Unlocking value opportunities in the UK

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I’m Staci West from FundCalibre, and today I’m joined by Richard Knight, manager of the Allianz UK Listed Opportunities fund. Richard, thanks for joining me today.

[00:10] Thank you so much for having me. Staci,

Let’s start with something a little bit more topical, which is the proposed British ISA, which was in the Spring Budget earlier this month for our UK listeners. So maybe just give us a few thoughts on this, how do you think that it will be beneficial? Will it be meaningful to the UK stock market? Is it an exciting thing? Is it, eh? What are your views?

[00:35] Yeah, absolutely. Really interesting topic. I think the the British ISA for those that perhaps unfamiliar, it’s the final details have not been ironed out, but it’s going to be a £5,000 incremental opportunity to invest in UK stocks and funds. Now quite what, exactly what that means still to be decided. But I think that the bottom line on it for me is it’s definitely a step in the right direction. 

The context here is there’s widespread dysfunction in the UK market. We have seen years of outflows from the UK equity market, pension funds structurally selling out down to quite a low level, institutional investors upset for many of the last sort of seven, eight years or so, for many reasons, Brexit, politics, Covid, and then of course the changes in prime ministers and things like that. Valuations are incredibly attractive. I think that the most important thing about the British ISA is that a little bit more than what it ends up actually impacting in terms of flows is it illustrates a sea change in sentiment. The government understands – and I think the opposition party also understand – that something needs to be done or should be done to address these kind of problems that have affected the UK market and make sure that we have a healthy, broad and deep capital markets system going forward. I think the British ISA definitely, is a part of the solution to getting there.

And you mentioned sentiment there, so how does the UK market kind of come back in favour so to speak? It has had a very negative sentiment for quite a while now potentially going all the way back to the Brexit vote. So, how do we change that now?

[02:27] Yeah, absolutely. I mean, regaining sentiment, I mean, it feels like it hasn’t been a lot of positive sentiment in the decade or so of my career, <laugh> in working in UK equities. I think there was a brief moment in 2015 and not much beyond that. And we can see this through, as I say, the relative valuations both the history and to other markets. In terms of regaining that positive sentiment, I think what you really need is a period of stability. You look back over that seven or eight years, we’ve just had too many volatile events in the UK. I mentioned a few of them: Brexit vote, its complex implications and possibilities; the prospect of a fairly hard left government in 2019; Covid and its various impacts on the economy. Of course, that was common to lots and lots of countries, but it really doesn’t help international investors get comfortable with the UK and it was quite a severe impact, at least initially on the UK economy. And then of course, the change in prime ministers – Liz Truss’ short-lived government in 2022. 

Now finally, we’ve got another election this year, but I really feel that this election coming up represents much less of a risk factor than actually many elections going on around the world that we might think of. And that’s because there’s a relatively settled, policy framework with the two parties that are really in contention on economic policy at least, relatively similar, a lot more so than they were in the past. 

And really what we need in the UK therefore is boredom: from a market point of view, boredom is good. It allows everyone to get very comfortable with assessing less risk and letting valuations approach what I would consider much more fair value in the UK, both for the market as a whole and for its individual assets. So boring, that’s what we need.

So, you mentioned valuations, depressed valuations, it looks cheap. So maybe let’s just touch on that quickly then. So you’ve given plenty of reasons as to why valuations would be cheap at the minute, but how does that make the UK market so attractive today as an investor?

[04:53] Yeah, really, really good question. So you know, I’m a value driven investor, so I look very closely at valuations for the individual stocks in which we invest. And of course, valuation is not just about a low price, it’s about a low price relative to what you’re buying, relative to the quality of what you’re buying. 

And what really stands out with the UK market is I think two things; is that the relative valuations – relative to other markets and its own history, and of course it’s not changed that much through time, so that’s quite interesting – are very modest and you can look at the US for instance, which is far, far more than double the valuation of the UK market, Europe quite a bit more expensive as well. But I think what I really want to underline is it’s not all about the market composition. It’s not all about the UK being cheap for a reason. There are significant divergences among similar companies. You find similar companies listed in the UK and you find them listed elsewhere and guess what, elsewhere, they’re more expensive. As a value investor operating in the UK, this is what I want because it means I can find bargains. And that’s a really nice thing to be able to do. 

I think the secondary and perhaps just as important impact as that sort of suppressed valuation at the market level is to understand that there’s a lot of mispricing within the market. The UK has got some very, very – relatively few but a reasonable number –  a very expensive or really, you know, fully valued or richly valued stocks. And then it’s got an awful lot of very, very undervalued stocks. And that dispersion is a very interesting landscaping in which to operate because it tells you that the market’s being inefficient or at least it gives you the hint that it probably is, it’s a nice kind of pond to fish in for good investment ideas.

