Just as the U.K. enters another national lockdown, the stars are lining up for Britain\u2019s long-suffering equities.<\/p>\n
Fresh from its worst annual drop in more than a decade, the benchmark FTSE 100 Index posted its best start to a year on record. It has rallied 6.4% so far in 2021, helped by a long-awaited Brexit deal and global growth optimism. Investors are also piling into the country\u2019s exchange-traded funds.<\/p>\n
The trade deal with the European Union removed a key obstacle for U.K. assets just as the FTSE 100\u2019s undervalued shares are in demand amid expectations of a global economic rebound. Many analysts and investors are looking beyond the latest pandemic restrictions, citing vaccine rollouts and the potential for more U.S. stimulus with Democrats in charge of Congress as reasons for their optimism about the longer-term outlook for equities.<\/p>\n
\u201cThe prevailing negative investor sentiment and discount valuations attached to U.K. equities now creates some interesting investment opportunities,\u201d said Chris Dyer, director of global equity at Eaton Vance. \u201cThe future looks brighter for the U.K. market and U.K. equities, though investors must remember that Brexit will continue to be a drag on the U.K. economy for years to come.\u201d<\/p>\n
Investors such as Toscafund Asset Management and Eaton Vance, as well as strategists at firms including Goldman Sachs Group Inc., Citigroup Inc. and UBS Group AG are bullish about British equities following the Brexit deal.<\/p>\n
Miners, energy shares and banks boosted the FTSE 100 in the year\u2019s first week of trading. Investors backed cyclical sectors around the world on speculation additional U.S. stimulus will spur the economy under the Democrats, and oil surged after an OPEC+ compromise on production cuts. Index heavyweights such as Rio Tinto Group, Royal Dutch Shell Plc and BP Plc all rallied 13% or more.<\/p>\n
Heavy exposure to these sectors and a slew of global franchises make the FTSE 100 one of Europe\u2019s best recovery prospects in 2021, according to Bloomberg Intelligence strategists Tim Craighead and Laurent Douillet. In a note last week, they called the market one of the \u201cbastions of value\u201d across the region.<\/p>\n
U.K. equities were the world\u2019s most popular underweight for months, according to the Bank of America Corp. fund manager survey. Such has been the underperformance of U.K. stocks that they would need to rise by 80% relative to the world to return to their medium-term relative values, Toscafund Chief Economist Savvas Savouri wrote in a Jan. 6 note.<\/p>\n
Manulife Asset Management\u2019s Nathan Thooft acknowledges U.K. equities are better off on an absolute basis, but is less confident they will overtake peers because many of the \u201cobvious\u201d positives — low valuations and an index tilt toward cyclical and value themes — are shared by other regions. The relative benefit of reduced Brexit uncertainty also hinges on the magnitude of the currency appreciation and value rotation, he said.<\/p>\n
\u201cWe expect both directionally but aren\u2019t necessary pounding the table for massive moves,\u201d Thooft, Manulife\u2019s global head of asset allocation, said by email.<\/p>\n
Even so, investors have piled into U.K. ETFs since the Brexit trade deal. The largest such fund focused on the country\u2019s shares, the iShares Core FTSE 100 UCITS ETF, saw inflows of 183 million pounds ($249 million) in the final week of 2020, the most since March.<\/p>\n
Shares exposed to the domestic economy were also in favor. The iShares FTSE 250 ETF saw record inflows in December, with investors bringing in almost 400 million pounds, and about 44 million pounds so far in January, according to data compiled by Bloomberg.<\/p>\n
\u201cPart of this may be positioning for a relative value trade, where U.K. equities are seen as strong value investments based on fundamentals,\u201d Citigroup analyst Kim D. Jensen wrote in a note, saying investors may also have been expecting that a weakening pound could support returns for euro- and dollar-based investors.<\/p>\n
As FTSE 250 firms\u2019 revenues are more dependent on domestic economic conditions, the recent flows are also positioning for U.K. strength, Jensen added.<\/p>\n