Extreme valuation dispersions in UK stocks have made UK equity markets among the most attractive globally for stock pickers, according to William Lough, manager of the ES River and Mercantile UK Dynamic Equity fund.
Valuation dispersion is near record highs in the UK as investors focus on an ever-narrower list of names, and this is creating opportunities for investors who are bold enough to move away from the stocks that have been winning recently.
"The UK stockmarket is today among the most attractive globally from a stock picker's perspective, due to valuation dispersion levels being at historic highs," said Lough.
"As a stock picker, the thing that makes the UK really interesting for me is the gaps between share prices. The difference between cheap stocks and expensive stocks in every sector is so wide, and much wider than usual."
"Currently, investors love the stocks that have already delivered, and really hate the ones that haven't. This has become far more pronounced than in a more 'normal' market.
"The opportunity then, for savvy investors, is to exploit that disparity."
Lough said the more extreme the gap, the greater the opportunity there is for an investor to take a divergent view from the market that pays off in the long run. He said it is now approaching the most extreme levels on record.
"The market valuation dispersion is now in the top 5% of extreme levels, compared against all the years measured since 1998," he said.
"Many names are highly undervalued thanks to the current crisis and don't deserve such a low opinion from the market, and when that gap closes again - which it always has in previous instances - the payoff will be significant."
Lough believes much of the issue comes down to psychology. When people pick up stocks that perform well, it creates attachment to them and vice versa for those which underperform.
"People just fall in love with their stocks. In turbulent market times, this attachment becomes extreme and, as a result, investors fail to observe the value opportunities that emerge in other parts of the market. If you are willing to take a more active approach though, this can pay significant returns.
"Investors should be prepared to look at a broader set of opportunities and not fixate on a narrow cohort of companies with very similar characteristics."
"There are really high-quality companies out there that are cyclical. The fact they are cyclical allows them to compound value at a higher speed over the long term.
"It is incumbent on investors to use crises like the one we're in to take advantage of those cycles."
Lough's own fund's portfolio positioning is currently a 'barbell' between bigger positions in larger caps with more defensive earnings profiles, and smaller weights in strong companies within cyclical or deeply out-of-favour sectors which will participate in any economic recovery.
"I think volatility will be a key feature of the next few months until there is more concrete news around vaccine progress, as well as what follows on from the current rounds of monetary and fiscal support.
"At this stage, we expect localised or targeted lockdowns to be more likely than the whole economy 'induced coma' previously deployed. A balanced approach to risk makes sense in this context."