Anthony Cross, co-manager on the Liontrust Economic Advantage Team, shares his thinking on the UK market’s underperformance.
We think the UK investment opportunity remains compelling but it’s easy to see why there are opposing views about the prospects for the stock market. Some more pessimistic commentators have pointed to the UK market’s underperformance versus global comparators and the number of companies falling prey to acquisition by private equity or overseas investors. However, we counter that the value and dynamism of the UK stock market shone through in the midst of last year’s Covid-19 lockdowns and associated cash crunches, and this has coincided with a pick-up in the number of new companies joining the market in 2021.
At the heart of concerns over the UK market is its poor relative recent performance. The MSCI World ex-UK Index of global developed markets has returned 30% since the start of 2020. But during this period – which encompasses the breakout of Covid-19 – the FTSE All-Share is only just in positive territory, at 2.4% (sterling terms, as at 30/09/21).
Partly due to this recent performance relative to other markets, the UK seems to be ‘cheaper’ than most. Using the same comparison, the FTSE All-Share trades on a multiple of 12 times (source: Bloomberg, as at 30/09/21) expected earnings in 2021 (or, alternatively, offers an earnings yield of 8.5%) while the MSCI World ex-UK trades on 20 times (a 5.1% earnings yield).
Direct comparisons between stock markets around the world should always be tempered by an understanding that they each have different constituent companies and industries. So, for example, the FTSE All-Share has a much lower proportion of technology companies (2%) than, say, the S&P 500 (28%) while it has more miners (11% vs 3%) and financials (16% vs 11%).
Together with a large number of takeovers of companies, this has created the impression that the best UK stocks are being cherry-picked away at cheap levels, leaving the market with fewer exciting stocks than exist in overseas markets or private hands. The takeover statistics are pretty stark in this regard: in the first seven months of 2021, Refinitiv calculates that UK takeover deals amounted to $198 billion, more than three times the level in 2020.
The Economic Advantage funds have been affected by the two largest of these deals: Fortress’s approach to WM Morrison Supermarkets and the TDR Capital/I Squared Capital purchase of Aggreko. Takeovers have historically been a relatively frequent occurrence for our funds due to the focus of the investment process on intangible barriers to competition; these can be easier to acquire than replicate. The Special Situations Fund, for example, has seen 27 stocks leave due to takeovers since it was launched 15 years ago.
Beyond the two private equity deals mentioned, our funds have this year seen Cisco pick off cloud communications specialist IMImobile for over £500 million and Tencent offer more than £900 million for video games developer Sumo Group.
However, while in some instances it is frustrating to see these takeovers (we voted against the Aggreko deal as we thought the bid level undervalued its prospects), it does not diminish our view that the UK stock market is a vital source of capital for companies and home to lots of vibrant companies offering compelling opportunities for investors.
Last year, we highlighted the vital role played by the stock market in allowing many listed companies to swiftly raise much-needed new capital as the pandemic choked off their cash-flows. The backdrop to this piece was a longer-term trend of ‘de-equitisation’ through which the number of companies on the UK stock market had slowly but steadily dropped over several years.
It seems that the events of 2020 may have served as a valuable reminder of the stock market’s key attractions for company managers and owners. So far this year, there has a been a renaissance of the UK primary market –stocks taking part in initial public offerings (IPOs) or other introductions to the UK stock market. Eighty three companies have joined the London stock market so far this year (raising £5.1 billion), already 50% higher than the total for 2020 and more than double the number in 2019 (source: LSE, Liontrust).
The primary market has always been a useful pipeline of potential investments that we can apply our investment criteria to and, with so many new entrants joining the stock market in 2021, we have been able to participate in a number of IPOs. So far, seven companies have been added to our range of funds in this way. The majority of these have been at the lower end of the market cap range, bolstering the ranks of the UK Micro Cap and UK Smaller Companies Funds. But we’ve also invested in Big Technologies, the remote monitoring tech specialist, which is currently capitalised at over £1 billion.
There are, of course, risks to be aware of. Some areas of the market look very expensive, but valuations will always fluctuate over the years and other pockets of the market look fair value. There will also be bigger picture challenges for businesses to deal with, such as the impact of Brexit and the ongoing public health battle against Covid-19.
We are optimistic about the prospects for investing in the UK market. The pool of stocks we can choose from when investing is healthy and replenishing. We’re very happy with the portfolios of stocks we hold in our funds, and we are finding plenty of interesting candidates for new investment.