Might the UK market be at a turning point?

While the French find themselves in uncharted water as no party wins its general election, the UK looks to be in much better shape. M&A activity is picking up, Labour is looking to boost growth and international investors might find UK equities look cheap and under owned.

By David Stevenson•11 Jul, 2024•

Like many I didn’t bother staying up past 11pm on Thursday night to see the election result, partly because I’ve done so many times before, and partly because the end result (a Labour government) wasn’t ever in much doubt. The next morning, I anticipated a long series of emails from investment managers making all sorts of claims about ‘what next for investors…’ – and was richly rewarded with observations, comments and the odd outlandish criticism. 

Stepping back from the noise of the election campaign, I think we can safely make a few observations. The first, is that no one in the City was sitting in cold sweat anticipating a hard left Labour government. The charm offensive by Rachel Reeves et al was just too high profile for the scare stories about a socialist revolution to make much headway. In fact, the next morning, sterling slightly strengthened, and gilts were also in the black. As for the stockmarket, by early afternoon on Friday – enough time for the result to sink in – the FTSE 100 had barely ticked up, while the more domestically focused FTSE 250 was up 1.39%. British home builders stood out, with an index tracking their shares up 2.3%. As for gilts, Reuters reported the premium that investors demand for the extra risk of holding gilts rather than top-rated German 10-year bonds has remained stable this year at around 160 basis points – far below the 230 basis points seen during a mini-budget crisis in 2022. That premium was down 2 basis points at 159 basis points on Friday.

The next observation I’d make is that the big majority for Labour should make the government fairly stable and what many investors crave above everything else is stability. 

I’d make two final observations. The first is that the UK market is under-owned by international investors and what will really make a difference to UK stocks – and funds – is whether the UK seems a more attractive, cheap way to buy exposure to the right business sectors. To understand this point consider these two facts :

  • The UK market comprises just 3.4% of the value of the Global ACWI index, compared to 5.1% for Japan. Back in 2011, that number was 7.5%, and even as recently as 2021, it was 4.9%. Japanese equities currently comprise 5.1% of the ACWI global index.
  • UK stocks comprise just 3.72% of the MSCI World index (which excludes emerging market stocks). Again, this percentage was much higher in previous decades.

For the UK market to really increase in value, we need more international investors to think the UK market is cheap. 

This brings me nicely to the final point: one crucial element in that equation – is the UK cheap and a great place to access the right sectors? – are closed-end funds and investment trusts. I sense that more and more international investors are beginning to focus on the FTSE 250 index, a more useful proxy for the UK, and that means investment trusts are crucial. 

Of the 250 companies in the FTSE 250, over 90 are investment trusts or REITs. In addition, 12 other companies in the FTSE2 50 are asset managers and custodians, many of which have significant investment trust exposure. Collectively, if we add up all the funds and trusts, we come to a total value of £125 billion compared to the total FTSE 250 value of £2.5 trillion. If we include 3i in that fund calculation, then we come to £155 billion. The average FTSE 250 stock has risen by 12.6% in price terms over the last 12 months whereas the average fund in the FTSE 250 index has risen by just over 10%. 

To put it as bluntly as we can, the difficulties faced by the investment trust sector – big discounts, patchy liquidity, lots of selling – have a major impact on the FTSE 250 index, which many international investors see as the better proxy for the UK economy. If the UK market is to enjoy a renaissance – and I’m more positive than most – then a large part of that resurgence will depend on international investors buying into investment trusts. 

I’ll finish with one positive data point – takeover activity. Charles Hall is head of research at broker, Peel Hunt, which has very publicly warned that the UK market – funds and operating companies – is in danger of falling into a death spiral because of a lack of interest in the UK and negative government policies. As an investment advisory firm, they have been admirably blunt about the headwinds, so when they come out with some positive news, it’s worth taking note. Hall recently circulated a research note stating that the pace of takeover activity for UK companies generally, and specifically smaller market cap companies, is increasing. Here are some choice quotes from the report:

  • M&A activity on the up – Bids announced YTD and still live amount to an equity value of £43bn. Including the bids announced last year and completed this year, and delistings from the UK, the total value is £95bn.
  • Going up the market cap – Of the 32 transactions announced in H1, 17 were in the FTSE 350, 3 in the FTSE Smallcap and 10 on AIM. In the whole of FY23, there were 39 transactions announced, of which 2 were in the FTSE 350, 14 in the FTSE Smallcap and 19 on AIM.
  • Increase in pace – There has been an acceleration in both the number and scale of transactions over the last few quarters, with Q2 being the busiest period both by number (21) and value (£26.5bn).
  • More corporate buyers – Last year, the majority (56%) of offers were from financial buyers. However, corporate buyers (72%) have dominated in 2024 as the rate environment and economic outlook have become clearer, demonstrating the value of UK companies.
  • Multiple offers – There have been 6 competitive situations YTD (Alpha, C&R, DS Smith, Hipgnosis, Spirent and Wincanton) and 8 raised offers.
  • High premiums – The average premium thus far in FY24 is 40%, with some offers materially higher than the undisturbed price (e.g., Wincanton +104%, Spirent +86%, IDS +73% and Keywords Studios +69%).
  • Overseas appetite – Overseas bidders are c.60% of the total YTD.
  • Sector focus – Tech and Real Estate have been the most active sectors.

Those last two bullet points are very relevant for investors in investment trusts: there is increasing appetite from international investors and real estate investment trusts are a particular focus. These trends are potentially very positive for investment trusts. I’d also note one other potential positive – more and more smaller cap companies on the London market are being snapped up by trade buyers. This bodes well for a large number of funds that are focused on the UK small to mid-cap sector.

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Until news, the trend is your friend.