Things haven’t been great for the UK stock market over the last two decades. Indeed, the City has been a “serial underachiever”, especially when compared with the US, says Andrew Jones, a portfolio manager on the global equity income team at Janus Henderson. It has seen poor returns, and there have been significant outflows from the market. UK equity funds have experienced net withdrawals for several years in a row. There has been an exodus of firms quitting the London market, going private instead, or heading for the American exchanges, and in some quarters this has given rise to the perception that the UK market is (or may become) “uninvestible”, as Jones says. There are, however, some rays of hope. An “uptick” in performance over the past few months has seen the FTSE outpace the US market. With valuations at “attractive” levels, this looks like a good time to start backing Britain.
UK stock market problems
Conversely, sectors traditionally associated with the UK market have fallen out of fashion. Chris Beauchamp, IG Index’s chief market analyst, points to shares exposed to commodities, which “faded once it became clear that the rise of China wasn’t going to lead to the expected boom in demand”. George Ensor, partner and portfolio manager at River Global, notes that while historically small caps have beaten their larger rivals by around 3%-4% a year, the cycle has turned against them, and “he can’t think of a single market around the world over the past four years where small firms have outperformed their larger counterparts”.
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Some of these wounds have been self-inflicted. Chris Morrison of Jupiter Asset Management’s UK Income Fund argues that political turmoil, from the Brexit vote in June 2016 to the “disastrous” Liz Truss budget of 2022, has “knocked international investors’ confidence not only in the UK’s ability to grow, but also to balance its books”. Sentiment matters too. Britain’s current government says that “things will get worse before they get better”. Investors understandably find this approach somewhat less appealing than America’s current emphasis on “making America great again”. Tom Wildgoose, head of equities at Sarasin & Partners, agrees that in the UK we do “have a habit of talking ourselves and our companies down”.
Such problems have just piled on top of the underlying structural ones. US markets have benefited from the willingness of both American institutional and retail investors “to take on huge amounts of risk, which has given their firms access to large pools of capital”, says Simon Pryke, executive chairman of Findlay Park Partners. By contrast, British investors have proved to be much more risk-averse. Keith Hiscock, chief executive of Hardman & Co, notes that successive waves of regulations have also forced pension funds to shun shares in favour of bonds, in order to cover their liabilities, and many of them have shifted their remaining shareholdings from domestic to global index funds. All these things have weighed on the British stock market.
Finding value in the UK stock market
The poor performance of the UK market over the past few years may have caused frustration for investors, but it has also made its shares attractive from a valuation perspective. The UK market has nearly always traded at a discount to the US of around 10%-20% in terms of price/earnings and price/sales ratios, but today the “discount to the discount” is of around 30%-40%, say James Harries and Blake Hutchins of Troy Asset Management. And the US market isn’t the only one that the UK trails – “there are plenty of great London-listed companies that are trading at much lower multiples than comparable companies listed in other countries”.
Job Curtis, portfolio manager of the City of London Investment Trust, agrees that UK markets appear cheap. He notes that UK companies also provide a much better income than those in other countries. So even if valuations don’t improve, you will still benefit from getting more in dividends than you would elsewhere. UK firms may have faced criticism in the past for putting payments to shareholders above future investment and balance-sheet stability, only to be forced to slash dividends when things turn sour, but today’s dividends “are on a much more solid basis” in terms of dividend cover (the ratio of dividends to earnings).
British companies are also taking advantage of the low valuations to buy back their own shares, which helps investors by boosting earnings per share. Andrew Jones of Janus Henderson notes that (as of 30 June) the UK has one of the higher distribution yields (the combination of dividends and buybacks), with the FTSE 100 at 6.1%, compared with 4.4% for France’s CAC 40, 3.5% for the German DAX and only 2.4% for the S&P 500. UK investment trusts are also trading at a much higher discount than normal to the value of the net assets in their portfolio. According to data from the Association of Investment Companies, as of June the average discount is 12.7%. This is less than the 18.9% it reached in October 2023, but still substantially below the average of the last 17 years of around 8%.
Takeover mania
Just because shares are cheap doesn’t mean the valuation gap will necessarily close, of course.
