Jamie Clark

The unique value opportunity in the FTSE 100

Jamie Clark

In my last blog I discussed liquidity and its bearing on our increased FTSE 100 weighting. Here, I develop the case for our UK large-cap allocation in addressing the current valuation opportunity.


The relationship between growth and value companies is one of finance’s most discussed topics. The last decade has seen returns from value companies trail the performance of their growth peers. This flows from the global financial crisis and the low interest rate policies adopted to stave off deflation. Short duration value companies, with their characteristic immediate returns, have been shunned in preference for long duration growth stocks, as low rates have fed discounted cash flow models and inflated the present value of tomorrow’s earnings growth.


Less obvious is what this means for the long-term relationship between growth and value. Below, we plot the spread, or difference in price-earnings (PE) multiples, between the most and least expensive US stocks. As is clear, ‘expensive’, a proxy for growth, is trading at a record valuation premium to ‘cheap’, or value. This chart is representative of a wider phenomenon that holds across geographies and financial metrics (cash flow-to-price, book-to-price etc).


US PE Spread 2951 to 2018

Source: (Kenneth French, Liontrust)

But this is curious. On any measure, the long-run data tell us that value outperforms growth over time. Below, we use UK data in evidence of this tendency:

 Average annual UK factor returns 1975 to 2018

Source: (Kenneth French, Liontrust)


We believe this divergence between growth’s recent outperformance and value’s superior historic returns is offering an unprecedented chance to buy value.


But where to find it? We think investors should concentrate on the UK in light of how cheap domestic equities are by international standards. In forward earnings terms, the FTSE 100 (12.75x) trades at a near five point discount to the S&P 500 and a 11 point discount to the Nasdaq Composite. Even the German DAX and French CAC indices, with all of Europe’s structural problems, trade at premiums.

Index forward PE multiples June 2019

Source: (Bloomberg, Liontrust)


Some may argue that the UK is cheap because of Brexit and will remain so. This is only partially true. Sterling’s performance since the referendum suggests that UK assets are as popular as flared trousers. In this time, the FTSE 100 has de-rated by 3.3 forward P/E multiple points against the S&P 500 and 6.2 versus the Nasdaq.


However, this is historic and needs balance. Brexit is finite, a strong jobs markets tells us the UK economy has coped and the data indicates that buying cheap works. In fact, it is this combination of factors which explains why, for the first time in a decade, our portfolio is now fully invested in UK equities.


Where, then, to find value in UK shares: big and boring, or small and racy? For us, big and boring wins.


This century to date, the FTSE 100 has underperformed the FTSE 250 mid-cap index by 319%; and the FTSE Small Cap index by 133%. This likely follows the FTSE 100’s bank weighting and the damage wrought in 2007-2009 and also hints at a size effect; the idea that smaller companies carry a higher risk premium and tend to outperform.


Examine post-Brexit returns and you’d be forgiven for thinking the FTSE 100  (+36.7%) has recently held its own against UK mid- (+31.5%) and small-caps (+37.1%). But any improvement is shallow by the standards of the last two decades.


It also says nothing of valuation. Judged by the yardstick of forward earnings multiples, the FTSE 100 is c.25% cheaper than pre-referendum levels. UK large-caps have de-rated by 1.7 forward P/E multiple points relative to the FTSE 250 and 5.3 against the FTSE Small-Cap Index.  

Foward PE multiples Brexit to June 2019

Source: (Bloomberg)


We believe the FTSE 100’s glaring discount may well be the catalyst for an episode of mean reversion that sees it outperform UK mid- and small-caps. This is a huge influence on our call to shift the portfolio up the market-cap scale, with 80% of the Macro Equity Income Fund’s assets now invested in FTSE 100 businesses.


But what type of UK large-caps offer the best value opportunities? The FTSE 100 is polarised. On the one hand, there is an array of businesses best termed quality growth; companies conspicuous for high, persistent, or growing returns and premium valuations to benchmark. On the other, there is a cohort of firms with value attributes; companies distinguished by more variable returns and trading at discounts.


Since the referendum, the FTSE’s quality growth constituency has re-rated relative to benchmark. To demonstrate, I’ve picked three example companies: consumer staples business Unilever, distiller Diageo and media business RELX. Below, I’ve plotted the progression of each business’ P/E premium to the FTSE 100. Each business is now materially more expensive in benchmark-relative terms.

Quality Growth PE premiums relative to FTSE 100 Brexit to June 2019

Source: (Bloomberg)


This likely reflects Brexit uncertainties and investor’s willingness to pay up for quality; certainly, there is a correspondence with Gilts. But such premiums are a precarious place to initiate investments and offer scant upside.


Instead, we see value in the FTSE’s miners, life insurers, banks and oil companies. Plotting their P/E’s relative to benchmark yields a mirror image of quality growth. To illustrate, I’ve chosen three portfolio companies: miner Rio Tinto, life insurer Legal & General and Lloyds bank.

Value PE discounts relative to FTSE 100 Brexit to June 2019

Source: (Bloomberg)


These businesses have grown earnings and dividends in this time and yet valuations haven’t budged. This is the epitome of today’s value opportunity: UK large-caps trading on discounts to benchmark and quality growth, but offering markedly progressive shareholder returns. We have endeavoured to position the portfolio to seize this opportunity.


A further and important expression of value is dividend yield. The income attractions of the FTSE 100 will be the subject of my next blog.

For a comprehensive list of common financial words and terms, see our glossary at: https://www.liontrust.co.uk/glossary

Key Risks 

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. Investment in Funds managed by the Macro Thematic team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The Fund’s expenses are charged to capital. This has the effect of increasing dividends while constraining capital appreciation. The performance of the Liontrust GF Macro Equity Income Fund may differ from the performance of the Liontrust Macro Equity Income Fund and is likely to be lower than its corresponding Master Fund due to additional fees and expenses.


The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.

Thursday, July 18, 2019, 6:19 PM