UK equities may be inexpensive but the idea that better opportunities lie elsewhere means both international and domestic wealth managers are sceptical about their potential upside.
While UK GDP fell 0.5 per cent in July 2023, fuelled by slumps in production, construction and the services sector, observers have been asking a broader question: what is the longer-term future for UK plc as an investment destination?
Family offices remain sceptical of a market hamstrung by low exposure to technology and little incentive to list businesses. Moreover, a currency hampered by political mismanagement of successive administrations leaves many investors underwhelmed.
“UK equities are inexpensive today, but the volatility of sterling combined with limited earnings growth for FTSE 100 companies are making the market less attractive for international investors,” believes Daniel Pinto, chief executive and founding partner of Stanhope Capital.
“Moreover, the focus on high dividend payouts, which has historically characterised the UK market, is less compelling at a time when interest rates are so high.”
The idea that better opportunities exist elsewhere means UK equity allocations are typically being reduced by domestic wealth managers. Brooks Macdonald, for instance, a leading UK player, has been gradually cutting back exposure to the UK economy, in favour of international opportunities and expects this trend to continue.
For medium risk investors, sterling-based equity allocations fell from 25 to 20 per cent over the last two years, “reflecting the global spread of opportunities that we seek to take advantage of for our clients,” says the firm, which identifies the “pressure on valuations as a result of post-Brexit fears” experienced by UK-centric mid cap firms. Moreover, Brooks Macdonald points to six bearish quarters at the AIM sub-market of the London Stock Exchange, spurred by falling valuations at the smaller end of the market.
By most indicators, the post-Brexit landscape is a largely negative one in the UK. Even those who backed the UK leaving the European Union in 2016 criticise the way Brexit has been handled. ‘While’ UK firms often lead in technological innovation, this is not reflected in a stockmarket dominated by pension funds investing in long-dated government bonds to immunise risks, reflects Max Thowless-Reeves, founder of wealth management firm Sorbus, based in the northern English county of Staffordshire.
“That is an absolute hindrance to investing in equities for sure, and one of the reasons why UK equities have a lower valuation. If you have a lower valuation, it's always going to lead to de-equitisation, where companies go into other stockmarkets. That's just a fact of life.”
Failing to seize the opportunities provided by Brexit has proved a major restriction to growth, he believes.
“What's the point of having done Brexit and all the associated disruption, if you do nothing with it,” he ponders. “There are huge opportunities for the UK to deregulate, but it just seems governments find it incredibly hard to do that. It's also very hard to see much distance between the two main political parties in the UK in terms of how they manage the economy at the moment.”
The solution, he says, must come from entrepreneurs themselves, re-investing in their local economies. “I would contend that every city outside London is in post-industrial decline,” says Mr Thowless-Reeves, who also manages a £20m ($25m) investment into entrepreneurship in Stoke-on-Trent, made by the Foundation of local philanthropist Peter Coates. “Central government intervention is about shiny new buildings, which does not create jobs. Venture capital to create new businesses is the only solution for cities like Stoke.”
While the UK venture capital industry is well behind its US counterpart in terms of successful investors backing their former universities and local regions, there are indications this could soon change, believes Mr Thowless-Reeves. “The tide is turning towards that model, where entrepreneurs believe that actually, the social good that they're doing, is all about starting the next cohort of entrepreneurs.”
Falling trend in listings
The issue of listing companies is clearly one currently concerning many wealth managers. “The UK equity market has for many years seen a falling trend in company listings. While there are specific UK factors which might be at work, it is important to recognise that in other overseas markets, there has also been a trend of fewer listed companies in more recent years, though admittedly perhaps not to the same degree,” says Stewart Sanderson, head of private clients at UK wealth manager Brooks Macdonald.
“Some of this might be down to a greater availability of different pools of capital for companies to tap into; instead of listed equity, companies have more access to debt as well as private equity investors.”
Yet he remains cautiously optimistic looking forward. “In a relatively tougher interest rate environment as we find ourselves currently, the relative attraction of equity as a source of funding for a company versus debt might change this de-equitisation trend,” believes Mr Sanderson.
“Another factor behind falling numbers of listed companies, which is arguably to be welcomed, is M&A, where internationally domiciled companies have in the past capitalised on relatively attractively-valued, quality UK businesses.”
The strong regional presence at these wealth managers is also linked to family businesses prospering in areas outside London in particular. Brooks Macdonald, for instance, has established 15 regional offices, which it says are now “embedded” within their local communities.
“In private markets, we continue to see wealth being earned and created across the UK,” says Mr Sanderson. “Many leading family businesses are now employing financial market experts and continue to innovate in areas such sustainability.”
Regional focus
At global asset manager Franklin Templeton, which owns a dedicated UK investment management arm based in the northern city of Leeds, under the Martin Currie brand, there is also a strong regional focus.
Small and mid-cap, entrepreneurial companies are favoured here, with the portfolio containing the likes of Tracsis. “This is a company that was born out of the University of Leeds, from a mathematics professor, who put together very complicated algorithms basically for train scheduling,” says Richard Bullas, co-head of UK equities at Martin Currie. “So you need to know the rostering and different hours and things like that. It kind of started there and then it has been built out by acquiring businesses and also developing his own technology. Now, when you get on any train, they are pretty much using Tracsis technology. They also got into signaling and traffic and detail as well. So we've held that in funds since 2017.”
Mr Bullas’ team organises 300 company meetings each year, with many of these smaller firms based in the Midlands and north of England, rather than London. “We're travelling all over the country. It's what we really love doing,” says Dan Green, a portfolio manager and research analyst who works with Mr Bullas in Leeds. “We’re seeing how these companies work and not just talking to the management team, but actually talking to the level below. Going in and understanding the culture is important for us.”
Unprecedented full employment
Their stockpicking approach is also underpinned by the trend-following discipline of chief investment officer Michael Browne, who, against a challenging economic backdrop, is analysing an “unprecedented” period of full employment.
“The remarkable thing is that we've been up to one and a half people per job in the past, but we've never seen one to one before. It still hasn't come down very far,” says Mr Browne. “There's no doubt that the number of new vacancies coming out of the UK economy will drift off from here. And we're in a period of significant slowdown caused by interest rates, but it's still at a rate that is unprecedented,” he says, with the cohort of workers being imported post-Brexit from abroad now tending to be more skilled, potentially generating higher growth.
“So we've now got a million more people in permanent jobs today than we had in 2020. There is a very different and much stronger structure to the workforce.”
From many quarters, this cautious optimism is often, however, based on a near-stoic staying power, a capacity to dig deep in the face of post-Brexit turbulence, rather than any real faith in the future of the UK.
“UK plc has undergone a lot of change and challenge; it forced several companies to revisit strategy and plan ahead,” says Mr Sanderson at Brooks Macdonald, who talks about a sense of “resilience” and “quiet confidence” among partners, clients and professional connections.
“Firms have had to work harder to stand still, as margins compressed and capital investment became harder to source and more expensive,” he says. Alongside supply chain challenges and increasing labour costs, this has certainly dented underlying profitability.
“But post-Covid, there is a strong internal market and UK firms focused on the UK market are seeing increased demand and confidence in the market,” he adds. “Trading outside the UK continues to be harder in a post-Brexit world, but the bureaucracy, costs, and unknowns, have been realised, so firms are adapting accordingly.”
