My bet on UK shares has disappointed - but I’m keeping the faith

Important information: the value of investments can go down as well as up so you may get back less than you invest.

The rally in global shares as the year comes to a close has left one set of investors slightly less jubilant than the rest.

Anyone backing the UK stock market will welcome the gains made in November and December - but will also look enviously to other markets that are seeing prices rise to new record highs after posting double-digit gains in 2023.

Leading the way is the US, where the S&P 500 is near new all-time highs after climbing 24.7% this year. In Europe, the Eurostoxx 50 is 17.5% better off and Japan’s Nikkei 225 is a whopping 31% above its level from the start of 2023.

Back in Blighty, both the FTSE All-Share and FTSE 100 have managed to eke out a narrow 1.8% gain year-to-date.

That has to count as a disappointment when, in theory, the same forces raising foreign markets should also have benefited British shares as well. The common diagnosis is that the UK is suffering a more persistent inflation problem than other economies, with higher rates needed for longer to correct it. There has been evidence for that this year but the most recent data suggests the UK, too, is quickly bringing inflation under control.

Growth, meanwhile, is slow but has not (yet) matched the worst predictions of recession.

It feels a good time, therefore, to revisit an investment I made in the UK at the start of the year to see if it still stacks up.

My bet on UK shares

As we entered 2023, the UK market had just posted a modest gain for 2022. That was despite many other markets suffering sharp falls in that year. Indices were near their all-time highs.

Despite that, valuations on the UK market were not excessive - and in some areas of the market they looked positively attractive. In particular, mid-cap shares - those grouped together in the FTSE 250 - looked well-placed. While trading on similar valuations to their counterparts in the FTSE 100, UK mid-caps scored much better on a range of other important metrics, such as the forecasted earnings.

It was enough to persuade me to allocate an overweight position to the UK via Fidelity Special Values, an investment trust that looks for UK shares with a value-bias and a skew toward mid-cap shares. You can read about that initial decision here.

As with any investment, the timeframe for judging it a success or otherwise should be longer than one year. Nevertheless, there’s no harm in revisiting the decision to see if it still stacks up.

In terms of returns so far, the trust has underwhelmed with a 1.7% loss year-to-date. As an investment trust, its share price moves independently of its assets. It began the year trading at a discount of 6.7% - which was cheap versus its history - but that has widened to 7.8%. That widening of the discount accounts for the loss this year - the value of the assets in the trust actually grew.

Looking to other fundamentals there is some cause for optimism. The FTSE 250 overall is trading on a valuation of 10.9 forward earnings. That’s cheap and close to the valuation of 10.5 times for the FTSE 100. But the FTSE 250 boasts much stronger forecasted earning than the blue-chip index, with earnings-per-share forecast to grow 11.1% in the next 12 months versus 3.4% for the FTSE 100.¹

As ever, plenty can go wrong - in particular if the UK suffers a sharp recession next year which scotches those earnings forecasts.

Yet there is enough to suggest that there is potential in UK mid-caps that is still being underappreciated by the market - and it’s enough for me to hang on to my investment in Fidelity Special Values.

Source:

¹ Peel Hunt, 11.12.23