UK and Russian stocks currently offer the best value global market opportunities, according to wealth manager Coutts.
The UK benefited from strong tailwinds in the second quarter of 2018, despite being unloved by investors. While Russian stocks have been one of the best performing in 2018 year-to-date, they are still hugely undervalued relative to their past, meaning opportunities abound.
Russia has been a position the firm has held for a couple of years now, with UK equities being added to portfolios in the wake of February’s market correction. “It’s interesting that UK equities are a contrarian call,” says Monique Wong, senior portfolio manager at Coutts.
“We used to talk about Russian equities as our big contrarian call, which sounds very exotic. UK equities sound run-of-the-mill but actually, if you look at surveys, UK equities are unloved, under-owned and underappreciated.”
One survey that bears this out is Bank of America Merrill Lynch’s global fund manager survey. As recently as March 2018, global investors had been net 41% underweight UK equities. However, since then that number has steadily crept lower. In June’s survey it had come down to 18%.
There are a number of factors at play, here. Wong notes that valuations are looking very attractive, at a price/earnings multiple of around 14 times, backed by a dividend yield of 4%. “UK equities are also an equity market which tends to be quite defensive in a late-cycle, more mature cycle,” she explains.
The tailwinds mentioned previously also helped. These include merger and acquisition activity in April and May; a rally in commodity prices, particularly the oil price; and US dollar strength against sterling.
Pragmatic on Brexit
The economic picture seems to be improving, albeit slowly. Despite Brexit still being an unknown, the UK economy is not performing as badly as expected, with the latest GDP growth figures edging up after a weather-affected start to the year.
The unemployment rate continues to stay at 40-year lows. While wage growth is struggling to find the same momentum – and is in danger of being overtaken once again by consumer price inflation – some believe it’s only a matter of time before this reverses.
“Employment has risen over the past three months and economic activity seems to show that labour demand should remain high over the coming months,” says Tom Milson, executive director at GWM Investment Management. “This would therefore suggest that wage growth should show some acceleration in the coming months.”
Coutts’ decision to add in February has already paid dividends, with a healthy 15% return in just under five months. However, Wong says they continue to like the position.
It has a slight bias to the FTSE 250, which makes it a little more domestically oriented. However, the team is at pains to point out that the mid-cap index is not as UK-centric as people sometimes perceive.
While the FTSE 100 derives around two-thirds of its revenues from overseas, the 250 derives around half of its earnings abroad, “so it’s actually surprisingly international”, says managing director Alan Higgins.
On whether Brexit ructions will cause them to re-think their UK equity exposure, Wong says they have a “very pragmatic view”. It’s difficult to read too much into negotiations, she adds, considering we’ve had denials that both a divorce payment and transition deal would be forthcoming, before both subsequently were confirmed.
“It’s important not to confuse economic fundamentals with politics,” continues Mohammad Syed, head of global markets. Some policy changes may impact economics, but the current climate – globally, not just at home – is “much more political than it is economics”.
“You want to divorce the two because economics will always over-ride political instability. You always have to focus on great companies, great cash flows and sustainability.
"Forecasting political events is quite speculative. You can’t make your decisions based on what you think may happen, which may not happen, when you don’t know the quantum.”
Russian Stocks Still Cheap
A long-standing contrarian position Coutts still holds is a long position in Russia equities, an asset class we have repeatedly suggested looks attractive.
This position is accompanied by a short position in the rest of emerging markets – they took profits from their general emerging market equity holdings earlier this year. “We’re looking for Russia to outperform the rest of emerging markets,” explains Higgins.
They bought in after early 2016’s geo-political market sell-off and amid the currency being “bombed out”. “Our response is to fade geo-political risk because generally markets do recover from them… and research shows buying an equity market after the currency has sold off is also a good thing.”
The value was there back then and, after a 2017 where the MSCI Russia Index moved up just eight basis points, it still is. Higgins says value is the most important consideration. “And I don’t mean value compared to China, I don’t mean value compared to India; I mean value compared to its own history.”
Another factor that played into Coutts’ positive view of Russian stocks is its positive view on oil. The Russian stock market is highly correlated to the oil price. “We’ve seen huge demand from emerging markets for oil, so we never believed in the really bearish case,” adds Higgins.
Coutts uses the Morningstar Bronze Rated Parvest Equity Russia fund to gain exposure to the country, noting that it also does a good job on engaging with companies. Higgins gives the example of Norlisk Nickel (GMKN), a miner on the UN black list and one of the biggest polluters in Russia.
Along with other institutional shareholders, Parvest – encouraged by Coutts – pressured the firm to take steps to clean up its mines in an attempt to get off the UN black list.
“Russia might be controversial for some of our millennial clients, but we point out for example that in areas like that it can be more important to be a force for good. Engagement is the way to go, especially if you’re investing in emerging markets," says Higgins.
