For investors feeling a little jaded after a trying year for UK equities, Mark Barnett provides some welcome optimism for value hunters. The Invesco fund manager who runs both Perpetual Income & Growth Investment Trust (PLI) and Edinburgh Investment Trust (EDIN) sees plenty of opportunity in the UK stock market across both the large cap universe and their mid-cap peers.

‘It’s got to the stage where the equivalent of £1 of sterling revenues are now valued lower in the UK than in emerging markets,’ he says.

Barnett believes the market is saying the long-term quality of UK businesses is ‘really impaired, and that represents an opportunity’.

There has been no shortage of issues to worry UK investors through 2018. Brexit negotiations continue to drag on, UK growth has remained stubbornly pedestrian and there is growing concern that the British economy could be plunged into a recession sooner rather than later.

These concerns and more have dragged on the UK stock market in 2018 which has remained on the back foot. Before the most recent sell-off the FTSE 100 had drifted about 2% down on where it started the year at 7,687.77. Those losses have escalated since 3 October, and at current 7,097.48 levels (22 October), the decline in the UK’s leading index stands at 7.7% for 2018.

Barnett’s investment style is very much buy and hold for the longer-haul, and so market weakness may well have proven to be a good opportunity to pick up more of what he already likes. ‘We seek companies with managers that view the equity in their businesses as a precious and rare resource,’ he says.

UK AT A DISCOUNT

Dig beneath the headline performance and a more interesting story is revealed. The mid-cap FTSE 250 index, which is more heavily skewed to the UK economy than the FTSE 100 (about 50% vs 75%), has fallen 9% year-to-date. Barnett highlights the price-to-earnings multiple of UK domestic revenues has fallen by a considerable amount versus UK companies which generate sales in the US.

Fundamentally, Barnett believes the wider stock market has ‘failed to discriminate between the strong and the weak, with a blanket de-rating’ applied to UK domestic earnings, particularly in areas like telecoms, financial services, property and retail.

Retail is particularly interesting given the deluge of profit warnings and financial stress in the sector over recent months. ‘Retail is being disrupted, we’re all buying online; there won’t be much of a high street left,’ he concedes.

Even Next (NXT) has not escaped from the sell-off. For years it was one of the few high street names that investors could rely on. Since June the stock has slid from £62.02 to £51.18 as trading has struggled to keep pace with previous expectations.

Barnett thinks the business is successfully moving with the times and is starting to ‘differentiate and pull away from the pack’. Next has proven that it is able to adapt and combine the best of online and offline sales.

‘It will not be the same in 10 years but I think Next will be a winner,’ say Barnett. ‘Next will still be on the high street in some form or other.’

Tesco is also an embattled retail business that Barnett backs for the longer-term, while UK domestic players BT (BT.A), Legal & General (LGEN) and property group Derwent London (DLN) all feature in Perpetual Income & Growth’s portfolio.

INCOME AND CAPITAL GAINS TARGET

How important are dividends? Massively, based on the returns performance of Perpetual Income & Growth. Since Barnett took the reins in 1999, the investment trust has averaged a return of 9.4% a year, which is an impressive performance.

More than 60% of total return has come from reinvesting dividends during the 19 years he’s been running the investment trust. Shares in the trust have increased by 177.5% in value over the past 10 years, a rough 70% outperformance over the FTSE All-Share index.

Patience is an essential ingredient according to Barnett to reap the rewards of this powerful compounding strategy. Discipline is probably right up there too; a capacity to stick to a fund’s remit even when the stress screws are being turned.

Barnett believes this is all part of being a responsible, long-term investor, not one that heads for the hills at the first sign of trouble. He would rather work closely with a company’s management team to find solutions to problems and make improvements to operating models, rather than run away in difficult times.

The current situation suggests the UK equity market, that’s about as inexpensive as any similar mature peer anywhere in the world, could be excellent stock picking territory for the next 10 or 20 years of  value creation. (SF)

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