We have four UK Equity strategies, each managed by separate investment teams and each following a different investment approach. UK Equity Income, UK Growth and UK Dynamic all experienced a tough year in performance terms to varying degrees while the more defensive UK Opportunities strategy comfortably outperformed its benchmark.

It was a particularly difficult year for our £3.0 billion UK Equity Income Fund (UKEI), which experienced substantial underperformance – in contrast to its excellent long-term track record – and net outflows of £427 million. As a value-oriented approach, the strategy faced a powerful headwind as investors sought out defensive and low volatility shares, seemingly regardless of their high stock market ratings, over cheaper ‘value’ stocks. The significant rally in these ‘expensive defensive’ names and multi-year underperformance of ‘value’ stocks has led to a major valuation differential between the two style camps. As the UKEI managers highlight, this bubble has now become so inflated that it has surpassed the TMT bubble of 1999-2000 in scale. September hinted at a possible shift in market leadership, however, as the market rotated dramatically towards ‘value’ names, which gave the UKEI strategy a welcome relative performance boost as the year concluded. Domestic-facing stocks, such as media company ITV, property company Hammerson and car dealership chain Lookers, laboured as Brexit uncertainty meant investors widely shunned UK companies reliant on UK-sourced earnings.

Positive flow momentum continued with our £2.2 billion UK Dynamic strategy, which has enjoyed major asset growth in recent years – net flows into the strategy in the 2019 Financial Year were approximately £500 million. Performance was more challenging, however, as this ‘value’-biased fund was also subject to pronounced style headwinds, with the fund, which focuses on companies undergoing strategic transformation, underperforming its benchmark. Stock selection was attributable for roughly two-thirds of the underperformance while sector exposure, mainly being underweight healthcare, accounted for the residual underperformance. In terms of stock selection, the fund suffered from not owning bond-like, high momentum stocks such as AstraZeneca and Diageo, while progress at the likes of holdings 3i Group and Moneysupermarket.com was overshadowed by weakness elsewhere in the portfolio, including The Restaurant Group, which sold off in reaction to a long-term value-enhancing M&A deal, and Hunting.

In contrast, our UK Opportunities fund materially outperformed the benchmark. The fund benefited from its focus on low risk cash generative business models and from the team’s aversion to indebted balance sheets. Stocks such as Tesco, Sage and Barrick Gold all contributed to performance. After two years of fund outflows following the retirement of the lead fund manager, we are now seeing a recovery in interest in this product. The fund remains defensively positioned given the investment team’s belief that absolute valuations are at unsustainably high levels. They avoid companies taking on excessive debt or facing structural or political risk and favour companies with strong balance sheets and recurring and stable cash flows generated from multiple products or geographies.

Finally, our smallest UK fund, UK Growth, experienced a tough year characterised by significant underperformance and investor outflows. The UK Growth strategy aims to identify mispriced or undiscovered growth stocks, focusing on stocks that have a high margin of safety but significant upside potential. It was hurt by a combination of stock-specific issues and its large weighting within UK small caps, an asset class that has faced substantial headwinds in recent years. It was also affected by what the fund managers believe to have been unjustified price action in fundamentally sound companies. To that end, the managers view this underperformance as largely cyclical rather than structural in nature and remain confident that the latent potential in the portfolio will be fulfilled in time.