To put that into context, the UK market as a whole is trading on a forward price/earnings ratio of around 10.6 times, which is extremely cheap relative to its history.

“In contrast, all other global regions are trading on higher forward P/E multiples than the UK, with many at the upper end of their own 20-year ranges,” comments David Holder, senior analyst at investment consultancy Square Mile.

In terms of share price performance, the FTSE 100 appears to be in rude health: profits of many companies have recovered since the pandemic and the blue-chip index approached a new all-time high in March, although the mid-and small-cap sectors remain some way off their high points. But low P/E ratios indicate prices are not reflecting UK plc’s full earnings potential.

What’s undermining UK valuations? The British economy has been battered by Brexit overhang, economic slowdown, sticky inflation topping 11% in October 2022, and rapid interest rate rises fueled by the 2022 Truss/Kwarteng government.

Investors dislike uncertainty

 

As Josef Licsauer, senior investment trust analyst at Kepler Partners, observes: “Investors, much like markets, dislike uncertainty – a persistent recent political theme that has contributed to pessimism around UK equities.”

Negative sentiment is compounded by “the sense that more exciting investment opportunities lie in other markets,” notes Ben Ritchie, co-manager of Dunedin Income Growth Investment Trust.

Nor did the recent Budget provide much game-changing excitement. Giveaways such as the reduction in national insurance and an additional £360 million for research support in the life science and manufacturing sectors should be “modestly helpful”, says Mick Gilligan, head of investment trust research at Killik & Co.

But the new British ISA providing private investors with an additional £5,000 of tax-free allowance for investments into British companies, though handy for the relatively few people able to use their full ISA allowance each year, “won’t move the dial in terms of the level of flows needed to inject life back into the market.”

On the upside, however, it seems that economically the worst is behind us. February’s consumer price inflation fell to 3.4%, its lowest level since September 2021, real wages are now rising, and base rate cuts from the current level of 5.25% are expected in coming months.

“Additionally, optimism around falling inflation and hope that interest rates have peaked mean businesses are spending again, with investment finally jumping above pre-Brexit referendum levels, which could signal a turning point in sentiment,” Licsauer adds.

Strengths for investors

It’s certainly the case that the FTSE has real strengths for investors in terms of its geographical diversity, generous and reliable dividend culture, and exposure to overseas markets - around 70% of FTSE 100 revenues are generated internationally. It also has “a relatively laissez-faire government when it comes to takeovers,” notes Ritchie.

But the FTSE’s lowly valuations mean the London Stock Exchange has failed to attract new listings, even from British companies. Instead, the likes of British chip designer ARM have listed on the strongly performing, highly rated US market, where they will be ascribed the highest valuations.

Worse still, there’s a trend towards existing plcs leaving the LSE. Tui, for example, has recently delisted, while others including Flutter Entertainment and Smurfit Kappa have obtained secondary listings on the NYSE. CRH, the Irish building materials firm, moved its primary listing from London to the NYSE last year.

Could the upcoming election and a potential change of leadership provide a much-needed catalyst to revitalise investor interest in the UK?

Uncertainty is unattractive to investors, regardless of their political leaning, warns Licsauer. “People want clarity on the economy’s direction and, if this is provided, the response should be positive – though this is far from guaranteed.”

Considering the myriad of wider economic pressures any new government will face, it could be a long time before much material change is seen, he believes.

Ritchie adds that a likely future Labour government is already priced into asset markets: “Given Labour’s current policy agenda, we don’t see a major impact on markets.” He believes a more direct kicker for the UK market could come from improving valuations and strengthening earnings in sectors such as banks, mining and oil.

However, he stresses: “We do believe that for the selective investor there are attractive opportunities offering compelling long–term return potential within the UK market, particularly among the smaller end of the FTSE 100 and the mid-cap part of the index.”

Dunedin Income Growth’s own portfolio focuses on high-quality businesses that are well-placed to grow cash flows, profits and dividends over the years. Importantly, they are driven primarily by structural rather than cyclical growth, through powerful long-term themes such as the ageing populations of developed nations and the importance of technology in boosting productivity.

“We therefore see our holdings as already well positioned to deliver attractive returns; if there’s an additional rerating as sentiment improves, that will service as a windfall on top of existing robust long-term total return potential,” Ritchie adds.

Mispricing provides rich pickings potential

For abrdn’s value-conscious UK investment trust stable, which includes not only Dunedin Income Growth but also abrdn Equity Income, abrdn UK Smaller Companies Growth, Murray Income and Shires Income, the current environment of widespread mispricing of attractive stocks is thus providing rich pickings for managers.

As Thomas Moore, investment manager of abrdn Equity Income Trust observes: “Our focus on value isn't an abstract concept - many companies we invest in are generating enough cash to pay healthy dividends, buy back their shares and invest in their businesses.”

Given the scale of the stock-level opportunities, Moore believes recent asset allocation shifts out of the UK to be based on sentiment rather than substance; “now is the time stay close to UK companies, identifying stocks that have been miscast due to being ‘in the wrong postcode’,” he adds.

History shows that the flow of funds into over-hyped areas of global markets can reverse abruptly. The abrdn team is ready to capitalise on the eventual return of some of these funds into the UK market.

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Other important information:

Issued by abrdn Fund Managers Limited, registered in England and Wales (740118) at 280 Bishopsgate, London EC2M 4AG. abrdn Investments Limited, registered in Scotland (No. 108419), 10 Queen’s Terrace, Aberdeen AB10 1XL. Both companies are authorised and regulated by the Financial Conduct Authority in the UK.