Is now the time to invest in the UK?

In a world dominated by the volatile progress of US technology companies, the UK stock market has largely laboured in the shadows. That said, UK shares have been coming up on the rails lately. That may reflect a new search for value and yield in a world about to enter a period of falling interest rates and lower yields. In that world, the traditional properties associated with UK shares might command a premium.

Will they, however? The first thing to say is that the UK stock market is no longer trading in absolute bargain territory, but it is pretty close to it. Valuations in the US – even after the hiatus in markets mid-summer – remain close to their recent peaks.

Moreover, the UK is now underpinned by several factors that didn’t really feature a year ago including more growth and the actual onset of falling interest rates. That could fuel a further unwinding of the discount that’s been applied to UK shares ever since the Brexit referendum in 2016.

Growth is back

The UK economy stalled at the end of last year, hit by a combination of high inflation and interest rates. So far this year, however, the UK has beaten both the US and the eurozone in terms of growth, reflecting a relaxation of price pressures that includes a drop in mortgage rates.

The signs are the UK economy is set to keep growing. In July, the IMF upgraded its forecast for UK growth in 2024 from 0.5% to 0.7%, while sticking with its forecast that the economy will expand by 1.5% next year². Meanwhile, Britain’s new Labour government says it has put growth at the centre of its economic agenda.

What about interest rates?

There is a broad consensus that, barring some kind of unforeseen economic shock, a first cut in interest rates at the beginning of August marked the start of an easing cycle. Despite its positive assessment for the economy over the course of the year, the Bank of England expects growth to slow to 0.4% and 0.2% in the final two quarters of this year³. Provided inflation stays close to the Bank’s 2% target (2.2% in July) this could help pave the way for a second cut in rates before the end of the year.

The political dividend

While the honeymoon period for Britain’s new government may now be over, the political outlook still looks more stable than in either the US or Europe. The UK’s post-Brexit years were marred by short spells of government that kept overseas investors away. The signs now are that the UK has the capacity for rehabilitation as a destination for foreign capital.

What are the risks to the economic case?

There is little evidence to suggest that long-running impediments to growth such as low productivity and a limited amount of wriggle room for the government to raise spending are going to be resolved anytime soon.

Rising energy bills after Ofgem raises its price cap in October and wage settlements considerably above inflation are risks but, on balance, a Goldilocks recovery for the UK is looking more and more likely.

Is the UK market still cheap?

The UK stock market has lagged behind ever since the Brexit vote of 2016. The valuation gap has closed a little this year, but the discount remains significant:

In recent times, a further factor behind the UK’s lacklustre returns has been a tendency among UK pension funds to more closely match their future liabilities by moving away from UK shares and investing in gilts. At the same time, their geographical scope has widened, again leaving UK shares out in the cold. In 2023, the Pension Protection Fund reported that the proportion of assets invested in UK equities by defined benefit pension schemes had fallen to a record low⁵.

Evidence of the market’s attractive valuation and newfound political stability comes from the number of foreign takeovers we’ve seen so far this year. According to data from Dealogic, which tracks mergers and acquisitions globally, the value of bids for UK companies hit its highest since 2018 earlier this year⁶.

High profile takeovers so far in 2024 have included bids for the cyber-security firm Darktrace and the paper and packaging company DS Smith. Deals like this are important because they suggest informed buyers see an opportunity in the UK’s lowly valuations.

A bid for Anglo American from BHP has fallen through for now, but even that saga has underlined the fundamental attractiveness of large UK companies. The Labour government’s plan to promote investment via a £7.3 billion national wealth fund may have the capacity to further increase interest in UK shares.

UK fund ideas from our Select 50

If you’re looking for fund ideas for your ISA or SIPP this year, our Select 50 features five funds that focus on the UK. Three of the funds are actively managed, while the other two track a stock market index.

1. Fidelity Special Situations Fund

This actively managed fund was first launched in 1979 and aims to invest at least 70% in UK companies. There’s a focus on companies that the manager believes are undervalued.

Our experts like this fund because the manager is a “seasoned UK investor.” There’s also a willingness to invest in smaller companies, an area in which Fidelity brings expertise.

The fund’s top holdings include DCC, a sales company that operates across energy, healthcare, and technology, consumer staple Imperial Brands, insurance firm Aviva and facility management firm MITIE Group.

This fund may be suitable if you’re looking for a sensibly managed UK equity fund.

The fund’s ongoing charge is 0.91%.

2. FTF Martin Currie UK Equity Income Fund

This actively managed fund aims to generate an income that’s higher than the FTSE All-Share Index.

Its top holdings include oil giant, Shell and BP, consumer goods company Unilever, pharma company, AstraZeneca and GSK, miner Rio Tinto, British American Tobacco, and utilities firm National Grid.

Our experts like this fund as it invests primarily in companies listed in the UK, although the investment manager has the freedom to invest up to 10% outside the FTSE All-Share Index.

The manager is also committed to UK equity investing, which can be a rarity, as most investment firms tend to focus on global investing.

This fund may be suitable if you’re looking for dividend income from companies primarily listed in the UK.

The fund’s ongoing charge is 0.51%.

3. iShares Core FTSE 100 ETF

This passively managed fund tracks the FTSE 100 Index - which includes the 100 largest companies listed in the UK.

Its top holdings include some familiar names, including Shell, AstraZeneca, HSBC, Unilever, BP, and GSK.

Our experts like this fund as it is views BlackRock as a seasoned investor in passive funds, and the fund’s costs are low.

This fund may be suitable if you’re looking for exposure to large UK equities, have a long-term horizon and you’re cost-conscious.

The fund’s ongoing charge is 0.09%

4. Liontrust UK Growth Fund

This actively managed fund invests at least 90% in companies that are incorporated, domiciled, or conduct significant business in the UK.

Shell, AstraZeneca, BP, Unilever, GSK, beverage company Diageo, analytics firm RELX and foodservice company Compass Group make up some of the fund’s top holdings.

Our experts like this fund as the managers seek to identify companies that possess intangible assets or other durable competitive advantages.

It’s worth noting that this fund’s approach has a ‘quality’ bias, meaning it will buy companies that tend to be more expensive than others. Due to this, the manager takes a very long-term view when investing.

This fund may be a suitable addition to your portfolio if you’re looking to invest for ten years or more.

The fund’s ongoing charge is 0.82%.

5. Vanguard FTSE 250 ETF

This passively managed fund tracks the performance of the FTSE 250 Index and invests in medium-sized UK companies.

Its top 10 holdings include, property developer British Land and financial services firm Alliance Trust.

This may be a suitable addition to your portfolio if you want to seek exposure to medium-sized UK companies, have a long-term horizon and are cost-conscious.

Given that the fund invests in medium-sized companies, there may be more volatility and risk arising compared to larger sized companies. If you’re concerned about risk, the iShares Core FTSE 100 ETF may be more suitable.

The fund’s ongoing charge is 0.11%.

Source:

¹ House of Commons Library, 15.08.24
² IMF, 16.07.24
³ Bank of England, 01.08.24
⁴MSCI, 31.07.24
⁵ Pension Protection Fund, 06.12.23
⁶ FT, 12.05.24

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Tax treatment depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55 (57 from 2028). Select 50 is not a personal recommendation to buy funds. Equally, if a fund you own is not on the Select 50, we're not recommending you sell it. You must ensure that any fund you choose to invest in is suitable for your own personal circumstances. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.