UK Equities: Rejection to resurrection?


26 Oct 2023

London-listed companies are unloved but attractive, so are institutional investors ready to jump back in? Moira O’Neill reports.


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London-listed companies are unloved but attractive, so are institutional investors ready to jump back in? Moira O’Neill reports.

Like most equity markets, the UK has its ups and downs. This year started well as funds flowed into UK assets, but bank failures in the US and Europe put an end to that.

This is just one of many headwinds UK equities have faced in recent years, with the list including everything from Brexit, frequent changes of government, Covid, war in Ukraine and the spike in inflation. But they have also enjoyed periods of phenomenal returns.

Putting the UK equities picture in a longer historical perspective, Will Ballard, head of equities at Border to Coast Pensions Partnership, says: “They annualised mid-teen returns throughout the 1980s as labour market reforms were enacted and inflation was brought under control.

“Then, following the bursting of the dotcom bubble, returns from 2003 through to 2007 were also exceptional, similarly after the correction induced by the financial crisis in 2008 and then in 2020 with Covid,” he adds.

Going global

Today, many analysts believe the opportunity for attractive future returns from UK equities may be at its greatest. UK stocks remain cheap on absolute and global comparisons. As the UK growth outlook improves, and interest rates peak – the UK is very much the laggard internationally in tackling inflation – the prospects for equity inflows must amplify.

Troy Income and Growth Trust senior fund manager Blake Hutchins says: “We’re definitely optimistic. One of the big attractions is that the UK is the most international stock market in the world, with 80% of its revenues coming from overseas. But there is undoubtedly a discount for UK stocks.”

So why are investors overlooking the region’s long-term attractiveness? Equity outflows have dominated the pensions world for many years and this includes UK equities. Stuart Widdowson, portfolio manager of Odyssean Investment Trust, says: “The long-term statistics show that pension funds have dumped UK equities over the past 35 years.”

He reports allocations falling from more than 50% of pension scheme assets to less than 10%. Schroders UK equity portfolio manager Graham Ashby says: “This would have been unfathomable to many of the post-war generation, when there was a boom in final salary pension schemes and a recognition that equities typically provide better long-term real returns than other asset classes, such as gilts or cash.”

He blames a succession of raids on the tax advantages previously enjoyed by pension funds (by chancellors Nigel Lawson and Gordon Brown) along with new accounting rules, which put pension assets and liabilities onto corporate balance sheets. This resulted in the closure of many of these pension schemes and a consequent major shift in asset allocation towards bonds.

Typically, XPS Pensions’ defined benefit (DB) clients only have a 10% allocation to global equities. Alasdair Gill, a partner at the pension consulting and administration business, says: “There’s very little new money on the defined benefit side – so they are de-risking and allocating more to bonds.”

By contrast, in the defined contribution (DC) world, XPS Pensions still sees plenty of assets going into equities and growth assets. However, there is a low allocation to the UK. “It’s partly because the UK became a smaller part of the world index,” Gill says.

Also, the growth phase of a DC pot is typically done on a market capitalisation approach and passively, as the mandates tend to go to lower cost investment approaches.

Although the UK made up 10% of global indices about 20 years ago, it’s only 4% now. “The fall has been driven by a mix of de-equitisation, fewer initial public offerings [IPOs] to replace companies being taken over – and there is less choice,” Widdowson says.

This begs the question: do international investors need UK exposure? Many now invest in equities on a global or thematic basis rather than in a single country. Ashby says: “Combined with the negative investor sentiment post-Brexit and it’s not hard to see why UK equities are so unloved.”

The 1.8% club

But there are other reasons for such a low allocation to UK equities. One is that pension schemes focus on being diversified across sectors and the UK equity market doesn’t help here. Elaine Torry, partner and co-head of trustee DB investment at Hymans Robertson, says: “Diversification is a key risk management tool for pension schemes and that is reflected in the way that the vast majority of pension schemes invest in equities, both at sector and geographical levels.”

Peek under the bonnet of the UK’s main stock market indexes and they are dominated by energy and commodities producers (Shell, BP and Rio Tinto), defensive consumer staples (Unilever, Diageo and British American Tobacco), banks (HSBC) and pharmaceuticals (AstraZeneca and GSK), with few of the fashionable technology stocks. And these sector skews are an argument for having more diversified exposure.

UK pension funds collectively now own just 1.8% of the domestic equity market, according to the latest data from the Office for National Statistics.

But it’s not just pension funds that are shunning UK equities. The market has undergone a significant change in ownership in recent years. Individual ownership of UK-listed shares fell to just 12% in 2020 (the latest figures available) compared with 20% in 1991. This has broadly been offset by a big increase by overseas institutions.

