UK equities: The stars have aligned

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The UK accounts for approximately 4% of the MSCI World Index, while the US accounts for almost 69% (1). As a result, the UK market has tended to appeal predominantly to domestic investors. However, as one of the best performing developed markets year to date, Adrian Gosden explains why he believes investors globally should consider it more closely.

26 July 2022

Today, the picture for the UK market looks very different to the period from 2016 to 2020, which was marred by a series of idiosyncratic events, which were compounded by the absence of large-cap technology at a time when many investors favoured the growth style. We believe there are four main factors contributing to the UK’s turnaround.

Return of dividends

The first point to note is the role that dividends pay in the UK market. Dividends have made up half of the return of UK equities over the last 100 years. Without them, it is hard to make money, as we saw in 2020 when the UK FTSE 100 returned -10%, while the Nasdaq was up 40% (2). Crucially, dividends are now coming back – and strongly. Today, we are operating in a market where dividends are increasing. This not only benefits the shares themselves, but dividend growth is a very useful tool to help investors combat the current inflationary environment.

We do not doubt that there will be earnings downgrades by some companies over the coming months, given the likelihood of recession, but we do not expect this to have a significant effect on dividends. During the pandemic, we saw UK dividends cut from GBP 100 billion to GBP 60 billion due to store closures and, in the case of banks, for regulatory reasons. With many companies having recently reinstated dividends, we do not expect cuts. In the UK market, dividends are sacrosanct and a company which cannot be relied upon to consistently deliver its dividend becomes less attractive in the eyes of the investor.

Extensive corporate activity

Secondly, the UK market is currently experiencing a significant amount of corporate activity. Business and financial information company Euromoney was this month bid for at a significant premium by a private equity firm. This was not an anomaly, but is happening nearly every week in the UK market. This is because sterling has fallen and the UK market is undervalued relative to others. Private equity firms are buying UK companies and taking them off-market – and they have the potential to make strong returns by doing so.

In addition, we recently saw GSK, one of the UK’s largest pharmaceutical and biotechnology companies, split into two separate companies – Haleon and Glaxo. The split has occurred because activist investors campaigned for this on the grounds that the company was worth more as two separate businesses. Again, this is not an anomaly and we have seen shareholder activism across several FTSE 100 companies, including Unilever and SSE. In summary, CEOs are no longer able to sit on their hands and wait; activists are demanding action and value creation.

Unprecedented amount of share buybacks

Further, unusually for the UK, we are currently seeing an unprecedented amount of share buybacks. UK companies, principally in the financial and energy sectors, having paid their dividends and with healthy balance sheets, are buying themselves. This year, we saw Barclays announce GBP 1 billion of share buybacks, NatWest GBP 750 million, and BP USD 5 billion. These businesses cannot make acquisitions in the wider market because it is too expensive and therefore, given the low price of their UK shares, they are choosing to buy themselves. We regard this as an attestation to the company’s value. Further, share buybacks matter to investors because 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.

Composition of UK market

As well as these three key features – dividends, corporate activity and share buybacks – which represent strong tailwinds for UK equities, the composition of the UK market is also worthy of note. Specifically, 1% of the FTSE 100 is in technology, while technology accounts for almost 30% of the S&P 500 (3). The UK market is instead dominated by financials, oil and gas and mining shares, all sectors which, in the current environment where we are seeing a rising yield curve, are likely to respond well.

Clearly then, after an extended period out of favour, the stars have aligned for UK equities in our view. We believe today presents an opportunity akin to that of 2000, 2008 and 2020. That is, to stick to a robust investment process, adhere to cash flow principles, put capital to work at the right time and crucially, be bold enough to make big decisions in this new investment paradigm.

(1) Source: MSCI, as at 30 June 2022
(2) Source: Bloomberg
(3) Source: FTSE Russell, S&P Global, as at 30 June 2022
Important legal information
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.

Adrian Gosden

Investment Director
My Insights

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