“People have been saying this for quite a while and nothing has happened,” as Wildgoose points out. But a catalyst for change this time could be the large number of firms being bought out. That is a “double-edged sword”, says Iain Barnes, chief investment officer of UK wealth manager Netwealth, as it could lead to a diminishing number of listed firms and a “shrinking market” in the longer run. But it could help push up the valuations of UK shares “as people anticipate interest from these buyers, nudging prices in some sectors higher”.
Like it or loathe it, the foreign appetite for British companies is not going away. Expectations that it might be a short-term phenomenon have been disappointed and takeovers have become a “well-established” feature of the British market. A large number of “pretty significant takeovers at pretty high premiums” are taking place this year, as Charles Hall, head of research at Peel Hunt, points out. A case in point is the industrial company Spectris, which was taken over a few weeks ago after KKR gazumped rival Advent with an offer that was nearly double the prebid price. As Hall puts it, “the fact that two private-equity funds were willing to engage in such a battle tells you all you need to know about the UK market”.
It isn’t just private-equity firms with cash to burn that are looking around for British companies, either. Hall points out that the majority of the interest is coming from American firms, even though corporate buyers tend to be much more “risk averse” when it comes to buying other companies. Overall, the average premium paid has been around 40% so far this year, only slightly lower than the 45% that companies were willing to pay in 2024. This suggests that US companies have not been put off by president Donald Trump’s tariffs on the UK and that the UK has “gone from being at the bottom end of investors’ sentiment, to much closer to the top end of markets that are seen as desirable”.
Improving fundamentals
Interest from abroad may help boost valuations, but “it is not a long-term solution” to the languishing UK market, says Tony Dalwood, CEO of Gresham House. Fortunately, the fundamental outlook for UK shares is also “improving”, he says, thanks to “strong fundamentals”. He particularly likes the fact that the Aim junior market “continues to be a critical platform for high-growth businesses”, while the main market continues to list many “world-class companies”, particularly in the pharmaceutical, financial, support-services and infrastructure and energy sectors. Going forward, these companies should act as a “key driver in boosting the performance of the UK market and closing the valuation gap”.
George Godber and Georgina Hamilton of Polar Capital agree that although UK economic growth has been “anaemic” in recent years, things are starting to look up. Since the pandemic, UK consumers have been saving more and consuming less, motivated by an uncertain economic outlook and the need to refinance mortgages. But consumers’ confidence is on the rise and, along with the interest-rate cuts that are on the horizon, this “should help to boost the economy”.
Trump’s decision to impose swingeing tariffs in April, combined with his impulsive behaviour and frequent policy changes, has also made investors, both in the UK and around the world, “think that they might want to put more money into non-dollar assets”, say Godber and Hamilton. Political uncertainty in the UK, on the other hand, is starting to dissipate, especially in sectors such as energy, says Jean-Hugues de Lamaze, manager of the Ecofin Global Utilities and Infrastructure Trust. Hence UK companies in those areas are starting to seem a lot more attractive.
Saving the UK stock market
One political change that could have a big impact on the UK stock market is the increasing recognition that something needs to be done to stem the number of companies leaving the UK market, especially those leaving for foreign exchanges. Some see this process as inevitable, with George Hiscox predicting that “we could end up with London and other national exchanges being subsumed by New York, in the way that the regional exchanges in Manchester and elsewhere were eventually merged with London”.
Others are more optimistic. Richard Stone, chief executive of the Association of Investment Companies, praised the recent Mansion House speech by chancellor Rachel Reeves and thinks that it shows the government “clearly realises that, in order to deliver the government’s growth ambitions, you have got to encourage both individuals and institutions to invest more of their capital in the UK”. Crucially, the government also realises that such investment will have to involve people “putting money into public, rather than just private, markets”. With the new government “having spent much of the last 12 months listening to concerns that London has become unattractive as a destination for companies to list in, it is now starting to act”.
