Why this time is different for UK equities

As part of a global trend, both the number and size (market capitalisation) of UK companies have declined over the past few decades. In the 1990s, the UK accounted for more than 10% of global stock market indices such as the FTSE All World index but is now under 4%. That means any UK investor with an allocation above that level exhibits a so-called home bias. But by contrast, the US market accounts for a staggering 63% of the index.

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Institutional investors such as insurance and pension funds have been gradually reducing home bias within equity allocations and jointly held a total of 4.2% of UK-listed shares in 2022, the lowest on record. Their holdings in UK shares have fallen since 1997 when the two sectors held a combined 45.7% (Source: Office for National Statistics, Ownership of UK quoted shares: 2022).

The main drivers of this decline have been the de-risking of portfolios through global diversification, and the shift from a UK-focused to a more global approach to equities (with allocations broadly in line with a market’s weighting in global indices to achieve much better long-term risk adjusted returns.) 

What about UK retail investors?

Looking at the MSCI PIMFA Private Investor Balanced Index, the average allocation to UK equities in retail investor balanced portfolios is still around 20%, emphasising the material bias towards the UK market. 

interactive investor regularly publishes data (the ii Index) on where its customers are investing – including regional breakdowns.

What is the takeaway from a retail investor perspective?

Every investor is different, but ultimately investment decisions should be guided by fundamentals and valuations, not necessarily the composition of global indices.

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The UK is a diverse and developed market offering investment opportunities across a range of sectors. It is home to a number of well-established global companies, many of which derive a good deal of their revenue from overseas, for example three-quarters of the revenue of FTSE 100 constituents comes from outside the UK. This means that for UK investors, UK equities can provide indirect exposure to global markets without currency risk.  

The UK market offers unique exposure for investors

Although it has fewer technology stocks, the heavy exposure to finance, energy, and mining sectors should offer diversification opportunities away from the US market, where investors are concerned about high technology concentration and stretched valuations.

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UK equites have performed strongly this year but lagged global peers over the past few years, most significantly since the Brexit referendum in 2016. Political uncertainty, weak earnings, and the lack of technology stocks has caused a sharp decline in valuations as investors have shunned the market.  

The chart below shows that over the last 10 years, the FTSE All-Share has delivered a 6.1% annualised total return, against 11.9% for the FTSE All World, and 15.7% for the S&P 500. 

Looking at valuations, then, the FTSE All-Share is cheap on both a price-to-earnings and a price-to-book basis, relative to the rest of the world (FTSE All World), especially the US (S&P 500).

Even after the recent outperformance, the UK market also looks cheap relative to its history, with a price/earnings ratio currently around 16.

UK dividends continue to grow: a deep dive into the data

This has been supported by dollar-based earnings from most of the country’s largest-paying companies such as HSBC Holdings (LSE:HSBA). According to the Q2 UK Dividend Monitor report from Computershare, UK dividends rose 11.2% year-on-year to a record £36.7 billion.

The data shows that most sectors are delivering growth, and it is expected to continue in the second half of the year. During the next 12 months, UK equities are set to yield 4%. Growing dividends should further improve the UK’s appeal as a high-yield market.

Past performance is not a guide to future performance.

Although the political and economic situation in the UK remains somewhat challenging, there are signs of improvement. Labour has announced plans to “rebuild Britain” by boosting growth at the centre of its economic agenda, and the economy and consumer confidence releases show that momentum is progressing.

In addition, the Bank of England has more scope to lower interest rates, which should be positive for the broader UK market. This should give long-term investors greater confidence to allocate more to the UK, and take advantage of the opportunities currently available.

Fund ideas: two ii-rated UK equity funds that could be good options for a balanced portfolio

The JPM UK Equity Core fund is a good “core” option for risk-conscious investors looking to gain active exposure to the UK equity market. The fund aims to outperform the FTSE All-Share index over the long term. The portfolio is constructed using both fundamental and quantitative analysis and is benchmark aware by having only marginal stock and sector overweight and underweight positions. The current yield is over 3%. The fund is also competitively priced at 0.30%. 

The Artemis Income fundaims to provide investors with a steady and growing income along with capital growth over the longer term. It mainly invests in UK companies but has the flexibility to invest overseas when attractive opportunities arise. The portfolio is well diversified, typically owning 50 to 70 holdings, which tend to be stable, well-established businesses with the financial strength to pay solid dividends to shareholders.

The fund’s managers, Adrian Frost, Nick Shenton and Andy Marsh, have many years’ experiences managing income strategies. Artemis Income Fund is a solid, core UK large-cap equity income option for investors. The current yield is 3.4% and the ongoing charge is 0.80%.