Market highs are usually characterised by strong demand for equities, particularly from retail investors eager to participate in rising prices. However, the recent rally, with the FTSE 100 and FTSE All Share indices both reaching record highs in March, has not been accompanied by increased equity demand.
The rise in the UK market is largely a result of currency weakness following the UK referendum; since 23 June last year the FTSE All Share is up 19 per cent on a total return basis in sterling terms, but is flat in US dollar terms. The prospects for UK companies, especially domestically focused businesses, are increasingly uncertain. Against this backdrop it is no wonder that retail demand for funds investing in equities, particularly those exposed to the UK, is weak.
Within the investment trust sector, negative sentiment towards an asset class or sub-sector is reflected in widening discounts. While the average discount for the sector overall has tightened over the last year and even since Brexit, many equity sub-sectors have seen their discounts widen.
Popular areas for retail investors such as UK Equity Income (5 per cent discount versus 3 per cent on 23 June prior to the announcement of the referendum result), UK All Companies (10 per cent versus 8 per cent) and UK Smaller Companies (14 per cent versus 10 per cent) now offer value, in our opinion, to contrarian investors.
As can be seen in the chart, these three sub-sectors were de-rated considerably in the immediate aftermath of the UK referendum and discounts have failed to tighten materially since then, despite a strong rally and all-time highs in the UK equity market.
This weak demand can also be seen in the Investment Association’s net retail sales data for open-ended funds. UK retail investors have withdrawn a net amount of £6.5bn from open-ended equity funds since the beginning of June last year (until the end of February), with UK All Companies experiencing the largest sector net outflows (-£3.5bn) and the UK suffering the most significant regional equity net outflows (-£4.4bn). This compares with net inflows of £4.3bn into fixed income funds over the same period and net inflows of £3bn into targeted absolute return funds, the most popular sector over this period.
However, this is not simply a UK story. Investor demand for mainstream equity strategies appears to be waning, with open-ended equity funds investing in Asia, Europe, Japan and North America, as well as the UK, experiencing net retail outflows in the 12 months to the end of February. Only Global equity funds saw net inflows over the year.
Within the closed-ended sector the direction of travel also appears to be negative, although there are exceptions, such as Finsbury Growth & Income*, a UK equity income fund that has raised £17m. Declining demand is reflected in aggregate buybacks across the investment trust sector of £1.3bn in the first quarter of the year, up from £542m in the first quarter of 2016, although this year’s figure is inflated by Alliance Trust’s buyback of Elliott Associates’ stake (£663m).
In contrast, issuance of £2bn in Q1 2017 has been dominated by infrastructure (31 per cent), property (20 per cent) and debt (10 per cent) and all four of the IPOs so far this year have been in the property or debt sectors, invariably offering a good yield. At the start of 2017, 25 per cent of the investment trust sector was invested in non-equity/alternative assets compared with 12 per cent 10 years earlier. Notwithstanding market moves this year, this weighting seems likely to continue to increase.
Emma Bird, research analyst at Winterflood Securities