Three reasons why retail investors are heavily selling UK funds

We explain UK investors’ rejection of their home market and name the catalysts that could bring them back.

Investors are ditching UK equity funds in their droves, with more than £1 billion exiting in June, according to the latest fund sales figures from the Investment Association (IA).

The worst-selling IA sector in June 2020 was UK All Companies with £662 million of investor withdrawals, while UK Equity Income saw £327 million removed from funds. This is quite a reversal of fortune for UK funds, as UK All Companies was actually the best-selling IA sector in December.

The latest Bank of America Merrill Lynch fund manager survey for July also found the UK market is unpopular with asset allocators.

So why are investors are giving UK stocks the cold shoulder?

1)   Brexit rumbles on

Britain is facing the double whammy of the economic hit of coronavirus, and Brexit, which has still to play out.

James Menzies, investment director at Greystone Wealth Management, notes that a lot of Brexit uncertainty remains, and this has been a strong driver of outflows from UK equity funds.

“The key reason is that renewed uncertainty around the Brexit process is coming back into focus. This has been out of the political headlines over the past few months due to the coronavirus outbreak, but negotiations between the UK and European Union have still been going on in the background – with very limited progress being made on a trade agreement. There is concern among some investors that a disorderly withdrawal from the EU at the end of this year will compound the hit the UK economy will take from the coronavirus pandemic.”

Menzies has been reducing exposure to the UK market in recent months, but still has some exposure across the firm’s multi-manager portfolios because he sees attractive valuations on offer, especially in mid- and small-cap stocks.  

“The UK equity managers we invest in focus on high quality businesses with good cash generation and strong competitive advantages. These companies would be expected to perform well versus peers in the event of weak economic growth,” he adds. 

2)  UK misses the ‘Zoom rebound’

The FTSE 100 is largely made up of cyclical sectors such as financials, basic materials and energy, and investors have turned away from these sectors as Covid-19 puts the economy under increasing pressure, says Alex Moore, head of collectives at Rathbones. 

A global rebound since March has seen sectors such as IT services, healthcare and e-commerce perform well as money pours into vaccine research, companies embrace digital communication, and locked-down consumers shop online. The problem, Moore points out, is the UK is under-represented in these sectors compared to, say, the US, and so it has lagged the recovery. 

3)   Dividends evaporate

Meanwhile, dividends have dried up, leaving the once-fertile UK landscape for income-seekers more of an arid desert. “Income investors in particular have had a bad experience due to Covid-19,” says Moore. “Before 2020, the UK had one of the most generous yields of all markets around the world, but a large number of companies are now cancelling or cutting dividends and giving as little guidance as possible due to the uncertainty on Covid-19 on future earnings. We are now seeing investors that were reliant on income streams via dividends selling as they are no longer getting the dividends they once were.”

What will bring investors back to the UK?

What would need to happen for investors to return to the UK market once more? Any sort of clarity around Brexit would be welcome, notably around a trade deal with the EU. “The markets like certainty, and a more clear-cut situation around ‘deal or no deal’ – deal, preferably – might bring enough certainty to encourage investors back to the UK,” says Moore. 

Another catalyst could be the return of banks paying dividends. At the end of March, banks were told by regulators to suspend their dividends and build capital buffers to be able to absorb Covid-19 losses and continue to lend, so UK equity income may become attractive once again when these banks reinstate their payouts. 

Any improvement in the global macro environment could benefit oil majors and basic materials companies too, adds Moore. Weaker sterling in the event of a macro shock, on the other hand, could benefit FTSE 100 companies that earn most of their revenues in dollars, just as we saw happening after the 2016 referendum. This could make the UK equity market look attractive to investors once more.