In 2020, the UK’s FTSE 100 delivered a negative return of -10% while returns from the Nasdaq reached 40%. The UK market’s fortunes have now turned, with the FTSE 100 the strongest performing developed markets index year to date (as at 11 April 2022).
GAM Investments’ Adrian Gosden and Chris Morrison examine the reasons for this turnaround and discuss the strong tailwinds the UK market is experiencing following an extended period of uncertainty.
The last five years have been complex for investors in UK equities. From the EU Referendum in June 2016, we saw uncertainties stack up against interest - and confidence - in UK companies and the pain pile on for investors in UK equities. A fall in the value of sterling exacerbated this pain for international investors. This woeful period was the result of both idiosyncratic events - the extended indecision over Brexit; the UK's poor record managing the Covid pandemic ahead of the vaccine rollout; and the dividend bonfire of 2020. This was compounded by the structural realities of the UK market, namely its lack of large-cap technology, large sector exposure to financials and oil and a perceived lack of growth. Today, the picture looks very different. Year to date, the FTSE 100 has delivered a positive return for investors, compared to the Nasdaq, which is down more than 10% (as at 11 April 2022). We believe there are four main factors contributing to this turnaround.
The first of these is the re-emergence of dividends, which are incredibly important for the UK market. In 2019, dividends from the UK market were approximately GBP 100 million, but they were severely cut as we entered the pandemic. Some businesses cut their dividends because they had to close their operations, while the banking sector was forbidden from paying dividends by the regulator. We are now seeing those dividends coming back. Indeed, in 2021, dividends increased by 40% and the UK market delivered a positive return for investors. Those dividends are continuing to grow and are well covered by the companies’ earnings, potentially laying a positive foundation for the future, in our view.
The second factor worthy of note is the unprecedented amount of corporate activity we are seeing in the UK market. Rarely a week goes by without a deal, which tells us that the UK market is inexpensive compared to other markets. Further, those involved in the transactions range from private equity to listed corporates on other stock exchanges. They are buying UK listed companies with premiums ranging from 30-80%, bringing forward the returns investors may have hoped for over a three or five year period.
In the UK market, we are not particularly accustomed to share buybacks, but they are occurring apace. This year, we have seen Barclays announce GBP 1 billion of share buybacks, NatWest GBP 750 million, and BP USD 5 billion. This is not limited to large caps but is occurring across the market cap spectrum and we expect it to continue over the course of the year. One might ask why share buybacks matter to investors. Crucially, they reduce the denominator on which dividend per share and earnings per share are calculated. As a result, earnings per share and dividend per share rise. We regard a company buying its own shares as a strong attestation to the company’s value.
These three areas – dividends, corporate activity and share buybacks – represent three strong tailwinds for UK equities. A fourth point to note is the composition of the UK market. For the last decade, the 10-year yield curve has been falling, leading investors to favour growth companies. We are now seeing that yield curve change shape, leading investors to question their allocation to growth. While the US market is 30% technology, the UK is heavily weighed to financials, such as banks and insurance companies, oil and mining companies, all of which likely respond well to a rising yield curve.
Clearly then, after an extended period out in the cold, the UK market is now experiencing strong tailwinds. To leverage this, we strongly believe one needs to stick to a robust investment process, to put capital to work at the right time and crucially, be bold enough to move away from some of the very reliable, defensive names of the last five years and into those companies likely to deliver in this new investment paradigm.
The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is not a reliable indicator of future results or current or future trends. The mentioned financial instruments are provided for illustrative purposes only and shall not be considered as a direct offering, investment recommendation or investment advice. The securities listed were selected from the universe of securities covered by the portfolio managers to assist the reader in better understanding the themes presented and are not necessarily held by any portfolio or represent any recommendations by the portfolio managers. There is no guarantee that forecasts will be realised. Indices cannot be purchased directly.