It is an interesting period for UK equity markets and for income investing in particular. We have spent the last few years telling anyone who would listen that the UK stock market is significantly undervalued – compared to history and to other markets.
Investors seem to have begun to listen, not only to us, of course. Over the last three years, the FTSE 100 has generated total returns of 45%. Last year, the FTSE 100 outperformed both the S&P 500 and Europe’s Stoxx 600, and on Jan. 2 it crossed 10,000 for the first time.1
Diving down a little deeper into last year’s returns shows that they were concentrated in large-cap global companies and in sectors such as mining, defence and financials. In fact, it was a deeply divided market, with investors rewarding companies with resilient cashflows and international revenue streams while mostly ignoring domestically exposed UK businesses, perhaps reflecting the mixed economic picture and lingering concern about the UK budget.
The FTSE 100’s 24% total return last year was nearly double that of the midcap FTSE 250 and the small cap indices.
Attractive valuations
As active investors our job is to seek out opportunities that others overlook and to find good companies whose prospects are mispriced. A bifurcated market creates opportunities. We see particularly good potential at the moment in those overlooked small and mid-cap domestic companies. The valuations in this part of the market are especially attractive, with the discount to large caps the most in around 20 years. In fact, it is these small and mid-cap companies that have been disproportionately impacted by nine consecutive years of outflows from the UK equities market.
We think the economic backdrop is broadly supportive for UK equities. First and foremost is the interest rate environment. The Bank of England is expected to continue to lower interest rates, possibly two cuts this year, as inflation is past peak and forecast to fall further. The US Federal Reserve also is expected to cut this year, which is an added tailwind for the global economy. Of course, markets must also contend with heightened levels of geopolitical risk and US policy risk.
Gilts and pound
UK economic growth is muted but stable, and gilt yields have fallen, with the worst of the budget concerns in the past for now. The pound is stable, which helps to keep UK assets appealing to overseas investors. The government has signalled a renewed focus on growth, housing and improved lending conditions, all of which we hope will help to underpin domestic demand. You can argue about the execution but the direction looks correct.
Two other factors that we look at are corporate activity such as mergers and acquisitions and asset sales, and also share buybacks. We have been seeing roughly a deal a week in the UK recently, and this reflects a recognition by private equity and trade buyers of good companies trading at low valuations. These deals tend to come with double-digit percentage price premiums. KKR’s acquisition of Spectris last year came at premium of nearly 100%.2
Share buybacks are a sign that companies have an excess of cash, well-covered dividends and a willingness to share cash with investors. Buybacks surged among large-cap UK companies over the last three years, and now are becoming more frequent in small and mid-cap companies – Hollywood Bowl and Gamma Communications are two recent examples. Some of these smaller companies are buying back undervalued shares having observed that this proved effective for large caps.
Health, construction
Turning to sectors, we see selective potential in healthcare, where tariff-related uncertainty has created valuation dislocations, and in construction-related stocks, where earnings recovery has been delayed rather than derailed, in our view.
In the case of housebuilders, activity has been muted and some companies are trading on low single-digit price-to-earnings valuation multiples despite having strong balance sheets and good dividend yields. The news flow is still negative but if that were to change, perhaps helped by lower mortgage costs for buyers on the back of rate cuts, there is considerable potential, in our view.
We think the UK is a natural fit for income investors, with its long history of dividend delivery and the market makeup of large, global companies in the resource, financial, consumer and health sectors. We would expect to see dividend growth in the market this year, and as income investors we see some of the most interesting potential opportunities in areas of the market that have been the most overlooked.
Strategy risks
Interest Rate Risk - The strategy can invest in assets whose value is sensitive to changes in interest rates (for example bonds) meaning that the value of these investments may fluctuate significantly with movement in interest rates, e.g. the value of a bond tends to decrease when interest rates rise.
Pricing Risk - Price movements in financial assets mean the value of assets can fall as well as rise, with this risk typically amplified in more volatile market conditions.
Market Concentration Risk (Geographical Region/Country) - Investing in a particular country or geographic region can cause the value of this investment to rise or fall more relative to investments whose focus is spread more globally in nature.
Derivative Risk - The strategy may use derivatives to reduce costs and/or the overall risk of the Fund (this is also known as Efficient Portfolio Management or “EPM”). Derivatives involve a level of risk, however, for EPM they should not increase the overall riskiness of the strategy.
Counterparty Default Risk - The risk of losses due to the default of a counterparty on a derivatives contract or a custodian that is safeguarding the strategy’s assets.
Smaller Companies - The strategy invests in smaller companies, which can be less liquid than investments in larger companies and can have fewer resources than larger companies to cope with unexpected adverse events. In less favourable market conditions these companies may therefore under-perform larger companies and the strategy may under-perform funds that invest predominantly in larger companies.
Footnotes
1Bloomberg as at 23.01.26. Please note that past performance is not an indication of future returns.
The value of active minds: independent thinking
A key feature of Jupiter’s investment approach is that we eschew the adoption of a house view, instead preferring to allow our specialist fund managers to formulate their own opinions on their asset class. As a result, it should be noted that any views expressed – including on matters relating to environmental, social and governance considerations – are those of the author(s), and may differ from views held by other Jupiter investment professionals.
Important information
This is a marketing communication. This document is intended for investment professionals and is not for the use or benefit of other persons, including retail investors. It is information only and is not investment advice. Company/Stock examples are for illustrative purposes only and are not a recommendation to buy or sell. The views expressed are those of the author(s) at the time of preparation, are not necessarily those of Jupiter as a whole and may be subject to change. Past performance does not predict future returns. The value of investments and income may go down as well as up and investors may not get back amounts originally invested. Exchange rate changes may cause the value of investments to fall as well as rise. Every effort is made to ensure the accuracy of any information provided but no assurances or warranties are given. This document may include ESG-related content which reflects Jupiter’s current policies and frameworks and may evolve over time. No part of this document may be reproduced in any manner without the prior permission of Jupiter. Issued in the UK and certain countries within the Middle East and Africa regions by Jupiter Asset Management Limited which is authorised and regulated by the Financial Conduct Authority. Registered address: The Zig Zag Building, 70 Victoria Street, London SW1E 6SQ.