Should you invest in UK equities?

UK equities have been in the headlines recently, creating a fair bit of noise. On the one hand, the FTSE 100 hit a record high this week. On the other hand, UK equity funds are in continual outflows as the region remains unfashionable with investors. 

As far as the UK economy is concerned, the picture is mixed too. Economic growth has proved more resilient than expected so far this year, after the UK dipped into a mild recession in the final three months of 2023. 

However, newly revised forecasts from the International Monetary Fund (IMF) suggest UK GDP will grow by a measly 0.5% in 2024 as a whole, compared to global growth of 3.2%. If these forecasts materialise, UK growth will be the second-slowest in the G7 after Germany in 2024. 

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The UK emerges from this backdrop as a cacophony of contradictions. Is the stock market riding high, as the latest FTSE performance might suggest? Or does it remain unloved and undervalued? 

What’s more, is the economy proving resilient or lagging behind? And, with only a quarter of UK equity revenues actually derived from the UK, how much of an impact does the UK economy even have on UK equities? 

We take a closer look. 

Why are UK equities unloved?

It has been a challenging few years for UK equities. The Brexit referendum in 2016 caused UK companies to fall in value compared to their global peers, and they have lagged behind them ever since. 

The EU withdrawal agreement was finally passed in January 2020, and had the potential to boost investor confidence by finally making the terms of Britain’s withdrawal from the EU clear. However, Covid followed hot on its heels, initiating the string of challenging economic consequences we are living through today. 

Since then, inflation in the UK has been stickier than in the eurozone and the US, with many putting this down to Britain’s overreliance on gas to heat its homes compared to other countries. The country’s growth has been weak compared to other G7 countries too – although the IMF is forecasting it to increase to 1.5% in 2025, which would bump it up from sixth to third position in the G7 league table.

This series of events has taken its toll on investor confidence and, in turn, UK equities have fallen out of favour with many investors. US equities and other more growth-oriented areas of the market (such as tech stocks) have proved more popular in recent years, thanks to the bumper returns they have offered.

Against this backdrop, the UK equity sector has experienced consistent outflows. The Investment Association reported that UK equity outflows in 2023 totalled £13.6 billion. 

Furthermore, Liontrust was in the news earlier this month after it saw net outflows of over £6 billion in the 2023/24 financial year. The asset manager has a large UK equity franchise, and the Financial Times reports that £4 billion of the outflows came from UK equity funds. 

With this in mind, the UK government is trying to encourage investment in the domestic economy by launching initiatives like the British ISA, a new measure announced in Jeremy Hunt’s Spring Budget on 6 March. 

Riding high but undervalued

Despite the challenges UK equities have faced, the FTSE 100 has now experienced a steady recovery from its pandemic low in March 2020. However, its record close should not be misread as UK stocks now being expensive. In fact, they are “far from it”, says Jason Hollands, managing director at Bestinvest. 

Hollands adds: “A better measure [of valuation] is where shares prices are in relation to expected earnings and in this respect the market is cheap. [...] UK shares are trading at a price/earnings ratio of c.11 times earnings, a 37 per cent discount to global equities, and well below their long-term median valuations.”

While domestic investors have been shying away from UK equities, this valuation discount has not been lost on private equity buyers overseas. “The number of takeovers of UK public companies reached the highest level in a decade last year”, Hollands adds, “but cheap valuations are also spurring many companies to launch share buybacks, which should boost shareholder returns.”

Another important point to note is that, although the outlook for the UK economy is somewhat mixed, many UK businesses operate globally. This means that, when you buy a stake in them, you are actually gaining exposure to a global opportunity set. In this sense, you could see them as a cheap play on global equities.

Invesco’s deputy fund manager Beth Shard made this very point in an investment piece we published back in March. “It is often overlooked that only around a quarter of revenues of UK listed companies actually come from the UK. Put another way, the UK is really a global market that looks attractively valued”, she said.

Should you invest in UK equities?

Despite the valuation promise that UK equities show, investors are still waiting for the catalyst that will turn things around. Commenting on this in a recent webinar, Fidelity International portfolio manager Jonathan Winton acknowledged that the timing of these things can be difficult to predict.

“Maybe something happens in the US. Maybe fundamental issues appear among some of the tech companies. Maybe we stay in a higher inflationary world and the UK looks more attractive because of that. Or, it could be that we develop closer relations with Europe”, he added.

Of course, proponents of UK equities have been singing about low valuations for many years now – so it is possible the market won’t experience a turnaround any time soon. However, the good news is that the UK stock market offers a strong dividend yield. At the very least, this means investors are being paid to wait.