Key Takeaways
- Pro-diversification does not mean anti-AI, says Schroders fund manager Sue Noffke.
- The UK market offers key opportunities to invest in both AI beneficiaries and non-correlated stocks.
- Continued interest from overseas investors shows the appeal of UK stocks at discounted valuations.
Karen Gilchrist: Following years of underperformance, British equities are showing increasing signs of revival. The FTSE 100 has hit new highs, overseas buyers continue to target UK-listed firms, and investors are increasingly looking beyond mega-cap tech stocks. But does this mark a sustained turnaround? To discuss the UK market outlook, diversification beyond AI, and where she sees the most compelling opportunities, I’m joined by Sue Noffke, manager of the Schroders Income Growth Fund SCF. Sue, thank you so much for joining us.
Now, one of the dominant themes so far this year has of course been AI, but also concerns about concentration risk. Now you have mentioned that to be pro-diversification does not mean to be anti-AI. So what does this mean for you in practice?
Pro-Diversification Is Not Anti-AI
Sue Noffke: I think for most investors, diversification covers a lot of the opportunity cost, as well as a bit of an insurance policy for not having all your eggs in one basket. And diversification hasn’t really carried a lot of performance weight; until most recently, concentration had been a winning strategy. When we look at history, and when we look from where we are today, diversification carries a lot of benefits for people’s portfolios.
What do I mean by diversification? Well, the best market returns have really accrued to those semiconductors at the pinnacle of the AI trade. But looking beyond that, and in your opening comments, market returns have actually broadened out beyond just semiconductors. And they broadened out to other areas, such as the UK, or other international equity markets that have a different mix of sectors and stocks. So if we think about banks and miners, if we think about consumer staples stocks, all of these are uncorrelated to the semiconductor AI trade. But they may benefit from other features of global growth, or the benefits of utilizing AI for productivity and cost benefits.
Karen Gilchrist: So certainly there are opportunities for investors who do want to maybe shift away from that really focused concentration. Can you go into a little bit more on some of those opportunities that you’re seeing in some of those mentioned sectors?
Sue Noffke: So if we take commodities, for instance, AI buildout of infrastructure is really commodity-heavy. It requires electrification, and electrification requires copper. In the UK equity market, we have some preeminent, world-class mining companies, where copper is a significant part of their portfolios and a significant part of their growth trajectory. So that’s one aspect. There are utility companies, as well, that are building out the infrastructure and being allowed in the regulatory returns to make an adequate return on the capital that they’re investing. So those would be a couple of examples.
If I think about financials companies, then many of them are harnessing the benefits of AI for productivity. And I think this is a multiyear trend that we’re going to see. So, companies are a bit shy on cost cuts, especially headcounts. But when we meet companies, we’re really pressing them to articulate and to quantify what those benefits would be. And in conversations I’ve had over the results season, the banks, the Big Oil companies have really been able to give examples of how much they’ll be able to save from their finance functions and their admin, for example.
Financial Services and Healthcare Among Top UK Stock Picks
Karen Gilchrist: So some interesting second-order beneficiaries there. You mentioned financial services, and I note that HSBC HSBA is the fund’s top holding. What gives you conviction in this particular firm, even looking beyond AI and some of the attributes that it holds there.
Sue Noffke: Well, it’s a global, well-diversified business, with preeminent positions in the faster-growing Far East. It also has significant market shares and growth opportunities in wealth. So across Asia we’re seeing more and more middle class and higher net worth individuals, who are looking to invest for their protection and for their growth in wealth going forward. And HSBC has a fantastic franchise, good name, has a very strong balance sheet to be able to deliver for both its clients and its shareholders.
Karen Gilchrist: We’ve certainly seen that paying off in the share price gains lately. I note that AstraZeneca AZN is another top holding and that remains one of the UK’s sort of most competitive companies. What gives you conviction in that healthcare trend, especially when we see the dominance of technology? What makes you think that this stands out too?
Sue Noffke: Investing in healthcare is all about the future, the drugs pipeline and the ability to deliver. What we’ve seen over multiple years with AstraZeneca is that it has been able to leverage its R&D platform to deliver a fantastic drugs pipeline. And the ability to convert that drugs pipeline into successful drugs has been among the best in the industry.
They have given investors quite a lot of pipeline opportunities, and it’s really up to the company and investors to evaluate the potential success of those. They’ve dangled a sales target of USD 80 billion by 2030, and they look on track to be able to deliver that. And, again, in a diversified franchise. So you’re not putting all your eggs on oncology; they’ve got a number of different franchises that they look to deliver on.
Karen Gilchrist: And while you mentioned opportunities to diversify away from AI, you of course have holdings in the likes of RELX RELX. Where do you think that the UK can position itself as potentially a leader with some of these AI companies as well?
Sue Noffke: The UK has got a number of business services groups that have fantastic data lakes and franchises that they’ve spent a lot of years and a lot of money investing in. So I would call out RELX and also London Stock Exchange Group LSEG as where they have regulatory parameters around that data, and the clients and customers really want to have security over what’s being delivered.
The AI that they have developed has been customer-specific. It’s allowed those efficiencies to be passed on to customers so that price rises are kept in check. You’re getting more for the same rather than paying through the nose. And I think that’s really exciting for the UK and for those companies.
Takeover Interest Highlights Discounted UK Opportunities
Karen Gilchrist: Now turning to another aspect of the UK market, we’ve seen continued interest from private equity, overseas buyers in some UK-listed companies. What does that tell you about how global investors see UK valuations?
Sue Noffke: I think it’s a really interesting question and a very important topic, because many of those buyers—be they corporates or private equity owners—are taking a longer-term view than many who are investing in the market on a day-to-day basis, and they’re looking through some of the political uncertainties. I know that many people will be fearful of a seventh prime minister in 10 years, but, fundamentally, what they’re buying is a revenue stream, some global franchises at a discount valuation to what they can find on markets internationally. And I think it really does underscore that opportunity being clouded by what people perceive as higher risk for attractive valuations. They’re paying premiums to the market price in order to gain those franchises, to invest in them and build them out.
Karen Gilchrist: And what more do you think investors would need to see for this to be a sustained rerating of European equities, rather than these periodic bursts? Is that something that you think could come potentially under a new government, or at least new prime minister?
Sue Noffke: I think it’s a really good question. About 60% of the market is owned by international investors. So they are very dominant. So I think being able to have less political headlines would definitely help. What I would look at is the valuation and the fundamentals on earnings. So we are seeing a robust earnings season in the UK and around the world. And it’s quite broadly based. So I think that gives you a good solid foundation. You’re getting that at a discount valuation. And I think you are getting something different by investing in the UK equity market compared to that AI trade, which has really captured people’s imagination but is quite well invested in people’s portfolios. So I think having a wider opportunity set and a wider mindset, backed by strong fundamentals, is what will carry things forward.
Karen Gilchrist: Sue Noffke, thank you so much for your time. For Morningstar, I’m Karen Gilchrist.
