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Magnificent businesses are not confined to the US. In this article, Imran Sattar, Portfolio Manager of the Trust, explains why there are reasons for investors to be optimistic about the UK stock market despite the well documented headwinds, including the fact there are many companies with high returns and good growth prospects.
I was appointed portfolio manager of Edinburgh Investment Trust earlier this year but I have been managing UK equity portfolios for over two decades and there have been a multitude of major market, economic and political cycles over this period. These have included the internet boom and then bust, Global Financial Crisis, Brexit, Covid and many mini-cycles in between.
This is one of the reasons why we believe it is important to have a pragmatic investment style. This leads us to spending the vast majority of our time on bottom-up stock picking – it is where we believe we have an edge. In practice, this means searching for companies with an advantage, an economic moat as we like to call it, ideally operating in industries where there is a structural growth tailwind. What gets us excited are companies with high returns on capital and the ability to sustain those returns.
The headwinds for the UK stock market over the last few years have been well documented:
- Declining pension fund allocations;
- Declining UK wealth manager allocations;
- Brexit and politics;
- Low economic growth versus Europe and the US
Reasons to be optimistic
But there are now reasons to be more optimistic about the UK economy. First, the gap with Europe has narrowed for GDP growth forecasts. While the US is still a little ahead of the UK, we are no longer an obvious outlier versus the G7 economies like we were 18 months ago. Second, political risks appear to be receding and again we are no longer an outlier against other countries. Third, the UK is in line with other countries in terms of the rate of inflation. Fourth, corporate balance sheets are in good health and UK consumers have saved relatively more of their Covid tailwind than in other countries. These factors combined mean the valuation gap between UK stocks in aggregate and other leading equity markets looks stark and unwarranted. Over time, this valuation gap is likely to close.
There is also a perception that the UK market is essentially made up of low growth and lower quality businesses; we strongly disagree with this. There are many world class businesses trading on attractive valuations listed in the UK. The UK stock market is global in nature; in fact, it is more global than most markets. The returns for businesses across the market are comparable with other stock markets, certainly against Europe.
Magnificent businesses
While we may not have the Magnificent Seven stocks (Meta, Apple, Nvidia, Amazon, Microsoft, Alphabet, and Tesla), there are magnificent businesses listed in the UK. It is possible to build a well-diversified portfolio of advantaged businesses with high returns and good growth prospects at a discounted valuation. These include:
Compass – a global catering business, highly regarded, well known to be the best run catering business. It is a market share winner.
Ashtead – one of the market leaders in equipment hire in the US, a great business with high returns. Again, it is a market share winner on a very reasonable valuation.
Autotrader – while this business is not global, it has the best in class business model for car internet platforms. If you talk to any competitor, they will say they aspire to becoming an Autotrader. The company has great margins, pricing power and a moat to protect returns.
Dunelm – again not a global company but it is a brilliantly run domestic retailer with a model that is not easy to replicate and is differentiated through its supply chain. It is a market share winner on a very reasonable valuation and with an attractive dividend yield.
3i – this is a home grown private equity business that owns Action, the largest European discount retailer, which has been a big winner for 3i and is well set to continue to drive great returns.
There are some key themes within the Edinburgh Investment Trust portfolio. One is data analytics. The value of data when you add analytics and AI (artificial intelligence) is increasingly important for businesses, consumers and the government. We have been increasing exposure to this theme; the holdings include:
LSEG – owner of much more than just the London Stock Exchange. It is a global business, well diversified, has mostly recurring revenue and 50% + margins.
Verisk – a US-listed data business for insurance, with high margins and return on capital. This is a good example of a company where we are using our 20% allocation to non-UK listed shares.
Admiral – a very well run insurance business that is a second order beneficiary of data. The company is using data and analytics to make better decisions in pricing insurance risk.
Macroeconomic outlook
As always, the focus for us remains on the bottom up and constructing a high conviction portfolio of advantaged businesses that can perform whatever the economic weather. From a macroeconomic perspective we are mindful of changing expectations for the path of interest rate normalisation as inflation has remained more entrenched than expected. This period of heightened monetary policy uncertainty coincides with a period of elevated geopolitical risks we have seen materialise more recently – making a flexible, pragmatic approach to investing important, in our view. Looking forward we expect risks to remain high, with 2024 seeing a significant number of elections globally – in countries accounting for >50% global GDP and >50% population – mostly notably the US, India, and the UK; and China continues to face growth headwinds as the economy seeks to transition from an investment led to a more balanced model with consumption led growth. With consumer confidence in China intimately tied to the property market, this transition is unlikely to be smooth.
With the elevated uncertainty across a range of factors, our focus remains on owning businesses with structural growth tailwinds, those that are market share winners or where there is an element of self-help to drive profit growth.
Our confidence in the portfolio comes from owning strong businesses, run by smart management teams executing on their business plans to drive total shareholder returns.
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