Neil Collins’ Notebook – Time to buy

Here’s a tip for 2021: UK shares. Compared to other leading stock markets, they are dramatically cheap, even after this week’s relief rally at finally getting Brexit done. It is nonsense to argue that markets dislike uncertainty, since as one is resolved, share traders will immediately focus on the next one. Markets are forever in a state of uncertainty.

Uncertainty has much more impact inside businesses. For the last five years, turmoil over Europe has provided companies with the excuse to put off big investment decisions, even before the tsunami of Covid-19 swamped balance sheets weakened by unsustainable dividend payments and too much debt. With the exit deal and the arrival of vaccines, both these over-arching uncertainties have been removed.

The prime minister’s constant references to our “friends” in Europe this week reflects the desire for grown-up relations with the European Union. It might even lessen the constant niggling arguments and frustrations that characterised UK membership. The EU itself has far bigger problems than dealing with Britain, and these will now come into sharper focus.

UK companies, meanwhile, have had the advantage of London’s deep and flexible capital markets through the pandemic, allowing them to fix balance sheets, cut dividends to levels which can be at least maintained and to think seriously about life beyond the short term. The contrasting responses to the crisis facing airlines, of more private capital in the UK against more state aid in Europe, are a demonstration of why London will remain the region’s pre-eminent capital market.

All of which should cause the investors, both domestic and international, who have been switching away from the UK to look again. The first thing to note is that the FTSE100 index is about as helpful a barometer here as is the Dow Jones in the US. Professionals there use the S&P500 as the market benchmark. Here, the FTSE100 has been bent out of shape by the weight of four international banks and two of the world’s leading oil companies at the top of the index. The problems specific to those industries have been drag-anchors on the main measure of the market. The mechanical way the rules for selection into the index work has meant the exclusion of the year’s most intriguing new issue, The Hut Group, despite its £7.4bn market value.

The rules have also produced the bizarre spectacle of a US hedge fund getting into the index at the expense of a domestic boiler servicer (which had only just been promoted). Bill Ackman, the man behind the hedge fund, shamelessly targeted entry into the FTSE100 for this very odd investment trust, Pershing Square, because tracker funds would be forced to buy the shares. These so-called “passive” funds have seen inflows of around $3tn worldwide in the last decade, money withdrawn from actively-managed share portfolios. As the analysts at Logica point out, “These are not passive investors – they are mindless systematic active investors with zero interest in the fundamentals of the securities they purchase.”

Buying trackers is a similarly mindless process, and combined with low fees, the money has poured in. This tide has some way to run yet, but when the trackers become so big that they are price makers, rather than price takers in the markets, it could turn quickly. There is much wrong with the business of managing other people’s money, but the platforms like Hargreaves Lansdown and AJ Bell offer investors the chance to connect with the underlying companies that trackers do not. Active fund management fees are coming down, and the opportunities to hide poor performance are getting fewer.

As the euphoria of getting Brexit done wears off, the scale of the post-Covid rebuilding needed will dominate the start of 2021, along with the realisation of just how much of the money spent by the UK government has been wasted. Recovery will take at least this year even without fresh scares. Buyers of shares today will need to exercise that most under-rated quality needed for successful investment – patience.

A (cough cough) share tip

Some stock market anomalies are impossible to explain by logic. Shares in British American Tobacco (which I hold) yield 7.5 per cent at £27, reflecting investors’ distaste for an industry which kills its customers, and the belief that if the law suits don’t do for it, those customers will one day wake up and stop smoking. It is treated as a dying business. This is perfectly logical.

Tobacco companies have been big borrowers in the bond markets, with $130bn of paper outstanding. BAT is typical. Because of its strong cash flow, it can borrow for 30 years at less than 4 per cent. This, too, is perfectly logical, except that it is the opposite of the equity market’s logic. Either it’s an industry with only a decade or so left (the share prices) or it’s a fine, long-term credit risk (the bond markets). It can hardly be both.

Analysts at the suitably-named Ash Park have tried to pick the bones out of this. They conclude that continuing to pay high dividends to ungrateful shareholders is a waste of money, but so is paying down that cheap debt. They conclude: “At today’s prices, by diverting all their free cash flow to share repurchases, three of our tobacco holdings could buy back all their shares and take themselves private – without increasing debt levels – in eight to nine years.”

This is the logic that propelled the Barbarians at the Gate takeover of RJR Nabisco. Those Barbarians from KKR saw that tobacco was viewed as a dying industry, and made wealth beyond the dreams of avarice when they proved it wasn’t. That was 32 Happy New Years ago.