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Ever since the unexpected result of the 2016 Brexit referendum, the UK market has, for many investors, fallen into the “too hard” basket. Years of uncertainty due to the implications of Brexit, Covid-led disruptions and the less-than-stellar initial Government response to the pandemic have led to UK equities being one of the least loved global developed markets. However, with the rollout of the vaccine program in the UK (and increasingly across the developed world), some resolution of the terms of Brexit with the European Union1 and a general re-emergence of the global economy from the pandemic, is it time for investors to re-examine the merits of investing in the UK market?
UK companies, global opportunities
Perhaps one of the most overlooked points throughout the discussions around the negative implications of Brexit is the fact that the UK equity market is about much more than the domestic UK economy. A quick look over the largest companies in the FTSE 100 Index reveals the global nature of the businesses included. Even with the prospect of a ‘No-Deal’ Brexit (now hopefully dispelled), the global nature of these businesses suggests they were being unfairly overlooked by investors.
BetaShares F100: Top 10 constituents
Source: BetaShares. As at 13 May 2021.
Another related factor to note is the share of UK companies’ earnings that come from outside the UK itself. As the chart below shows, only 23% of FTSE 100 companies’ earnings were derived from within the UK. A negative outcome for the UK economy would not necessarily lead to a corresponding negative outcome for these UK-domiciled businesses.
FTSE 100: Geographic Revenue Exposure2
A value opportunity?
A commonly used measure of value by investment professionals is price-to-earnings ratio (PE), that is, how much an investor pays for a dollar of earnings.
Traditionally, UK equities have traded at a lower PE than their U.S. counterparts, partly in recognition of the U.S. market’s higher exposure to higher-growth technology companies. As seen in the chart below, post-Brexit and post-pandemic, this gap has widened significantly, making UK equities look comparatively cheap. The UK market also offers exposure to sectors such as Energy, Pharmaceuticals, Materials and Banking, making it an attractive offset to the larger U.S. market with its dominant tech companies.
UK stocks trade at a steep discount to US peers3
Investing for income
With interest rates around the world at unprecedented lows, the quest for yield has become increasingly earnest. Exacerbating this is the fact many companies cut dividends to hoard cash during the depths of the pandemic in 2020. As the global economy continues to reopen, and companies look to reinstate dividend payments, markets such as the UK, with a strong dividend paying history, may increasingly become of interest to investors. Recent analyst forecasts have suggested a rebound of over 20% in dividends for 2021 off the 2020 lows, indicating an expected dividend yield for the FTSE 100 in excess of 3%.
FTSE 100 historical and forecast dividends4
Source: Company accounts, Marketscreener, consensus analysts’ forecasts.
How can Australian investors gain exposure to the UK sharemarket?
With the resolution of the Brexit question and the thus far successful rollout of the Covid vaccine, much of the reason for the UK’s relatively unloved status amongst investors is dissipating. With the market trading at a valuation discount to much of the rest of the developed world, and with an attractive dividend yield, the UK may be worthy of consideration by investors.
One of the most efficient ways for Australian investors to gain exposure to the UK market is via the BetaShares FTSE 100 ETF (F100). F100 aims to track the performance of the FTSE 100 Index (before fees and expenses), which provides exposure to the largest 100 companies by market capitalisation traded on the London Stock Exchange.
There are risks associated with an investment in F100, including market risk, country risk, currency risk and index tracking risk. For more information on risks and other features of F100, please see the Product Disclosure Statement, available at www.betashares.com.au.
2. https://insight.factset.com/have-uk-stocks-with-eu-exposure-underperformed, 9 October 2019
4. Cited in https://www.youinvest.co.uk/articles/investmentarticles/223890/ftse-100-dividend-payments-swamp-cuts-and-cancellations-april