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UK equity market concept

Equity Markets continued to grind higher throughout 2017. The FTSE 100 Index in particular really put on a late show during December as it closed at a record high, returning more than 5% over the month compared to about 1% and 0.5% from US and European benchmarks.

The FTSE 100 has benefitted more than most other indices in the recent environment. A world of synchronised growth reflected in strong ecomic data, such the Purchasing Managers Indices, is feeding demand.  Oil is trading at a 3-year peak ramped up by demand and, aided by weather conditions, reducing inventories.  Closer to home the deterioration in value of the pound over the past couple of years is benefiting exporters and giving a boost to non-domestic earnings in the Index.

Table 1 below summarises the constituents of the FTSE 100 by sector. Using the average return of each sector weighted by sector size gives an approximate contribution to the return of the Index. 

The sectors delivering best returns through December tended to be the largest sectors in the Index which in turn drove performance of the overall market.

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Of the FTSE’s 5% return in December, almost 2% of it came from the commodity related sectors.

Whilst we have some exposure to the index by way of a tracker fund in our cautious and balanced portfolios and (indirectly) through our range of defined return products, we have preferred exposure further down the market capitalisation scale.  Smaller companies in our view have the greater long term potential for strong earnings growth and with good fund selection alpha capture. 

The makeup of the small cap universe is very different to that of the FTSE 100, gone are the multinational banks, mining and oil giants of the main index, replaced with smaller services companies and domestic focused real estate and construction names.

Whilst still relatively well correlated the differences between small cap and large cap indices does lead to periods of disparity in terms of performance. 

Table 2 below is equivalent to table 1 but focuses on constituents of the FTSE Small Cap (ex IT) Index. 

The highest returning sector returned somewhat less than the highest returning large cap sector (Basic Resources) and unlike the FTSE 100 Index, the sectors with best return made up a lower proportion of the Index.  This resulted in a positive if less than spectacular performance of 2.8% compared with 5.0% in the FTSE 100 during December.

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Further to our preference towards small cap stocks is our use of active funds where we pay managers to invest away from the index weightings with the aim of capturing alpha or excess gains. 

The UK equity element of our portfolios is made up of 6 active funds and a passive FTSE All Share Index tracker fund.  The sector breakdown of this sub-portfolio is shown in table 3 below.

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Our preference towards smaller cap stocks and the positioning of our UK equity holdings led to an underperformance compared to the FTSE All Share Index in December.  However, when we look back over the whole of 2017, our positioning has been well rewarded in comparison. Our UK equity portfolio returned close to 16% compared to 13% from FTSE All Share.  We continue to hold our focus further down the cap scale where we see more favourable valuations and potential for long term outperformance.

As global equity markets continue their run into 2018 we remain cautious.  The recent rally could be the last push in what has been coined the most hated equity bull market of all time as many investors have reluctantly continued buying into markets at increasing valuations.

Past performance is never a guide to future performance.  The content contained in this blog represents the opinions of Equilibrium investment management team. The commentary in this blog in no way constitutes a solicitation of investment advice. It should not be relied upon in making investment decisions and is intended solely for the entertainment of the reader.