15th November 2024
The statistics describing outflows from UK equities continue to astound. Calastone tells us that October’s outflow of (just shy of) £1bn, marked 41 consecutive months of outflows. Numis’s Ash Nandi, in her excellent monthly report, highlighted Investment Association data (to end September) which spoke of the last month of net inflows into UK equity funds being July 2021. The UK has experienced the largest net outflow of any geography in every month since August 2021. Since the beginning of 2022, equity funds have seen cumulative outflows of c.£44bn, of which 82% have been from UK funds. The major beneficiaries have been US and global equity funds.
There is an element of “so what” about this stuff. It’s common knowledge that UK equities are a lot cheaper than US equities, and the trend of cheapening UK equities vs US equities has been in place for years. The desire to sell UK equities leads to this undervaluation. Flows are the other side of that coin. But we seem to have become stuck in a doom loop. Investors are extrapolating the performance of the recent past into the future; continued outflows perpetuate the UK’s underperformance.
We believe that no single factor explains future investment returns. We also believe that the price you pay for an investment (i.e. its valuation) is the best of all factors to consider. The problem is it requires patience for this to play out: valuation is a very poor determinant of returns of periods less than 5 years.
Hence we have high weightings to UK equities – or more specifically, to the especially cheap parts of UK equities, which are REALLY cheap relative to their own history. So, for full disclosure, there is more than an element of us talking about our own books in the next few paragraphs!
We are concerned that the cheapness of UK equities relative to the US is partly a function of differences in policy frameworks. The relative cheapness of a country’s stock market should matter to a government. The cheaper the UK’s stock market, the greater the cost of capital to companies that want to list here. I.e. when a company wants to list – e.g. in search of growth capital – if it has to do so on a lower valuation, that costs the company more as it has to give away a greater share of its earnings. Larger companies might decide to list their shares on other country’s stock markets. But smaller companies, who tend to have more domestically-focussed businesses, and whose only option is one of the UK’s stock markets, are simply faced with a higher cost of capital.
In turn, this means lower amounts of capital being raised (or none at all), lower amounts of growth capital being spent, companies not expanding their operations, and ultimately fewer people being employed, less tax being paid, government finances being worse off and the entire economy suffering.
When the Labour party released a document entitled “Financing Growth” -Labour’s plan for financial services in January 2024 – we were very encouraged. Indeed, the authors wrote:
“The de-equitisation of the UK capital markets has been partly driven by a decline in institutional investment in UK equities over the last two decades…….The Capital Markets Industry Taskforce estimates that increasing UK pension fund investments in UK assets from 5-6% to the 2007 level of 25% could deliver over £900 billion additional capital for the UK economy.61 In addition, participation by retail investors in UK public equity markets remains well below comparable markets. The UK lacks a pro-equity culture with only 11% retail direct ownership of stocks and shares, compared to Sweden with 22% and the US at 16%.62 New Financial research estimates that an additional £740 billion could flow into the UK economy if households invested a quarter of their savings in shares and funds.”
By the time you read this, the Chancellor will have given her first Mansion House speech (Thursday 14th November). We sincerely hope to hear of some of the rhetoric in Financing Growth turn into policy action.
If not, we fear that the doom loop in UK equities – poor relative performance begetting outflows begetting poor performance will continue. The end game will be continued de-equitisation of the UK market. The incredible value on offer in the UK is vindicated by the fact companies are ferociously buying back shares and bid premiums are high, as companies are either taken private or taken over by foreign entities, but the presence of this cohort of buyers seems to be having no effect on domestic investors (institutions and wealth managers) who continue to shift towards more global and benchmark aware equity positioning.
As investors, we will still benefit from big one-off gains from take-overs and buybacks. But we’d much rather benefit from re-equitisation of the market. We’d like to see UK companies re-rate to valuations in line with international peers and thus for their cost of capital to be reduced to the benefit of the wider economy.
There are strong arguments in favour of mandating pension funds invest a minimum percentage of their assets into the UK. Pension scheme members enjoy generous tax breaks. It’s a shame if these assets find their way into overseas markets, lowering the cost of capital in other countries. On the other hand, trustees are right to rail against such mandates – they should be free to allocate where they see the best returns for their members. That’s why we think the healthiest outcome would be for the government to create the right policy framework to incentivise investment into the UK’s capital markets. With the right incentives, returns will improve naturally as capital flows return and equities re-rate. And the doom loop will turn into a virtuous circle.
Ben Conway – Head of Fund Management
For professional advisers only. This article is issued by Hawksmoor Fund Managers which is a trading name of Hawksmoor Investment Management (“Hawksmoor”). Hawksmoor is authorised and regulated by the Financial Conduct Authority. Hawksmoor’s registered office is 2nd Floor Stratus House, Emperor Way, Exeter Business Park, Exeter, Devon EX1 3QS. Company Number: 6307442. This document does not constitute an offer or invitation to any person, nor should its content be interpreted as investment or tax advice for which you should consult your financial adviser and/or accountant. The information and opinions it contains have been compiled or arrived at from sources believed to be reliable at the time and are given in good faith, but no representation is made as to their accuracy, completeness or correctness. Any opinion expressed in this document, whether in general or both on the performance of individual securities and in a wider economic context, represents the views of Hawksmoor at the time of preparation and may be subject to change. Past performance is not a guide to future performance. The value of an investment and any income from it can fall as well as rise as a result of market and currency fluctuations. You may not get back the amount you originally invested. FPC24210.
