To great fanfare, the FTSE 100 surpassed an index level of 8000 during the last quarter, reaching a new index high and prompting a mixture of headlines, ranging from the soothsaying “When will it hit 9000?” to those questioning “Will it still stay at its highs?”. The FTSE 100 hit 7000 in March 2015; a month when Jeremy Clarkson got suspended from Top Gear (what changes?), when UK inflation was reported at 0% (everything changes!) and the UK was in the last months of a Cameron—Clegg coalition. It was also the year before the UK voted to leave the EU in June 2016’s referendum, which from a global asset allocators perspective, plunged the UK on to the back foot with the allure of a faster, more dynamic US equity market with its large tech stars.
In the time it took the FTSE 100 to go from 7000 to 8000, excluding dividends, the US market (shown in green below) rose far more significantly, almost doubling over the same time, whereas the poor old FTSE 100 investor, in stumbling over the 8-years in getting to 8000, received an almost snail-like return of 1.7% per annum at a headline index level.
But what about those valuable dividends, I hear you cry? Well, yes, that has absolutely made a difference. Sticking in local currency terms for now, the healthy dividends that UK companies have traditionally delivered, has thankfully helped investors in the UK market to a slightly more respectable annual return of 5.6% assuming those dividends were reinvested. Comparing this to other global markets, the US remains head and shoulders above other markets, but the FTSE 100 has actually delivered a return slightly ahead of European, Japanese and Emerging Markets equities, when dividends are taken into account.
So, maybe UK equities haven’t been a lost case after all? Well, we all know that is the case because we can see it in portfolios and look in the ‘returns’ column, so what else is going on? If you are a UK based investor holding overseas assets, then assuming you aren’t hedging currency fluctuations, your return will come from the price movement of the asset you hold and from the difference between sterling and the overseas currency. A weak sterling increases the return from holding overseas assets and a weak sterling we’ve had. The chart below shows how when you take into account currency movements, returns from the same equity markets, boosting their returns and putting the FTSE 100 back down at the bottom of the league table.
Unloved and Unwanted
Since 2015, there have been some major headwinds for UK assets more broadly. First, an uncertain political backdrop in the years since the EU Referendum. From the initial vote in 2016, through the fractious negotiations between not only the EU and the UK, but also within the Conservative Party, particularly during the May Premiership, all conspired to diminish the attractiveness of UK assets for overseas investors. This heightened political risk associated with UK assets meant, for many overseas investors, the UK market was filed away in the ‘too tricky to worry about box’ and they were happy to reallocate elsewhere.
But the move away from UK equities was already well underway. The reduction of UK equities as part of the asset mix within UK defined contribution corporate pensions can be traced back to the beginning of the millenium, where it was typical to not only have a high percentage invested in equities but for this to be predominantly UK equities with only a relatively small amount in overseas equity markets. The losses suffered in equity markets from the ‘dot-com’ era, saw equity allocations reduce. This sped up in the years following the global financial crisis as the bank heavy FTSE 100, found itself out of favour and the gradual reduction of UK equities continued from the portfolios of UK investors. The decade or so since the Global Financial Crisis, saw US equities increasingly in favour as ‘tech’ was in, and again, the UK market with its energy, resources and financials, found it mis-positioned to attract investors who increasingly applied an ESG overlay (environment, social and governance).
2022 saw a better return for the UK market, but the relentless torrent of investors giving up on UK assets continued. According to Morningstar, £12.6bn was taken out of UK Large Caps during 2022, approximately £2.5bn out of multi-cap and equity income funds and £3bn out of UK Small Caps.
So where do we sit today? UK equities remain unloved by global asset allocators, but with the US equity market giving domestic investors a bloody nose in 2022, for the first time in many years, it is not uncommon to hear US market commentators highlight the value that can now be found outside US markets.
UK equity markets look cheap versus their own history at c10x forward price/earnings ratio. They also look relatively cheap versus US and European markets, whilst offering one of the highest dividends of any market and that’s before any share buybacks are accounted for. With a sector composition that all of a sudden seems to chime more with the global rhetoric of energy security and a declining political hangover, we could just be entering into a more favourable backdrop for our domestic market.