Are UK stocks back in from the cold?
After 25 years, are UK stocks back in from the cold?
Given the UK’s FTSE 100 was one of the best-performing stock market indices in 20221 – a particularly tough year for stocks – you would’ve thought it would curry more favour among investors. Apparently not.
According to funds network Calastone, while company shares were broadly shunned by UK fund investors throughout a dismal 2022, with £6.29bn in outflows averaged across all equity (share) sectors, the intensity of selling at UK-focused funds was individually worse, seeing £8.38bn in outflows – a dreary record. It’s not a picture that’s improved this year either: the selling has continued every month in 2023.
This seems perplexing. So, why has the UK stock market become so unpopular with British investors?
A chilly climate
For more than a few years, the UK has been left standing out in the cold by investors. A host of factors are responsible. Most recently, the idiosyncrasies of Brexit, the pandemic, and Tory political turmoil have made UK shares non-grata, as the economy and government finances have gradually deteriorated.
If we broaden our scope and look at markets since the global financial crisis, we see investors have tended to prefer the ‘new economy’ technology and growth companies of the US stock market, and shun the ‘old economy’ banks, miners, energy, financials and tobacco stocks that broadly adorn the FTSE.
And yet, expand our time horizons again, and we find another powerful force looming over UK markets. Since the late 1990s, successive changes to regulation, tax and accounting standards here, have led to a significant shift in risk appetite across UK pension funds and insurers, now managing a whopping £4.6 trillion in assets.2 Not only have they wound down the portion of shares in their portfolios and significantly increased holdings in bonds (fixed income) to better match their long-term liabilities, but they’ve also sought a more exotic variety of overseas equities in their remaining allocation, kicking UK equities to the kerb.2
We can see the dramatic shift in allocation below:
How the UK market has been affected
The impact has been to pressure UK markets through the continued selling of UK stocks, which weighs on prices; at the end of the day, they are simply a result of the interplay between buyers and sellers in the market. As a result, the UK stock market has seen a long period of lacklustre returns in comparison to other markets, for example, the US. As we look back over 25 years – which includes the disastrous dotcom crash – the US stock market has grown by nearly three times in value; the FTSE 100, on the other hand, is just 31% higher.3
It means – and back to our conundrum of why UK shares are not more popular following a stellar 2022 – investors seem to be simply cashing out following a dire few decades in the UK’s stock market.
And yet, as the world economy changes gear for the first time in a while, there are reasons to believe that a sea change could be underway for UK stocks, and that, finally, the FTSE might be the stock market to tip.
Changing fortunes
There are a number of reasons to believe why investors may warm to UK stocks.
First, the ‘old economy’ cash-generative financials, miners, and energy stocks have become significantly more attractive in a world of higher inflation and rising interest rates. It’s why UK markets performed so well in 2022. These may continue to do well if elevated inflation and higher interest rates are here to stay, which is possible if trading across the global economy fragments amid higher geopolitical tensions, and governments start increasing spending, in areas such as green infrastructure and defence.
Second, the UK stock market continues to look cheap when compared to its own history4 and other markets such as the US.5 While some may believe this is justified, investing when markets are cheap usually yields much better results over the long term, than when they appear overpriced. Warren Buffett is one of the most famous proponents of this value-based approach.
Third, if things become more dire in the economy, for example, if higher inflation and interest rates continue to ratchet up the pain on UK consumers and businesses, then the low valuations of UK shares may act as a buffer against overly severe falls.
Fourth and finally, the UK market is a bone fide strong dividend payer. In a world where higher inflation persists, dividends serve as a great source of income, as companies, to varying degrees, have the ability to raise prices, which should translate into higher profits and dividend rises that at least have a fighting chance of keeping up with inflation.
Alliance Trust in the UK
Alliance Trust doesn’t take aggressive country positions; however, the Company’s Stock Pickers are nevertheless finding great companies in the UK that have attractive valuations and business characteristics and fundamentals. As a result of the opportunities the Stock Pickers are finding, the UK percentage of the portfolio has grown to almost 10%, which compares to its benchmark’s weighting – the MSCI All Country World Index – of 3.8%.6
A good example of a UK investment might be the recent inclusion of Diageo in the portfolio, by Stock Picker Veritas. It has an industry-leading portfolio of drinks brands, and in many countries, dedicated routes to market. It also develops and influences the evolution of various luxury spirits, for example, super-premium scotch and tequila, and is growing brands of the future, including no- and lower-alcohol choices, by acquiring them, developing their own brands, or investing in entrepreneurs through its business accelerator programme.
Another good example is Alliance Trust’s investment in Ashtead, by Stock Picker Metropolis. It is a UK-listed rental company for equipment such as forklifts, earthmoving equipment, pumps, power generators, and scaffolding. Its business model is straightforward: to buy equipment at scale to access discounts, to rent it out for about seven years, and then divest at 35-40% of the original price, booking around a 20% return. It then invests this cash in opening new branches across its markets in the UK, US, and Canada. As a result, it is the market leader in the US alongside competitor United Rental.
Marcus de Silva, Freelance Investment Writer
1. https://www.telegraph.co.uk/business/2022/12/30/london-beats-rivals-worlds-best-performing-major-stock-market/
2. https://capitalmarketsindustrytaskforce.com/wp-content/uploads/2023/03/2023.03-Unlocking-the-capital-in-capital-markets-New-Financial.pdf
3. https://www.google.com/finance/quote/.INX:INDEXSP?comparison=INDEXFTSE%3AUKX&window=MAX
4. https://simplywall.st/markets/gb
5. https://simplywall.st/markets/us
6. as of 31st of March 2023
This information is for informational purposes only and should not be considered investment advice. Past performance is not a reliable indicator of future returns. The views expressed are the opinion of the Manager and are not intended as a forecast, a guarantee of future results, investment recommendations or an offer to buy or sell any securities. The views expressed were current as at May 2023 and are subject to change. Past performance is not indicative of future results. A company’s fundamentals or earnings growth is no guarantee that its share price will increase. You should not assume that any investment is or will be profitable. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
TWIM is the authorised Alternative Investment Fund Manager of Alliance Trust PLC. TWIM is authorised and regulated by the Financial Conduct Authority. Alliance Trust PLC is listed on the London Stock Exchange and is registered in Scotland No SC1731. Registered office: River Court, 5 West Victoria Dock Road, Dundee DD1 3JT. Alliance Trust PLC is not authorised and regulated by the Financial Conduct Authority and gives no financial or investment advice.