LONDON A booming population, fuelled by immigration, will help Britain's economy to grow more strongly than Germany's later this decade and could drive its stock market much higher, according to one of the UK's biggest equity hedge funds.
Toscafund, with $1.3 billion of funds open to investment, made its bullish predictions amid signs the UK economy is starting to recover from five years of torpor brought on by the financial crisis, while the euro zone is mired in recession.
"No-one ever gets how good it's going to be until it (the stock market) moves," founder Martin Hughes told Reuters.
Hughes, ranked 7th in this year's Sunday Times Hedge Fund Rich List with a 375-million-pound fortune, cited Britain's rising population as a driving force for growth.
As a result, he warned the economy could be harmed if Britain voted to leave the European Union and restricted immigration. Prime Minister David Cameron has pledged to hold a referendum on EU membership by 2017, if re-elected.
"If we do leave, the lights will stay on, but we mustn't use it as an excuse to raise the drawbridge. Inflation and interest rates to a certain extent are low because of immigration," said Toscafund chief economist Savvas Savouri.
Toscafund's optimism is also based on Britain's "strong" labour market, while "property is robust and car manufacturing is healthy", added Savouri.
"Looking at all three metrics, not many other places in the world have that. Debt servicing is not a concern because most household debt is secured on property whose value is trending higher."
Savouri, who was correct in his prediction last May that Greece would not exit the euro zone, said Britain's "dynamic, open" economy would enjoy GDP growth above Germany's in the coming years, rising close to 4 percent by 2020.
He is working on the basis that Britain's population will exceed Germany's within a generation, even though it is currently 20 million lower. Britain's fertility rate in 2010 was the highest since the early 1970s, according to official data.
"Where there's population growth, there's GDP growth," Hughes said, adding he favoured domestically-focused stocks such as housebuilders, as well as commercial property.
Toscafund owns more than 14 percent of housebuilder Redrow (RDW.L), nearly 27 percent of Daisy Group DAY.L, a provider of telecoms to small and mid-sized businesses, and 8.5 percent of online dating firm Cupid CUP.L, according to regulatory data.
STOCK MARKET STRENGTH
With a bullish view on Britain's economic prospects, Toscafund predicts its stock market, already at around 5-1/2 year highs, could rise much further.
Hughes pointed to the UK equity market's earnings yield - earnings per share divided by market price - which is above that of many bonds. German 10-year yields are 1.38 percent, for instance.
"The UK stock market's p/e (price to earnings ratio) of 11 is generally good value. If it's got a 5 percent earnings yield, why can't it be a 20 times p/e? The UK offers emerging market growth dynamics at valuations of a declining developed economy."
The UK FTSE Mid 250 midcap index .FTMC has rallied around 40 percent since June, as central banks have tried to prop up Europe's stuttering economies. According to Reuters data its p/e ratio is 9.7 times, meaning that a p/e of 20 times would see the index at roughly double current levels.
"Mid-cap UK corporate valuations are exactly the same as for European equities but Europe is shrinking and the UK is growing. The UK stock market is on a 35 percent discount to the U.S." said Hughes.
He is also taking advantage of an "unbelievable opportunity" to buy UK industrial, mixed use and shopping centre properties particularly outside London, from capital-hungry banks who are selling them off at a discount.
Such sales, driven by banks trying to meet regulatory capital targets, are triggered by a property's loan-to-value ratio rather than income earned on the property, said Hughes.
"Banks are repossessing it on the basis of loan-to-values, due to capital regulations, so you can pick up an income earning asset in double digits."
Savouri added that real estate investment trusts (REITs) may be better value than first appears because net asset values may be too low. "With REITs I am convinced surveyed asset values are conservative, and so premiums to NAV over(stated) and discounts understated."
(Additional reporting by Tommy Wilkes; Editing by Mark Potter)