In 2021, investing in UK equities began to feel a little less lonely. The FTSE 100 index rose by more than 10%1
for the year by early December and UK companies resumed dividend payments after the pandemic-induced
economic freeze in early 2020 when all hope seemed extinguished.
Indeed, since the market’s March 2020 lows the FTSE 100
has returned more than 40%. But that is nothing compared
to the runaway train that is the US S&P 500 Index, which
has more than doubled in that time.2
In fact, despite an excellent year, the UK remains relatively
unloved. Investors pulled £8 billion from UK equity funds in
the first 10 months of 2021, from a total of £235 billion.3
This means there have been outflows for five out of six years
since the 2016 Brexit referendum. One hedge fund called the
UK the “Jurassic Park of stock exchanges” with investors not
interested in growth and only hanging around for the robust
dividend payments.4
The absence of tech shares goes some way to explain this,
as the US tech giants have totally dominated global markets
since 2018 (Figure 1). But strip out the big six tech stocks
– Alphabet, Apple, Amazon, Facebook, Netflix and Microsoft
– and S&P returns suddenly look a lot like everywhere
else, while the Nasdaq without its five tech giants is deeply
negative year-to-date.5
Figure 1: Apple’s market cap outstrips the entire FTSE 100
Source: Refinitive Datastream, December 2021
Beware the bezzle
This has also been a time of what economist JK Galbraith termed the
“bezzle” in the 1920s: an as-yet-unrevealed inventory of nasty shocks built
up in the good times, which only reveal themselves when tougher times
arrive. A whole generation is learning to trade crypto currencies and NFTs
(non-fungible tokens) rather than stocks, and when they are dipping their
toes into markets it’s via “meme stocks” popular among retail investors
shared on social media platforms.
When tougher times arrive, this crowded capital could be exposed
to bezzle assets that quickly plummet. Central bank backstops have
conditioned investors to buy on the dip, but in fact have made the whole
system more fragile. A shock such as the Omicron Covid-19 variant
partially circumventing vaccines could be such a catalyst to send
equities into a ferocious nosedive.
Back in business
The UK, meanwhile, is quietly going about its business. The volatility of
the post-Brexit deal seems to have settled, JP Morgan recently turned
bullish on UK equities for the first time since the referendum,6 and in
the summer Bloomberg was hailing “the City’s IPO renaissance” as new
listings during the first six months of 2021 rose by 467% with a valuation
of $20 billion. All the while the UK retains its valuation arbitrage and
remains cheap: M&A is at record levels, helped by the GBP which is at
35-year lows versus the dollar, and there have been 12 transactions above
$500 million in the UK market in 2021 so far – the most since 2007 – with the average transaction value now at $2.6 billion, almost an alltime
high. This has seen $10 billion in premia paid by the private equity
community to public equity to close the valuation arbitrage – a record
level – with deals such as that for Morrisons supermarket.7
According to JP Morgan’s chief markets strategist, the majority of
equity investors today don’t buy or sell shares based on stock specific
fundamentals.8 But we do. The UK market is much more nuanced than
people suppose – it’s a stock picker’s market – and we have the team
for this. We know there are good companies out there because we
engage with them. This is crucial to our process and is something
we take seriously.
This rising number of passive investors, and trading-orientated
managers, means we have a meaningful say in the way companies are
run. So we actively engage to probe the reasons behind performance,
and we have a say in stewardship and governance. We’re not afraid to
vote against issues, but are confident in our process and happy to
explain our rationale.
Looking ahead
While the UK has rallied a long way, it remains a reliable alternative to more
highly valued, crowded markets and has further to go. The market is more
nuanced than simply buying banks and commodities. Our fundamental
research process uncovers hidden gems, with an eye for unloved stocks
that have disappointed but remain good businesses. Meanwhile, our active
engagement probes what is behind performance. We will be pragmatic and
patient as the recovering UK delivers on its promise.
