The challenges facing investors in UK shares have been myriad in recent years, with political uncertainty and pandemics combining with longer-term issues around the composition of the UK equity market resulting in years of outflows.
Last year was supposed to be different. The composition of the UK market, for so long a headwind owing to the lack of technology exposure, became a positive as investors clambered into oil and commodity stocks.
That resulted in the FTSE 100 being the best-performing developed equity market in the world in 2022, but the outflows have continued, with more than £5bn pulled from various UK equity sectors to the end of April 2023.
But with the economic outlook changing rapidly, what could be next for investors in the UK’s domestic market?
Alexandra Jackson, UK equity manager at Rathbones, says: “UK equities usually trade at a bit of a discount to the US, but the discount is now around 40 per cent, and that is hard to justify.
"I think the change will come simply from the memory of the stuff that caused the problems in the first place – the “mini”-Budget and the Northern Ireland protocol – receding into the distance. The evidence of optimism is actually there, because we can see that sterling has risen a lot.
"The FTSE 250 index typically trades alongside the pound, that is, they rise or fall together, but we are not seeing that now.”
Jackson notes that while the FTSE 100 did deliver a positive return in 2022, that was the consequence of big gains from 15 companies, with the other 85 components of the index being mostly in negative territory.
The FTSE 250 was down in aggregate as well, which Jackson says is normal in times of market stress.
But her view is that when investor sentiment has improved a little, then the mid-cap index would be expected to outperform relative to the large-cap market.
One reason why there may be a dislocation between the movement of sterling and the movement of the FTSE 250 is that the latter is gaining ground based on expectations of higher interest rates, but higher interest rates are not necessarily a positive for the wider economy.
But if the economy’s health is robust enough to cope with rate rises, that should imply that UK-listed companies can benefit from the improved outlook.
Nick Kissack, UK equity portfolio manager at Schroders, says that while recent political factors, including Brexit, have not helped sentiment towards the UK market, the discount relative to the US predates that – a factor he attributes to the composition of the UK market.
But he notes: “The new macroeconomic regimes globally, with a focus on higher interest rates and tighter monetary policy, actually suit the UK market.”
Abby Glennie, deputy head of smaller companies at Abrdn, says an indicator that the tide of sentiment is turning comes from the level of private equity investment currently being deployed in the UK, frequently to buy listed companies.