So, I think that that kind of negative sentiment we’ve seen in the UK has led to this position where the market both as a whole in aggregate and at the sort of individual stock level, there’s got an awful lot of mispricing in it. And there are many different ways to cut that, but none of the explanations that people occasionally talk about. Like for instance, lack of technology stocks for instance, or too much old economy. None of the explanations really stand up as, as a full and proper sort of explanation for what’s gone on.

So are you like spoiled for choice then? It sounds like you, you’ve been having a good time hunting around for companies?

[07:24] Well, absolutely. As mispricing sort of increases it’s sometimes a bittersweet because it means that sometimes the things you own and the things you think are mispriced are getting more mispriced. But of course, like I prefer that situation because it means finding new ideas and finding opportunities is easier. 

We just find so many examples of companies trading well below their fair value and it’s good to stand back as well. I’m not a global specialist, but many markets around the world, particularly the US, are at relatively elevated levels relative to their history and relative to their current fundamentals, sort of the earnings these companies are producing. And it’s really nice to be in a position in the UK where that’s really not the case. It’s quite easy to see mispricing, to be able to buy assets that are trading far below what we consider to be their intrinsic value. So, I do feel spoiled for choice. There are many interesting stocks and sectors. I’m happy to go into them.

Well, let’s do exactly that. So, is there a sector that you’re finding kind of more opportunities either than maybe another sector or just against its history for that particular sector?

08:45] Yeah, that’s a great question. I should say about our process that we don’t look at sectors first, we look at stocks first. We’re bottom-up fundamental driven investors, and it’s really all about those individual investment cases. But of course, sometimes we find lots of good ideas in a particular sector and, as long as subject to our kind of risk control, we will then hold a fairly high weight in that sector. And at the same time, if we don’t find good ideas, we are very comfortable not holding any particular sector. 

But we are finding good ideas at the moment in a few sort of fairly correlated sectors. Oil & gas, for instance, is very interesting. We think that a lot of that industry really is going through a favourable period in its capital cycle. Essentially there is underinvestment in a lot of capacity that will be necessary for those commodities going forward. 

I think that banking too really has rejuvenated itself after the global financial crisis. And this cycle is in a much better position, stronger balance sheets and also can benefit on the income side from the turn in the interest rate cycle that we’ve seen which is a tailwind for UK banks in particular, for many years to come and even as rates go down, actually. 

And then just finally, I thought you could give our listeners just a little bit information about how you would view this fund fitting into a wider investment portfolio.

[12:06] Well, that’s a difficult one for me but very happy to give it a go. I mean, what we are trying to do in the UK [Listed] Opportunities fund is really go within the UK opportunity set, so within the UK market that’s the first thing to say, the most obvious thing that that’s the pool we are looking at. But that market has got an awful lot of different and differentiated ideas in it, many of which are not very much to do with the UK. The UK market is particularly notable for having a relatively low proportion of its kind of market weight related to the domestic economy. It’s probably only 20% or 30% or so. And it’s also got a huge breadth of ideas across the small, mid-cap space and the large-cap space. So what we’re asking our clients to do is really in the [UK Listed] Opportunities fund, to do what it says on the tin is to seize the opportunities wherever we find them within the UK market, whether it’s small-cap, whether it’s large-cap, whether it’s mid-cap, whether it’s UK domestically orientated or more internationally orientated stocks. And we take the positions that make the most sense, not from any top down judgment on whether the UK economy is going to be fantastic or less fantastic in the future, but rather we investigate what the individual stocks are telling us and what are they pricing in. If they’re pricing in a terrible situation and it’s not likely to happen, that’s a really great place to start. 

So, what I expect the fund to be able to do for people is also offer a differentiated kind of approach. You should expect us to be opportunistic, you should expect us to be able to perform through the cycle using a value-driven approach. Sometimes there are headwinds, sometimes tailwinds, but over the long term, we should be able to generate a good return. And I think the UK market is a particularly interesting place to be fishing right now, not just because of the valuation points we mentioned, but also because it tends to be a differentiator. We saw in 2022 that the UK market performed very differently to other markets. I think people should start seeing – international investors in particular should start seeing – the UK market as as a differentiated area to look for interesting investment ideas. And ultimately if you look around the world and and see valuations may be a little bit stretched with lots of risks, whether geopolitical or economic, that idiosyncratic risk, that ability to outperform a market, find mispricing and generate excess returns from simple mispricing and not necessarily where the whole market’s going, I think will become more valuable over time in a world that’s perhaps a little bit less correlated than it has been.

It’s certainly an interesting place to be right now, that’s for sure. Richard, thank you so much for joining me and walking me through so much of the UK market and value in the fund. So, thank you very much. 

[15:05] Thanks, Staci, it’s been absolute pleasure. 

And if you’d like to find out more information on the Allianz UK Listed Opportunities fund, please visit FundCalibre.com.