Deep discount

Today, the significant valuation discount in UK equities is increasingly attracting interest from those overseas institutions. Ashby says: “To be clear, the FTSE100 is not expensive – trading on a prospective price-to-earnings (P/E) ratio of below 11 times. However, this is now almost exactly the same prospective P/E for the FTSE250, even though mid-cap stocks should over time offer higher growth potential. Small caps look even cheaper, with the FTSE Small Cap on a prospective P/E of just over eight.”

This is all in stark contrast to the US, where the S&P500 trades on 18 times earnings. However, Ballard says: “There are big structural differences between the two equity markets that cannot be ignored. Despite that, it is remarkable that this 40% dis- count is near the cheapest it has been.”

Another sweetener for investors is that the FTSE All-Share offers an aggregate prospective dividend yield of 4.9%. And Schroders says the prospects for dividend growth look good because the dividend cover ratio, which represents how many times a company can pay dividends to its shareholders using net income, is higher than average across the UK equity market.

Unloved, but attractive

Sterling has also been the best performing currency within the G10 so far in 2023, which suggests that international investors are less concerned about the longer-term outlook, even with the uncertainty of an upcoming general election.

Another positive is that the tightening of interest rates is nearing an end. And though inflation may not be completely tamed and the rise in the oil price is problematic, it is still marching in the right direction.

“We believe that UK equities currently offer some of the highest potential for total returns over the next decade,” Ashby says.

But pension funds are still treading cautiously, as Ballard explains: “For exceptional returns there is a need for exceptional market events. These occur around unpredicted tail events, events which we, as long-term investors and with a responsibility for ultimately looking after the assets of our pensioners and future pensioners, hope are not going to occur in the near future. We would however argue that the UK has the potential to deliver attractive equity returns, in absolute and relative terms. It is an unloved, under-appreciated market where headwinds are abating and yet expectations and prices are still low.”

But he points out the broad market consensus expectations are only for 2% to 3% earnings growth next year. This stands in stark contrast to global equities, for example, the MSCI World, where expectations are for earnings to grow at closer to 10%.

This is despite the FTSE100 generating near 80% of its revenue overseas and having grown its earnings by roughly 9% per annum during the past 20 years.

Pension consultants remain cautious too. Gill at XPS Pensions says: “The UK has lagged global [equity] markets materially for five to 10 years and has caught up a bit over the past three years. But it wouldn’t be a reason to take a punt.”

Elaine Torry at Hymans Robertson doesn’t expect a material reversal in the trend for schemes to diversify geographically. “Whilst the attractiveness of the UK market has arguably improved over the last 12 months, it remains a concentrated market by sector and issuer [with the latter being heavily influenced by global parents] and so is something that would require careful consideration if a meaningful increase was to be made to a scheme’s UK equity allocation.

“Ultimately, like all other asset classes, the allocation to any specific region for any asset class, including equities, must be considered in the context of each individual scheme’s wider investment asset allocation and needs. There is no ‘one-size fits all’,” she adds.


In July, Jeremy Hunt, the Chancellor of the Exchequer, delivered his first Mansion House speech, announcing measures designed to unlock pension investment in unlisted or private companies. The intention is to incentivise companies to start-up and then grow in the UK. Outlined in the reforms was an agreement by nine domestic pension providers to assign 5% of their default funds to “unlisted equities” by 2030.

But investors are still waiting to see whether the agreed allocation includes not just private equity, but stocks listed on London’s Alternative Investment Market (AIM), which are quoted, but technically unlisted as it was created to help smaller companies to access capital.

“Having traded on a significant premium for many years, AIM-listed shares are beginning to look interesting,” Schroders’ Graham Ashby says, adding that the FTSE AIM All-Share trades on a prospective price-to-earnings ratio of 8.5, making it look good value.

Some professionals say boosting UK pension fund’s exposure to earlier stage, high-growth companies is uncertain to have an immediate impact on the main market of the London Stock Exchange or bring positive drivers for AIM.

Nevertheless, Odyssean Investment Trust’s Stuart Widdowson says: “If AIM stocks are included, I expect they will re-rate materially on the back of new buying. Liquidity is limited and there is a shortage of good quality decent sized AIM stocks.”

He also says if this happens, it is likely to be a catalyst for more new companies to list in London.

But nothing is certain with AIM. “Individual share ownership of AIM-listed stocks of 24% is double that of the FTSE All-Share due to inheritance tax advantages,” Ashby says.

Business property relief is an extremely valuable relief for individuals who invest in qualifying AIM companies because it can provide exemption from inheritance tax.

But this tax advantage may disappear if the Labour Party comes into power, or if Rishi Sunak follows up on his rumoured plans to abolish inheritance tax.


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