When Nick Train recently said that the UK was a “remote corner” of world markets, he was merely expressing a long-held belief among investors.
The well-known fund manager, who has previously argued that UK corporate stocks offer untapped value, reflected on how out of fashion they have become.
In November 2021, hedge fund boss Paul Marshall expressed similar thoughts, saying the UK had become the markets’ “Jurassic Park.”
And even after a strong start to 2023, after a year in which the FTSE outperformed most other markets, UK equities remain unloved. In February, UK investors pulled £926 million from UK funds, the third largest ever outflow.
Has the UK become irrelevant as a perpetually undervalued and unloved market? Or could an era of higher inflation and interest rates mean a fresh start for the UK?
The UK market has been described as the ‘backwater’ of global equities after years of underperformance
Why is the UK market so unloved?
In a recent update to Finsbury Growth & Income investors, Train said the UK had moved into the “back water” of global equity markets after a long period of “dismal capital performance”.
Meanwhile, UK pension funds have come under fire for reducing their exposure to UK equities in recent years – a recent ONS survey shows that UK pension funds held 2% of the UK market, up from 32% in 1992.
And despite being a largely UK-focused fund manager, Train defended the funds for reducing their exposure to London-listed stocks.
he said: “Perhaps they have reacted rationally to the lack of value-creating companies listed on the London stock market and have been wise to focus instead on more promising global stocks, or even Index-Linkers.”
The gloomy outlook may come as a surprise to UK investors as the FTSE 100 in particular has continued its strong performance from 2022 onwards.
This decent performance since early 2021 is largely due to the composition of the blue-chip index, which is heavily weighted towards large-cap energy and commodities stocks.
In the longer term, the picture is not so pretty. Morningstar Direct data shows that the FTSE 100 and FTSE 250 have underperformed the S&P 500 over five and 10 years, and also lag their European counterparts.
So why has the UK market managed to go wrong?
James Penny, chief investment officer at TAM Asset Management says: “There is now so much investor interest in a global mindset that it is hard to maintain that such a large portion of a client’s investment exposure is in the UK. ‘
Part of it can be attributed to Brexit, which has created growth barriers, as well as increased pressure on the pound and the more domestically focused FTSE 250.
The growing size of the US market and investors’ focus on chasing growth stocks has also contributed little to the UK’s reputation.
“Global markets are evolving rapidly in both their level of innovation and their ability to be accessible not only to professional investors, but also to retail investors. The level of interconnectedness and disruptive technological innovation makes it easier than ever before to capitalize on investment opportunities from around the world,” says Penny.
“The US market continues to be the beacon of innovation and the flow of capital to that region has rewarded those who have invested there.”
‘Inflation will change everything’
However, not all is lost. The period of underperformance in the UK market came in an ultra-low interest rate environment, with central banks holding interest rates close to zero.
As they respond to higher inflation, an era of higher interest rates could benefit the more income-oriented UK market.
Gervais Williams, manager of the Diverse Income Trust, thinks Train is ‘100 per cent wrong’ and that the UK’s underperformance can be explained by demand for high-growth stocks.
He says, “I think globalization was defined by a period where we had unlimited deflationary imports, which killed inflation. And of course, as debt goes down, we’ve used more and more debt.
“Both of these effects have pushed stock market valuations up… In fact, over the past 30 years, people have turned out to be complete bandits just buying stocks.
Gervais Williams, manager of the Diverse Income Trust, thinks Train is ‘100% wrong’
“So during those last 30 years you wanted fast moving companies and people bought a lot of US stocks. And because they performed better, they bought more and the valuation gap between the UK and the US is huge.’
The undervaluation of the UK market has been used by critics and supporters alike.
For those who think the UK is a backward area, it shows that the market is consistently lagging behind its competitors.
Others view cheap UK stocks as a huge opportunity.
Says Williams: ‘British stocks start out cheap, and if most people don’t own them, which is where we are… when people start buying them back and they start going up, they can go up for 20 years. That’s why I’m so optimistic.