Not everyone thinks that the measures outlined by Reeves, which involved promises of “targeted support” to encourage savers to put more of their money into shares, go far enough. Chris Beauchamp of IG Index, which has launched a “Save our Stock Market” campaign, wants to see the government bring in a raft of extra measures. These include “increasing the pressure on pension funds to invest more in UK shares and an overhaul of the governance code to make it easier to offer the sort of salaries that can attract high-performance CEOs”. He also wants the government to think about cutting, or even abolishing, the 0.5% stamp duty tax on buying shares, “which is hobbling the stock market and making it much less attractive”.
Realistically, a cash-strapped government “will always want to spend money on the NHS, rather than tax breaks for investors”, say Godber and Hamilton. They also acknowledge that the idea of pushing (or even compelling) investors to buy more UK shares may be controversial, as shown by the last-minute decision to drop the closing of cash ISAs amid lobbying. However, over the next few years it is “inevitable” that the government will be forced to take more aggressive measures to push investors into shares.
This is partly because “we are pretty much the only major economy that doesn’t require pension funds to have a minimum allocation to domestic shares”. What’s more, if we don’t act, more companies will move their listing and domicile to the United States, which will reduce the billions that the government gets in corporate taxes, “blowing a hole in public finances”. Of course, when the government does start to bring in these measures, they are likely to act as a “magic bullet”, boosting valuations almost overnight.
The best investments to buy now
The most straightforward way to invest in the UK market is through an index fund, such as the SPDR FTSE UK All-Share UCITS ETF Acc (LSE: FTAL) or the SPDR FTSE UK All-Share UCITS ETF Dist (LSE: FTAD). As the names suggest, these aim to track the FTSE All-Share index and their five largest holdings are drug company AstraZeneca, bank HSBC, energy company Shell, consumer-products firm Unilever and the information and analytics company Relx. Both funds have a total expense ratio of 0.2%. The only difference between them is that the accumulation (Acc) fund reinvests the dividends, while the distribution (Dist) one pays them out. At the moment, the index has a yield of 3.5%.
A more active alternative is the City of London Investment Trust (LSE: CTY). This fund, which has been managed by veteran manager Job Curtis since 1991, primarily focuses on blue-chip companies, with an emphasis on ones with a good dividend, strong balance sheets and an attractive valuation (while aiming to avoid “value traps”). This conservative approach has been vindicated by four decades of dividend increases and by the fact that it has outperformed the market, both in the long run and over the last year. The ongoing charge is a relatively modest 0.35% a year.
A riskier alternative is the River UK Micro Cap Red (LSE: RMMC). Run by George Ensor, the fund focuses on listed UK companies with a market capitalisation of less than £100 million at the time of purchase. There are currently 33 holdings, with some of the largest including specialist lender Distribution Finance Capital Holdings, chain manufacturer Renold and consumer-goods company Supreme. Not only has the fund outperformed other UK-focused small-cap funds over the last year, but it also trades at a very attractive discount of nearly 20% to the net value of the shares in its portfolio, with an ongoing charge of 1.29%.
George Ensor believes that the UK market is particularly strong when it comes to fintech and is very bullish on Boku (Aim: BOKU). Boku helps the big US-listed technology companies, including Apple, Spotify and Meta, aggregate local payments providers, so the big merchants “only have to integrate once to Boku, rather than thousands of different payment networks”. This niche has enabled the firm essentially to double revenue since 2019, with earnings per share going up eightfold over the same period, more than justifying the fact that the stock trades at 29 times 2026 earnings.
Until recently, the UK energy sector has suffered from political uncertainty. Moving forward, its prospects are much brighter. One company that looks attractive is SSE (LSE: SSE). EcoFin’s Jean-Hughes De Lamaze notes that, despite its “well-diversified portfolio, clean power generation, good networks and strong earnings growth” it is one of the cheapest names in the utility sector in Europe and the world. The shares trade at less than ten times 2026 earnings and yield 3.8%.
Engineering company IMI (LSE: IMI) is also worth considering. It makes high-quality valves and industrial automation equipment. Sarasin’s Tom Wildgoose thinks IMI epitomises the extent to which UK firms are undervalued. Despite being a “great company doing great things, with steady sales growth and a good return on equity”, its shares trades at a much lower multiple of earnings, of around 16 times 2025 earnings, compared with similar US companies.
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