UK equities: A low-bar opportunity hiding in plain sight

Source: Trustnet

With political noise around the UK Budget growing louder, many investors have become increasingly wary of allocating to UK equity funds. Outflows have picked up in recent months, driven in part by concerns that further tax increases, such as the capital gains adjustments seen in the previous Budget, have motivated investors to crystallise gains and reduce existing positions.

The fear is that higher taxes will squeeze household spending, soften growth and push inflation lower due to this demand destruction. These worries are amplified by the lingering scars of the 2022 fiscal misstep under the Liz Truss government and momentum-chasing flows favouring overseas markets.

But this narrative risks missing the other side of the coin. Expectations are so low that even modest improvements in the macroeconomic backdrop, or simply a clearer monetary policy path, could generate a disproportionate upside.

For investors willing to look beyond the headlines, the Budget may be less of a threat and more of a potential clearing event.

Valuations underscore the opportunity

The UK remains one of the cheapest major equity markets in the developed world, on relative historical measures.

Persistent outflows and years of global under-allocation have pushed valuations to levels that embed a significant degree of pessimism. This gloom is well known, but what is less discussed is how modest shifts in the outlook could be enough to turn sentiment.

Tax adjustments or fiscal tightening in the Budget may curb consumption but for equity investors the more important factor is what happens to the rate outlook.

If the Budget reinforces credibility in the UK’s fiscal trajectory, it could give the Bank of England the confidence to set a clearer path towards rate cuts, something the market has been waiting for. It has already raised the likelihood of a Bank of England rate cut in December if disinflation accelerates.

Lower yields could unlock key equity segments

Lower yields are not simply a macro talking point; they matter deeply for several sectors. Banks, property companies and domestically focused mid- and small-caps are all highly sensitive to rate movements.

A downward shift in yields would ease funding costs, revive credit conditions and improve discount rates, a powerful combination for areas of the market that have been overlooked.

This is also fertile ground for mergers and acquisitions (M&A). While a de-equitisation of the UK Index is a friction, it can be supportive of price discovery. International buyers continue to see value in UK assets and a more stable rate backdrop could provide the conditions for more consistent dealmaking, bringing further support to valuations.

Not without risks. But the asymmetry is attractive

There are legitimate concerns. While this is not the market’s base case, overly aggressive fiscal tightening could leave the UK flirting with a stagflationary mix of weak growth and stubborn inflation.

Even so, expectations for the UK market are already muted and sentiment remains fragile. That creates an environment where risks persist but the bar for positive surprises is very low.

If the Budget helps unlock a clearer monetary policy trajectory, UK equities could emerge as one of the more compelling asymmetric opportunities in developed markets: limited downside from already-subdued expectations and meaningful upside if rates begin to move in the right direction.

For those prepared to look beyond the consensus, now may be the time to revisit UK equity funds. Active, selective positioning will be essential in navigating the evolving policy landscape.

The funds best placed, in our view, to capture opportunities in an evolving UK landscape, include Invesco UK Opportunities, Rathbone UK Opportunities, AXA Framlington UK Mid Cap, RGI UK Listed Smaller Companies and TM Oberon UK Smaller Companies.

Sheridan Admans is founder and chief executive of Infundly. The views expressed above should not be taken as investment advice.