Is now the time to return to UK domestic stocks?

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Brighter prospects for a UK recovery is seeing some UK equity managers rebalance portfolios to include more domestic names, but others argue that opportunities have already moved elsewhere.

Indications of improvements in the UK economy appear to be building, with the International Monetary Fund  last week upgrading its 2013 forecast for the UK to 0.9 per cent GDP growth compared with 0.7 per cent in previous estimates.

UK equity managers have also been looking to early indicators that the  recovery may be gaining momentum, prompting some to rebalance portfolios between UK domestic-facing equities and those with international exposure.

Artemis’ Tim Steer has been biased towards international names for some time but has recently tweaked his portfolio to include more UK-centric stocks.

“About a year and a half ago, the fund was basically full of UK equities but with lots of overseas exposure,” he says.

“Now it is much more balanced. I wouldn’t say I have changed the focus to the UK but there is much more emphasis on UK-centric stocks than there was in the past.”

The £536m Artemis UK Growth fund currently holds domestic facing UK stocks including ITV, easyJet, Howden Joinery, William Hill and the Daily Mail all as part of its top 10 holdings.

Steer attributes improvements in the wider economy as one reason why UK-focused stocks appear attractive, with expectations indicating that UK household income can grow by approximately 3 to 4 per cent in 2014 and 2015.

The increased consumer spending likely to be triggered by these improvements in household income could “directly benefit” companies such as easyJet and Sports Direct, says Steer.

Old Mutual Global Investors UK small cap manager Daniel Nickols has also been selling down some of his largest international holdings, including Oxford Instruments and Renishaw, while buying into a number of UK domestic names.

However while greater conviction in the UK recovery has played some part in this recent the manager of the £679.4m Old Mutual UK Smaller Companies fund says that other factors such as stock selection, remain crucial.

He says: “I wouldn’t want to overstate it but there is some evidence that the general UK economy is performing a little better. Almost on a daily basis now we are seeing upward tweaks on the trajectory of growth from economists and investment banks. But we are still talking about sub-trend growth.

“Indiscriminate buying of UK names probably won’t tide you over, you still have to be very selective when looking at stocks. I think the way forward is being a bit more positive on the UK economy on the one hand and finding self-help angles to give an extra dimension.”

Nickols has been adding to his position with Thomas Cook as an example of a self-help story, with the expectation that the stock can re-rate following progress made by the management to rehabilitate Thomas Cook brand.

He also adds that is has “been easier to sell” international names in favour of UK domestic stocks, following concerns that capital goods stocks in particular could be looking expensive in terms of valuations.

Standard Life Investments UK equity manager Ed Legget has held a range of domestic names for some time including a range of housebuilders, Howden Joinery and Lloyds.

However the manager of the £635.6m SLI UK Equity Unconstrained fund argues alternatively that the opportunity in these stocks may already have passed and is currently looking elsewhere to UK stocks with emerging market, European and commodities exposure.

He says: “In my view the stockmarket is generally pretty optimistic on UK consumer and a lot of this optimism has been priced into share prices already.

“The opportunity in UK consumer stocks was 18 months ago when everyone was desperate to get overseas earnings.Not to say that share prices can’t go higher but there might be some disappointment if things don’t get better as fast as the share prices suggest.”

Legget does highlight certain UK domestic stocks which he believes still have further to go including pub company Enterprise, car dealer Pendragon and Wincanton logisitics.

The two stocks bought most for the fund over the last three months are international miner Rio Tinto and emerging market bank Standard Chartered, according to Legget.

He argues that the exposure of these stocks to emerging markets and commodities present the current unloved and mispricing opportunities. He says: “Sentiment is heavily against these stocks.

“However this maybe gives you the opportunity that UK domestics had two years ago to buy good companies with strong balance sheets on very low multiples, when everyone is bearish about them.”