Making the case for UK equities in 2025

With companies buying up their own shares, foreign investors returning to the UK and attractive valuations on offer, should investors be looking closer to home for opportunities in 2025?

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The trouble is we’ve heard the case for UK equities turning a corner before. The reality is that UK equities have been facing significant challenges since the Brexit vote of 2016 – not only has sentiment been challenged, it has been compounded by investors being seemingly more enthused by high-growth US technology stocks.

Performance over the past eight years since the Brexit vote has been muted when compared with the likes of Europe and the US*. However, UK equities have performed solidly over the past four years since the pandemic. In fact, the UK market has very much held its own against global markets since 2020. Interestingly, the performance of the UK has been powered by corporate earnings rather than the narrowing of the valuation gap versus other markets**.

This highlights just how poor sentiment is towards UK equities. The UK market remains undervalued not just compared with its global peers but also relative to its own historical levels. Not only have foreign investors steered clear, but investors have been selling UK funds in their droves.

Between 2016 and 2023 we’ve seen almost £50bn of outflows from UK equity funds, £33.6bn of which came between 2020 and 2023, when the market had improved slightly. The figures are no better for 2024, with almost £10bn of outflows in the first nine months of the year***.

This has had a huge impact. The MSCI World is a widely followed global stock market index that tracks the performance of around 1,500 large and mid-cap companies across 23 developed countries. The UK accounted for 5.3% of this index a decade ago**** – it has now fallen to 3.6%^.

Poor sentiment is having an impact for no real reason. UK companies are effectively trading on a 15-50% discount to their US peers, depending on the sector^^.

Plenty of reasons to suggest things are changing

However, there are a host of reasons to suggest we are starting to see green shoots for UK PLC. The vanguard for this movement has been both mergers & acquisitions (M&A) and share buybacks by companies.

While valuations, strong cash returns and rising earnings may not have attracted fund buyers, corporates/private equity entities have been circling UK companies – we have seen over $56bn of deals in the UK market over the year to date^^. This was even despite a lull heading into the UK General Election – with more activity expected heading into 2025. Buybacks (companies buying back their own shares because they believe they are cheap) have risen 144% over the past year for FTSE 100 companies; the numbers are even larger for the FTSE 250 and FTSE Small-Cap, with rises of 323% and 408% respectively^^^.

Artemis UK Select fund manager Ed Legget says another way companies are actively working to close the UK valuation gap is by relisting their shares, often in the US, where they can tap into a bigger pool of liquidity and instantly be awarded significantly higher valuation multiples. He says the combination of M&A, buybacks and re-listings has taken away about 6% of the UK’s market-cap (shares taken off the market)^^.

Why a UK recovery can be sustained

Ed says fund flows from overseas will be the big kicker for UK equities to start recovering, believing he says the political stability brought by Labour’s recent victory in the General Election has already started to bring an upswing in the market from global institutional investors. This is supported by the latest Bank of America’s fund manager survey showing global asset allocators looking to move to an ‘overweight’ stance in UK equities for the first time in three years^^.

Poor sentiment towards UK equities has also overridden some of the long-term benefits provided by the home market – not least that it offers diversification from technology (a sector which has had a bit of a pullback following strong outperformance). By contrast, the UK has strong exposure to banks, utilities and energy companies. Remember, the UK is the leader in dividend providers globally – meaning investors are being paid well to wait. The UK also offers exposure to a number of companies with global revenue streams - the companies in the FTSE 100 derive an incredible 74% of their revenues from overseas^^^^.

There are two other subjects worth touching on. The first is innovation – particularly among smaller companies. Liontrust UK Special Situations manager Anthony Cross says the UK market is rich in intellectual property and is an attractive region for start-ups. Fundamentally, Anthony believes the UK provides great conditions for businesses to thrive and prosper.

He cites the fact the UK has the number one tech ecosystem in Europe, with a combined market valuation of $1.1 trillion. There was $21 billion invested in UK tech startups in 2023. The UK has created 171 technology unicorns (a private company worth over $1 billion), including the likes of Monzo, Revolut, Darktrace and Deliveroo*^.

The UK also ranks eighth globally for manufacturing output and punches above its weight on healthcare, boasting two of the top 10 global pharmaceutical companies. Within the subsector of med tech, the UK is the sixth largest market globally, submitting over 470 patent applications in 2021 alone*^.

Anthony says of the top ten performers in the Liontrust Special Situations fund over the past decade, eight were bought as small-caps*^.

The final point is political impact. UK pension funds’ exposure to British equities has been dramatically dwindling over the past 25 years. It’s not surprising that the government have had their eyes set on UK pension pots as a way of providing investment to stimulate growth. The total amount of UK pension investments is estimated to be approximately £3 trillion by 2030**^. UK pension funds have reduced their allocation to equities from 73% to 27% and they have slashed their allocation to UK equities from 53% to mid-single digits**^. Only a small change to mandate more into UK equities would lead to a significant swing in the fortunes of UK PLC.

There are plenty of reasons to back the UK from here. From the “paid well to wait” strategy of investing in the world’s leading dividend payers on these shores, to innovation in the small-cap markets, there are now other catalysts at play which can change the tide for the region.

Those looking for multi-cap UK equity offerings might consider the likes of Artemis UK Select, which invest in 40-50 holdings. The fund’s ability to short (profit when the share price goes down) a small number of holdings is a differentiator which sets this fund apart from its peers. Liontrust Special Situations has an overweight to small and medium-sized businesses and has an excellent track record dating back two decades.

Those wanting an income option might consider the likes of Rathbone Income or ISFL Marlborough Multi-Cap Income, while those looking for a pure small-cap play might look to the Fidelity UK Smaller Companies fund.

*Source: FE Analytics, total returns in pounds sterling, 18 November 2016 to 19 November 2024
**Source: Fidelity Special Values, 24 October 2024
***Source: Investment Association, Net retail sales of funds by asset class
****Source: Goldman Sachs - The bullish outlook for UK stocks
^Source: MSCI index factsheet, 31 October 2024
^^Source: Artemis, 8 October 2024
^^^Source: CityAM, 4 September 2024
^^^^Source: Morningstar, 31 December 2023
*^Source: Liontrust, 15 November 2024
**^Source: New Financial, March 2023

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the author and fund managers and do not constitute financial advice.