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Why I worry British investors will miss out on a UK rally
The government hopes that by providing additional tax breaks, the UK ISA will increase the capital available to domestic businesses. But Paras Anand says the main reason for Britons to invest more in the FTSE is their own prosperity.
In the ‘90s, everyone in this country seemed to have most of their investments in UK shares. Articles would appear in the Sunday papers exhorting us all to think more globally. And we listened.
The trend towards passive investing made it much simpler for investors to buy international shares. Trackers that mirror indices such as the MSCI World have just 4% exposure to the UK market. More than 70% of the index is in US stocks.
Back in the ‘90s, defined benefit pensions funds and insurance companies owned around half the UK equity market. Today it is just 3%1.
The surprise recently was perhaps not so much that one of the UK’s best-known wealth managers was reducing UK equity exposure from more than 20% to less than 3%, as how long it took it to make that decision. Has it got its timing wrong?
In recent years, investing in the US over the UK has been a smart move. But there is a growing argument that this is changing. The FTSE 100 hit 12 record highs last month2. I believe that trend can continue. My big concern is that UK investors will miss out. We’ll come to that point later. First, I should make the case for why I am so bullish on UK equities.
There are three main reasons I believe UK equities can continue to rise in value:
1. The pension shift
First, even without a change in asset allocation, UK pension funds will be buying more UK shares. Research from Goldman Sachs shows that old-fashioned final salary pensions schemes – defined benefit (DB) schemes as they are known – currently hold seven times the assets of modern defined contribution (DC) schemes. But they are shrinking, whereas DC schemes are taking in more than £20bn a year in fresh employee and employer contributions. By 2032, DC schemes will be bigger3.
DC schemes have nearly half their money in equities compared with just 15% for DB schemes – so three times as many UK shares, proportionally. It means pension schemes are now net buyers of UK shares.
I don’t want to exaggerate the impact of this shift in the pensions landscape, but it helps. If pension funds were to reconsider their allocation to the UK, that would make a bigger difference. They would certainly struggle to allocate less than they do today. In Australia and Italy, pension funds invest about 40% of assets in their own domestic markets4.
A change in sentiment in UK markets, and possibly some carrot-and-stick encouragement from government, could lead to a meaningful change in flows. That debate is now happening in Westminster and the City.
2. Valuations
The UK is still cheap5 – relative to its own history and to the rest of the world. This is a well-rehearsed argument. Only technology stocks are more expensive than their 10-year average. Some sectors – consumer staples, utilities, financials and telecoms – look extremely cheap versus history.
Internationally speaking, UK shares are among the least loved in the world6. In developed markets, the UK is the cheapest region. The make-up of the FTSE 100 and the American S&P 500 are very different, but looking at the commonly used price/earnings ratio, the FTSE at 11.4x is nearly half the price of the S&P500 at 20.7x7.
3. Resilience
There is a lot going for the British economy today – if you can see through the gloomy headlines. Britons have more excess savings than Americans or Europeans on average. Data suggests most of the population are coping with the cost-of-living crisis. Retail sales declines have stabilised8. There is real wage growth9. The UK is becoming less dependent on others for its energy as renewables grow10. Business confidence is growing11. The upcoming election might create a new political backdrop – continuity where it matters, and – perhaps – a healthier relationship with Europe.
How high can UK equities go?
We have in Japan a recent example of what happens when sentiment finally turns on a market that has been languishing for years. Since the beginning of last year, the Nikkei 225 has risen nearly 50% in local currency terms12. There is a good chance that the UK stock market could mirror Japan’s rise.
In situations like this, where a downward spiral suddenly turns into a virtuous circle, investors on the sidelines jump in. Institutions increase their asset allocations towards the UK. Positive momentum builds.
Will UK investors win?
My big concern is about who will benefit. Currently, it looks like it will be the overseas investors and private equity houses that are pouncing on British companies, picking them up at the right time. The hefty premiums to the market price they are often paying underlines just how cheap UK shares have become and the opportunities that lie here.
I am worried that UK investors will miss out – whether that is because they have their money in global trackers, or in pension funds that shadow global index equity allocations, or with wealth managers who have followed the trend of selling down the UK and are yet to recognise the opportunity.
It seems to me a shame that the people who are generating this wealth – the hard-working employees helping to deliver strong profits – risk not getting to share in it.
In the ‘90s, investors had to be encouraged to invest globally. I believe it’s now time we encouraged them to buy British.
Sources
1 https://www.ons.gov.uk/economy/investmentspensionsandtrusts/bulletins/ownershipofukquotedshares/2022
3 Goldman Sachs UK Weekly kickstart 12 April 2024
4 Bloomberg email 15 May
5 Goldman Sachs ibid
6 Goldman Sachs ibid
7 Goldman Sachs ibid
8 https://www.wsj.com/economy/u-k-retail-sales-rebound-weakly-in-may-report-says-b9375cd7
10 DB “UK residence: Despite it all”
11 https://finance.yahoo.com/news/uk-business-confidence-reaches-eight-125647878.html
12 Nikkei 225 Jan 6th 2023 to May 15th
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