well positioned to navigate challenging macroeconomic conditions.

We have been deploying cash recently to add to existing positions in quality companies we believe look significantly undervalued, including IG Design and Brickability Group.

Looking ahead, we believe the long-term case for innovative, agile UK smaller companies and their ability to outperform slower-moving corporate giants, remains as strong as ever.

UK Equity Income

Sid Chand Lall, Manager of Marlborough Multi Cap Income

We are continuing to see the majority of our portfolio companies trading strongly and delivering updates either in line with forecasts or surpassing them, despite the challenging economic backdrop.

Asset manager Man Group is a good example. The company reported $1.1bn of inflows in the first quarter, which was slightly ahead of expectations. The company pays an appealing dividend yield of 6.5%, which is covered twice by free cash flow, and it has £700m of net cash. It is on an attractive valuation, with a price-earnings (P/E) multiple of 12.5x (falling to 8.5x for estimated earnings in 2024), and is well positioned for future growth.

Morgan Sindall is a construction company that operates in areas where we see particular opportunity, including infrastructure, social housing and urban regeneration. It reported record results earlier this year. The stock is on a dividend yield of just under 6%, which is covered 2.5 times by free cash flow, and, unusually for the construction sector, the business has maintained average daily net cash of £256m on the balance sheet over the past year. Morgan Sindall is on a P/E multiple of less than 8x and we believe it has very healthy long-term growth potential.

With valuations at current levels, we believe the quality dividend-paying companies in our portfolio present a highly attractive opportunity, particularly since small and mid-cap companies are likely to be at the forefront when investor confidence returns.

UK All Companies

Richard Hallett, Manager of Marlborough Multi-Cap Growth

The vast majority of our companies are continuing to trade successfully, despite the macroeconomic headwinds.

We identify businesses that have a sustainable competitive advantage in a sector underpinned by a long-term structural growth trend. We believe these companies should be able to maintain their growth trajectories irrespective of the wider economic backdrop, and this is what appears to be happening in most cases.

We have added only one new stock to the portfolio so far this year, online sports betting, gaming and entertainment company Flutter, which was formerly Paddy Power Betfair. It is a strong business focused on the lucrative US market and we also see the company benefiting from a planned additional New York share listing.

We have trimmed several of our stronger-performing large-cap holdings and added to a number of the small and mid-caps in the portfolio. One small cap we have increased our holding in is Volution Group, which supplies the construction industry with market-leading ventilation equipment. It has made several sensible acquisitions and is growing its market share.

We have trimmed several of our stronger-performing large-cap holdings and added to a number of the small and mid-caps in the portfolio. One small cap we have increased our holding in is Volution Group, which supplies the construction industry with market-leading ventilation equipment. It has made several sensible acquisitions and is growing its market share.

The performance of the fund has strengthened this year, which we believe is a sign company fundamentals are coming to the fore once more. Recent trading updates, combined with current valuation levels, reinforce our view that the long-term outlook is very positive for the companies in our portfolio.

Risk Warnings
Capital is at risk. The value and income from investments can go down as well as up and are not guaranteed. An investor may get back significantly less than they invest. Past performance is not a reliable indicator of current or future performance and should not be the sole factor considered when selecting funds. Our funds invest for the long-term and may not be appropriate for investors who plan to take money out within five years. The funds will be exposed to stock markets and market conditions can change rapidly. Prices can move irrationally and be affected unpredictably by diverse factors, including political and economic events. The funds invest in smaller companies which are typically riskier than larger, more established companies. Difficulty in trading may arise, resulting in a negative impact on your investment. The funds invest mainly in the UK therefore investments will be vulnerable to sentiment in that market which may strongly affect the value of the funds. In certain market conditions some assets may be less predictable than usual. This may make it harder to sell at a desired price and/or in a timely manner. On Marlborough Multi Cap Income, all or part of the fees and expenses may be charged to the capital of the fund rather than being deducted from income. Future capital growth may be constrained as a result of this. Dividends paid by companies are not guaranteed and can be cancelled, which may impact the fund’s ability to deliver an income to investors.

Regulatory Information
This material is for distribution to professional clients only and should not be distributed to or relied upon by any other persons. It’s provided for general information purposes only and is not personal advice to anyone to invest in any fund or product. Information taken from trade and other sources is believed to be reliable, although we don’t represent this as accurate or complete and it shouldn’t be relied upon as such. Calls will be recorded for training and monitoring purposes.

Issued by Marlborough Investment Management Limited, authorised and regulated by the Financial Conduct Authority (reference number 115231). Registered office: PO BOX 1852 Lichfield, Staffordshire, England, WS13 8XU. Registered in England No. 01947598. Investment Fund Services Limited (IFSL) is the Authorised Corporate Director of the Fund. IFSL is registered in England No. 06110770 and is authorised and regulated by the Financial Conduct Authority. Registered office: Marlborough House, 59 Chorley New Road, Bolton, BL1 4QP. Copies of the Prospectus and Key Investor Information Documents are available from www.ifslfunds.com or can be requested as a paper copy by calling 0808 178 9321 or writing to IFSL at the registered office above.