Revisiting ‘trade of the decade’
In his book on Oliver Cromwell over 100 years ago, the historian John Morley suggested, ‘Only time tells all.’ Time and history assist perspective. This is certainly the case when considering portfolio construction, in part because it encourages patience – a much-underestimated component of good portfolio management – at a time when there is too much short-term market ‘noise’ and resulting portfolio turnover.
In that vein, five years ago I suggested it can occasionally be useful to step back and consider portfolio composition if one could not deal for ten years. How would a portfolio be constructed on that basis? Could such an approach better encourage a focus on valuations and long-term thematic trends? Could it encourage greater questioning of the consensus, which might even lead to treasures closer to home?
With that in mind, I suggested the UK market was set to come out of the shadows en route to sunnier uplands – that it was set to perform better, certainly relative to expectations and the larger equity markets. It is fair to say the column ‘Trade of the decade?’ (14 May 2021) attracted scepticism. Given we’re halfway through the journey, it’s time to take stock and, importantly, consider the next five years – in expectation, the best is yet to come.
Progress so far
The scepticism at the time was understandable given the UK’s track record over recent decades and the noise about Brexit. Yet, while not outperforming the US, the market has performed better than many expected. The FTSE 100 has kept pace with the S&P 500 index over the last five years, while the FTSE All-Share has not been the laggard compared with some other markets. The last five years have seen various tailwinds gather force.
The UK now hosts Europe’s leading technology ecosystem and one of its largest life-science clusters. In fact, the country is world-leading in areas such as technology (outside AI), finance, life sciences, specialist engineering and research (including fusion energy). Indeed, over the last 10 years the UK’s economic performance has been comparable to France and Italy and has been better than Germany’s.
Meanwhile, other market tailwinds have been helpful. Regular readers of this column are aware of the portfolios’ early focus on ‘growth’ stocks when they were first introduced in 2009 – given the low-interest rate environment in the ‘Alice in Wonderland’ world of Quantitative Easing. That is, until five years ago. The column ‘Preparing for inflation’ (13 March 2021) marked the beginning of a portfolio shift into value stocks.
Up to that point, a major factor counting against the UK market had been its composition. The weighting towards financials, energy, pharmaceuticals, commodities, industrials and defence, and the absence of technology, weighed against it. It was seen primarily as an ‘old economy’ value index at a time when growth and technology were the rage. Most investors had turned their back for better opportunities elsewhere.
Yet, as highlighted in my May 2021 column, stagflation was on the horizon. The prospect of rising inflation remaining stickier and more volatile, together with pedestrian growth in most Western economies, was to usher in a renewed focus on value as an investment style given its track record over such periods. Well-run, cheaper companies that offer predictability and income are usually rewarded during such times.
And the UK market has found itself well placed for the gradual but discernible upswing, especially given the disparity in valuations between value and growth at the time. The market’s less-fashionable sectors were set to come into their own. Yet despite better performance since, the market remains attractively valued – perhaps even more so, relative to improving prospects.
The next five years
So, what of the next five years? I suggest value will continue to be rewarded. For reasons revisited in the column ‘Preparing for inflation (2)’ (18 July 2025), inflation is set to remain elevated and volatile – in contrast to what central banks have been saying. And unless governments start living within their means and debt and taxes are pared back, growth is set to remain subdued in most Western economies.
We remain wary of the larger US technology companies. We remain doubtful whether the huge and increasing AI spending boom will be justified. At the present rate, the companies concerned risk losing their positive cash flow characteristics, thereby raising their risk profile. It is noteworthy that those reporting more prudent spending are being rewarded by the market. The increase in company crossholdings also tells its own story.
As investors sense uncertainty, better risk-adjusted returns are available elsewhere. The UK market remains well positioned. Financials should continue to benefit from higher-than-expected interest rates, commodities from stubborn inflation, energy and defence from having the highest exposure to oil of all European markets and heightened geopolitical uncertainty, and industrials from servicing many niche and growing markets.
Meanwhile, the market is home to its own technology/data leaders. London Stock Exchange, RELX, Sage, Experian and others possess an almost unique ability to constantly replenish proprietary business data at scale. Despite market concerns, this is something AI will reward rather than penalise, given trusted high-quality data will be sought after in a world awash with second-rate information. Valuations are currently cheap relative to prospects.
And, as if to illustrate the point more generally, these valuations are attracting a huge crop of mostly foreign takeovers. Recent figures suggest the total value of bids so far this year is more than double the whole of last year’s. Many of the bids are opportunistic – the average bid price being well below the target’s five-year high. Again, this tells its own story. Retail investors will come to recognise just how attractive UK companies are.
Where is the catalyst? For the FTSE All-Share to make up ground over the next five years, smaller companies must take up the baton after a decade of underperformance. The reasons for this poor performance are various, including pension funds’ reduced UK allocations. There have been many sellers despite the fundamentals deserving better. The good news is smaller companies look well placed to take up the mantle.
Attractive valuations when bought are essential to good long-term returns. Recent figures suggest the FTSE 250 index relative to the FTSE 100 is near the bottom of its range over the last 20 years. And further research suggests UK small caps are very cheap – trading at the largest discount to their 10-year average forward P/E rating of any major market. Sentiment is unduly poor, and few are talking about them.
Yet historically they have produced superior returns – more than twice that of the FTSE All-Share over the last 70 years. In contrast to a lack of flair in many of our bigger companies, our entrepreneurial spirits are usually found in smaller companies – we were recognised as a ‘nation of shopkeepers’ by Napoleon. The column ‘Smaller companies are due their time in the sun’ (21 February 2025) suggests further reasons to be positive.
Portfolio positioning
While our portfolios are underweight equities in general relative to benchmarks, they tend to be overweight the UK. A focus on value and income prevails. Holdings include Fidelity Special Values (FSV), Temple Bar Investment Trust (TMPL), Merchants Trust (MRCH), Henderson High Income (HHI), and City of London (CTY).
And within the portfolios’ UK weightings, they are overweight smaller companies. In addition to FSV and TMPL’s healthy exposure, holdings include The Mercantile Trust (MRC), Montanaro UK Smaller Companies (MTU) and JPMorgan UK Small Cap Growth & Income (JUGI). This portfolio overweighting has not assisted performance in recent years, but it is hoped patience will once again be rewarded – and the omens are looking better.
I intend to revisit my prediction in five years’ time. However, one further thought. In these uncertain times, when it comes to the concept of ‘comparative advantage’ mentioned earlier, perhaps those factors listed towards the end will become even more important. Stability may come to be more highly valued by the markets. Another positive for the UK market? Time will tell.
Disclaimer: The information contained in this article does not constitute investment advice or a personal recommendation, and it is not an invitation or inducement to engage in investment activity. You should seek independent financial advice as to the suitability of any investment decision. Past performance is not a guide to future performance. The value of investment company shares, and the income from them, can fall as well as rise. You may not get back the full amount invested and, in some cases, nothing at all.
Return to News