“I think a lot of people look at the past trend and just assume it will continue. If you look in the rear view mirror you can see where they are coming from. You can say, well the UK has been useless for the past 30 years, whatever it is, and you say well, that’s the only way forward. What you don’t recognize is the scale of change with inflation.
Everything changes with inflation. The cost of debt is rising and the companies struggling to generate cash are going out of business. Those who generate a lot of excess cash not only survive, but buy the companies that have gone bankrupt, debt-free, at low prices.”
London loses to New York
Even as inflation pushes investors away from growth stocks, concerns are growing that the UK has lost its way when it comes to attracting new businesses.
Initial public offerings (IPOs) on the London Stock Exchange fell to their lowest level in a decade last year, according to figures from UHY Hacker Young.
Only 41 companies listed on the main market last year, raising £1.2bn in new issues, up from £6bn last year.
What is more concerning is the trend of de-listing to cross the Atlantic. CRH, supplier of building materials on the FTSE 100, has said it will move its primary listing to New York, with gambling firm Flutter considering a similar move.
In another blow to the city, chip designer Arm has said it will also reappear in the US stock market.
There have been numerous government and regulatory backed stock market reviews in recent years to try to change listing rules and improve competitiveness in the marketplace. But that has not worked so far.
Even if inflation picks up, the inability to retain and attract innovative new businesses threatens to become a deep-rooted structural problem in the UK market.
Richard Buxton, investment manager, UK Equities, Jupiter Asset Management recently wrote in The Times: ‘The UK, with its world-class universities, has tremendous opportunities in life sciences, engineering, carbon capture and storage, nanotechnology and IT. But we don’t seem to be able to fund or keep these businesses growing in this country.”
What is the UK doing wrong?
Williams says: ‘UK equities are undervalued, while US equities are relatively highly valued. If you are a board of directors of a PLC you can choose to take your primary listing to the US and in many cases you can drive up the share price. And if you’re primarily interested in increasing your stock price in the short term, you understand where that’s going.
“I’m a little worried that the drop will become a trend.”
The city is shunned in favor of a New York listing for many companies, including chip designer Arm
Which British companies are doing well?
Despite structural barriers and negative sentiment, there are some bright spots in the UK market.
Train itself refers to some of its own UK holdings, notably “one of the best consumer brands in the world” Diageo, in which Warren Buffett recently doubled his stake. Train also owns shares in RELX, which he describes as ‘one of the UK’s most promising brands’. growth companies’.
It is these types of companies that are proving popular with global fund managers looking for exposure to the UK.
Chris Elliott, manager of the Evenlode Global Equity Fund, which owns 15 percent of the fund in UK companies, generally favors large multinationals.
The fund invests in Unilever and, like Train, has interests in Diageo, RELX and the London Stock Exchange Group.
“Companies like Unilever and Reckett… these companies have developed a very strong portfolio of brands over a long period of time, especially recently getting to the point where they are shortening that portfolio and looking for new brands.
“More importantly, and I think this is where they probably differentiate themselves from their peers, they are very good at operating in different international markets partly because of their heritage and the way they were founded.
The lack of exposure to growth remains a problem for many managers. The FTSE All Share Index holds just under 3 percent in technology and telecommunications, while the MSCI World Index holds more than 20 percent.
“I very much hope that given the amount of money going into VC in this country, we’ll see that change over time, but it’s not an easy process and it’s not fast,” says Elliott.
‘[But] actually overall in terms of the prospect of these companies, I’m actually pretty confident about it. Especially when you come into times where there may be a bit more economic uncertainty and volatility. These are business models with very good revenue visibility.”
Obviously, if you’re looking for exposure to growth, it’s going to take some time for the UK to catch up. Negative investor sentiment doesn’t help, nor does a trickle of companies moving their listings to New York.
But as we leave an era of near-zero rates, priorities will shift and with that comes plenty of opportunity in the UK market.
Williams is the most optimistic he’s been in 30 years: “This is what I’ve been waiting for and that’s why I’m so excited.”
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