There has been a lot of attention recently on the ongoing ‘dismal’ performance of the UK equity market and what the likely causes of that may be. One particularly well-known investment manager has gone so far as to suggest that the UK is ‘a backwater in 21st century equity markets,’ no less.
I have been vocal for some time about the incredible value on offer in the UK equity market which, despite all the negativity, remains a top 10 pool of equity capital globally, with a total market valuation of some $3trn and full of world leading business franchises. I can see no reason to change this viewpoint.
Given this long-held conviction, I have been asked numerous times recently what the catalyst might be for this supposedly fantastic value to be realised. Let me start by confessing that I really dislike the word ‘catalyst’ as it relates to investing. In my experience catalysts are rarely identified in advance and usually only ‘obvious’ with the benefit of hindsight.
That rather large caveat aside, are there legitimate reasons for optimism going forwards or should we accept the UK market’s inevitable backwater fate and move on? For sure, the list of reasons why performance has been so dismal is lengthy and includes the tortuous Brexit process, political instability, lack of dynamic growth companies, relentless selling by UK domestic institutions (particularly pension funds), quality companies choosing to list overseas, UK-focused retail funds experiencing non-stop outflows (22 months and counting according to Calastone) and on and on.
With such significant headwinds it is little wonder that relative performance has been so poor. It is certainly true that over a long period – indeed most of the past 20 years – the MSCI UK has been a laggard relative to the MSCI All Country World index, as the chart below demonstrates. What is perhaps less well observed is the consistent, albeit still modest, pick up in performance in recent years.
Relative return of the MSCI UK vs MSCI All Country World index over 20yrs
Source: Bloomberg
What those who denigrate the UK market overlook is that MSCI UK has been outperforming since late 2021, despite the relentless negativity towards anything and everything UK related. This is, at the very least, interesting. Perhaps some of those headwinds we have endured are, at the margin, starting to ease, or possibly already fully discounted now they are front page news.
But what if this trend persists for another year or so? Will ‘momentum’ turn in favour of the UK? Will technical analysts start buying the UK? Could performance chasing lead to inflows and beget more outperformance?
Perhaps this all seems wishful thinking right now but that, generally, is how investment trends typically start. Of course, if it were to transpire there would be the inevitable chorus of ‘it was so obvious’ – such is the way with hindsight bias.
One notion for which I have a great deal of sympathy is that alternative market participants, such as overseas corporates and private equity funds, are already recognising and acting on the incredible value opportunities available in the UK.
Perhaps this trend, should it persist, will convince others of the outstanding bargains they have hitherto been missing. Following a short hiatus in mid/late 2022, activity appears to be firmly back in 2023.
There have been nearly $16bn of confirmed or potential deals already in 2023, typically at large premiums to the prevailing share price, notwithstanding headwinds such as rising interest rates and a mini banking crisis in the US.
To be clear, I take no pleasure in seeing our publicly traded companies taken private on what, in many cases I am sure, is still an undervalued basis. However, I can certainly understand why it is happening and while the value opportunity persists, I suspect the trend will continue.
To conclude, I do not really know or frankly care that much what the catalyst(s) may be to see improved performance from the UK equity market in the years ahead. Maybe it will be the multitude of recent headwinds fading away. Perhaps the M&A activity at material premiums to prevailing prices will persuade investors. Or maybe it will be nothing more than improving performance that convinces people. Then again, it could be something entirely different altogether.
What I do feel confident in saying is that there is significant value in broad swathes of the UK equity market, and I firmly believe that value ultimately prevails. I entirely reject the notion that the UK represents anything like a ‘backwater’ but rather has faced some very material, largely cyclical, headwinds over recent years that has left sentiment unbelievably depressed.
Whilst I, alongside everyone else most likely, cannot necessarily spot the catalyst, I can most definitely spot the opportunity. I am sure that, one way or another, others will do likewise – eventually.
Simon Murphy is manager of the VT Tyndall Real Income fund. The views expressed above should not be taken as investment advice.