UK equity ‘dark age’ reflects alarming desertion
If the British government is trying to steer more domestic investors back into unloved UK stocks, it has a mammoth task on its hands given the scale of the desertion over recent years.
In his budget speech last week, finance Minister Jeremy Hunt unveiled a new “UK ISA”, or Individual Savings Account, that allows individuals to invest £5,000 taxfree in UK equities annually, in addition to the £20,000 allowed under existing taxfree ISA schemes.
Hunt reckoned this meant that “British savers can benefit from the growth of the most promising British businesses as well as supporting them with the capital to help them expand”.
Downplaying the impact of the tweak, many experts reckoned the added incentive to stay local would only likely appeal to a small proportion of investors already maxed out on ISA limits.
But what it did serve to do is spotlight just how increasingly unwanted British stocks are even among Britons – who, unlike Americans for example, appear to be abandoning any sense of “home bias” as they drift away from actively managed British funds to cheaper and more globally-spread index trackers.
A spiral seems to have ensued as persistently lagging British performance merely tempts savers further into overseas funds – cutting demand for new British equity-fund launches, which have dwindled in favour of shiny new global offerings instead.
The problems of the British economy over the past decade are well documented of course – not least due to outsize hits from the banking crash of 2008, the protracted and messy exit from the European Union, and the pandemic and subsequent energy shock more recently.
for many global fund managers, British exposure has become a far less significant part of portfolios and many even bat away questions on the whys and wherefores of British markets.
At its most basic, the startling under-performance of both the blue-chip FTSE100 index of largely globally-exposed British stocks and the FTSE250 index of mid-sized domestic-facing stocks over the past decade speaks volumes.
In sterling terms, both the FTSE100 and FTSE250 have gained a meagre 13%-17% over the past 10 years compared to the 260% boom in Wall Street’s S&P500, a near quintupling of the tech-laden Nasdaq, a 140% rise in Japan’s Nikkei and even a 62% jump in the eurozone benchmark.
While those major markets surge anew since 2022’s interest-rate setbacks, British indexes are still in negative territory for the past 12 months – and also for 2024 to date.
The valuation discount of the FTSE Allshare index versus MSCI’S World index is now at a record near 40%, and British weightings in that World index have more than halved to just 4% over the past 15 years.
It may be “cheap” of course – but investment flows are streaming in the other direction.
Numbers released by the Invest Association (IA) last Thursday show the scale of what’s happening.
British savers took £24.3bil out of all funds in 2023 – the second consecutive year of net withdrawals and the only two such years ever recorded. The relative attraction of higher interest rates in cash savings accounts was partly to blame.
But the really alarming bit is a record £14bil exit from British equity funds – the eighth straight negative year since the Brexit vote in 2016, outstripping a dire 2022 outcome and continuing a bleed that long precedes the recent rise in interest rates.
While there was some switching to money market and fixed-income funds last year, index-tracking funds also saw a healthy £13.8bil of inflows.
It’s the whopping £38bil record outflow from actively-managed British funds that’s particularly stark.
And it didn’t end last year. Net retail and institutional fund sales of the £1.42 trillion industry were both negative at more than a billion pounds each again for January.
“The UK funds industry is going through a dark age,” said Laith Khalaf, AJ Bell’s head of investment analysis, commenting on the IA figures. “The scale of these withdrawals is absolutely unprecedented.”
“This doesn’t augur well for confidence in the British stock market, which is leaking members and performance to overseas competitors,” he said, adding that it was an “existential crisis” for British active funds, where less than a third have outperformed passive equivalents over the past 10 years.
That “crisis” partly reflects worldwide changes in asset management trends toward passive, process-driven and more global strategies – and an exit of many ‘star’ fund managers from the British scene. Rising annuity sales, which jumped 46% last year, may also have taken from those seeking British equities in pension pots.
But there’s a clear unwinding of “home bias” among British investors too, Khalaf noted, showing the share of British equities in the average balance fund has almost halved since 2009 to just 27% while US equity holdings more than trebled to 39%.
The mere 4% weighting of British equity in the MSCI World could spell much further reductions ahead if the global index tracking boom continues.
And to the extent that higher interest rates may have exaggerated the issue over the past couple of years, hopes for rate cuts ahead seem unlikely to give the UK much of an advantage over anywhere else this year.
The Bank of England is currently expected to start cutting rates later than its US or eurozone counterparts, around August at current pricing, and also deliver fewer cuts over the course of the year.
Tweaking ISA rules won’t do any harm of course, but may just be a cotton wool ball to soak up a flood. —