Jeff Salway: UK economy's bad reputation means companies are undervalued

JUST days after Anthony Bolton's China Investment Trust opened for business, JP Morgan launched the first trust focusing solely on another of the leading emerging markets: Brazil.

Fidelity's China Special Situations trust opened to subscriptions last Friday and with Bolton at the helm – the UK's best known fund manager – it is expected to raise some 640 million with ease.

Now JP Morgan has unveiled the Brazil Investment Trust, the first London-listed trust offering exposure to domestic companies in the world's 10th largest economy.

The two launches are well-timed, with investors increasingly prepared to accept the volatility that comes with the long-term growth opportunities in emerging markets. Whether that growth is best accessed through funds investing in single countries is questionable though, as is the cost of investing in Bolton's new trust, with a 1.5 per cent annual management fee that is more expensive than most investment trusts.

The launches also come at a time when UK economic woes have convinced many investors to reduce their exposure to domestic equities in favour of overseas markets. That was overdue, with most investors underexposed to emerging markets in particular for too long.

But is there a danger that too much money is being moved away from UK funds and shares? Odd as it may seem, the UK has been downgraded as an investment opportunity to such an extent that favouring domestic equities now constitutes an almost contrarian stance.

David Cumming, manager of the Standard Life Investments (SLI) UK Equity Recovery fund, is well placed to comment on this, having returned 105 per cent – almost double the sector average – since the fund was launched a year ago. He believes the negativity surrounding the UK economy means many companies are significantly undervalued, giving investors a rare growth opportunity that is likely to be open for some time, barring an unexpectedly strong recovery in investor sentiment regarding the UK's recovery prospects.

Cumming, head of UK equities at SLI, predicts that monetary policy is likely to remain supportive for the time being, helping to stimulate housing market and retail activity, while a continued global recovery should improve credit conditions. So it's unsurprising that he thinks the FTSE has every chance of reaching the 6,000 mark this year as the market moves into a more conventional cycle and gathers momentum.

There will be more headwinds, he cautions, but he believes the UK economy is well positioned to move away from quantitative easing and reduce public spending without hurting the recovery.

His optimism extends to the banks, even though his fund is underweight in financials despite holdings in Barclays, Royal Bank of Scotland and Lloyds. Cumming describes the banks as currently representing "ok value" for investors, with bad debt levels improving quicker than many had anticipated. However, he acknowledges that the financial sector continues to face issues around funding, balance sheets and regulatory pressure on capital levels.

Recovery funds traditionally target sectors and companies that are unloved by the market but are expected to bounce back strongly. This helps explain why Cumming is interested in UK-centric stocks that have been hit especially hard and are consequently at low valuations.

Does Cumming's initial success in finding value in unloved UK companies offer encouragement for UK investors? While emerging markets may be perceived as the most attractive right now, it can be argued that the UK offers better value, given current prices. Many UK companies have been unfairly dragged down by a bearishness that might well, in the long run, prove to have been excessive.

Cumming remains in a minority with his relatively bullish views on the UK, given the warnings of a double-dip recession and the higher weightings towards non-UK holdings in many institutional and private investment portfolios. The average investor with sufficient time until retirement would be well served by increasing their exposure to emerging markets, which are volatile but have the biggest long-term growth prospects. That said, domestic companies remain the bread and butter for most investors and those recovery fund managers hunting the UK's most unloved stocks could be on to something.