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Evening Standard
Evening Standard
Business
Alan Miller

The UK equity death spiral: A drain on the lifeblood of British business

A very concerning trend has emerged in the financial landscape of the United Kingdom. One that threatens the very foundations of British business - a significant and steady decline in domestic investment in UK equities.

The combined ownership of UK quoted equities by insurance and pension funds has dramatically fallen from 45.7% in 1997 to just 4.2% in 2022, marking the lowest level ever recorded. This shift poses a grave risk to the UK economy's stability and sustainability.

The reasons for this dramatic shift are multifaceted. The allure of higher returns from investments overseas has increasingly drawn investors away from the UK market. Additionally, changes in pension fund regulations have prompted a cautious move towards less risky assets, diminishing the appeal of equities generally. As domestic investors retreat from the UK market, foreign investors have stepped in to fill the void, with their share of the UK market soaring to 57.7% by the end of 2022, up from 30.7% in 1998.

However, the overall effect is that the gulf between the valuations of UK equities and overseas equities has become steadily larger. SCM Direct analysed the 10 largest FTSE 100 stocks currently, that account for nearly half the FTSE 100 and compared their P/E Ratios with their global peers. SCM Direct found that the UK traded at a 25% discount to global stocks. One immediate impact of the UK discount is that it increases the UK plc cost of capital. As fewer domestic investors are willing to engage with UK shares, companies are forced to offer their shares on lower valuations to attract necessary capital, inflating the costs of raising funds for investment and growth.

Furthermore, this decline in domestic ownership renders UK companies more susceptible to foreign takeovers, potentially leading to job losses and diminishing the global presence of British firms. Recent takeovers and attempted acquisitions, such as Spirent Communications by a US firm and Curry’s by a US company, underscore this vulnerability.

Against these trends, the urgent need for government intervention has never been more necessary. Current proposals, such as the £5,000 UK Equities ISA announced by Jeremy Hunt in the Spring Budget is insufficient to address the magnitude of the issue. More radical approaches such as mandating a minimum exposure to UK equities within the equities portion of pension funds to maintain their tax-privileged status, could significantly alter the current trajectory.

Whilst this challenge is not unique to the UK, the degree of investment decline in UK domestic equities is particularly alarming. Comparatively, pension funds in countries like Australia and Canada hold a much larger portion of their assets in domestic equities. It’s very telling when even the pension fund for Britain's MPs and Ministers invests a mere 1.7% in UK-listed companies, which appears to indicate they do not have confidence in UK equities and companies. A catch 22 situation.

Retail investors, too, are exiting the UK equity market, with the Investment Association reporting a withdrawal of £14 billion from UK equity funds in 2023 alone. This marks the eighth consecutive year of outflows. Furthermore, the growing popularity of Exchange Traded Funds (ETFs) exacerbates the situation, as the UK now represents just 3.6% of the World equity market. Any investor wanting to invest £1,000 in the world according to the market cap, will be allocating just £36 to the UK.

It is no wonder that the UK is experiencing one of the most significant outflows across European markets. This disinterest among domestic investors is a contributing factor to the UK stock market's underperformance, with the FTSE 100 showing a gain of 2.5% in 2024, starkly contrasting with the 12.4% gain of the Euro Stoxx 50.

The path forward requires decisive action from the UK government and financial regulators to counteract this concerning trend. Measures to stimulate domestic investment in UK equities are crucial for the continued health and competitiveness of British businesses. Without a concerted effort to address this issue, the UK risks a future where its businesses are increasingly owned and controlled from abroad, compromising our country's economic independence, prosperity, and GDP.

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