Investors Signal a Return to UK Equities: A Turning Point or Temporary Hiatus?

After three and a half years of persistent net outflows, UK equities witnessed a revival in November 2023, with retail investors injecting a net £317 million into British stock funds. This marked the first positive inflows since May 2021, ending a challenging period for UK equities, which had seen over £25 billion in net outflows across 41 consecutive months. However, the question remains: is this a genuine turning point or merely a tactical pause driven by fiscal considerations?

Key Drivers of the Inflows

1. Capital Gains Tax (CGT) Hike and Tax-Motivated Moves

   The November surge was primarily attributed to a record £3 billion inflow into equity funds, as investors acted swiftly to minimise tax liabilities following the UK government’s announcement of a significant CGT increase. Chancellor Rachel Reeves unveiled an immediate rise in CGT, with the lower rate jumping from 10% to 18% and the higher rate from 20% to 24%. The scramble to sell and then reinvest profits illustrates the nuanced behaviour of investors adapting to fiscal policy shifts.

   While this tactical repositioning is noteworthy, Edward Glyn of Calastone warns that this could represent a "hiatus" in outflows rather than a sustained resurgence. He highlighted the absence of a major catalyst for UK equity markets, which remain overshadowed by global growth stocks and the lingering sentiment of investor scepticism.

   
   

2. Valuation and Takeover Activity

   Amidst the broader scepticism, signs of optimism have emerged. The UK market continues to trade at significant discounts compared to global peers, with companies responding via share buybacks and takeover bids. Dealmaking activity accelerated in late November, with £5.3 billion worth of bids announced in a single week.

   Fund manager Rebecca Maclean of Abrdn noted that the “well-rehearsed valuation argument” is gaining traction, with international and domestic buyers targeting attractively priced UK companies. This dynamic underscores a potential turning point where deep-value opportunities could fuel investor confidence.

Analysis: Cheap Valuations vs. Long-Term Sentiment

The UK equity market has long been plagued by underperformance, unattractive growth narratives, and the appeal of international markets, especially US technology stocks. Despite recent inflows, the sentiment gap remains wide. Investors are cautious, recognising that the structural challenges facing the UK economy—including tepid GDP growth, inflationary pressures, and Brexit aftershocks—continue to weigh on the market.

However, there are reasons for optimism:

• Relative Value: UK equities are trading at some of the lowest price-to-earnings (P/E) ratios among developed markets.

• M&A Potential: Accelerated takeover activity suggests that UK-listed companies are perceived as undervalued by strategic and financial buyers alike.

• Fiscal Stability: Although the CGT hike prompted short-term volatility, the lack of dividend tax increases has bolstered sentiment among income-focused investors.

Outlook: Challenges and Opportunities

While the inflows in November signify a break in the downtrend, sustained recovery will likely hinge on the following:

• Domestic Growth Catalysts: The UK must address its economic challenges to instil confidence in both domestic and foreign investors.

• Global Market Dynamics: Continued dominance of US equities, especially in technology, and macroeconomic uncertainty could limit UK equity appeal.

• Investor Education on Valuation Opportunities: The valuation argument, as highlighted by industry experts, could be a pivotal factor in shifting sentiment further.

My Take

The resurgence of interest in UK equities is encouraging but not definitive. It reflects tactical repositioning rather than a broader structural shift in investor confidence. The undervaluation narrative is compelling, particularly for value-focused investors and dealmakers, but the lack of immediate growth drivers leaves the UK market vulnerable to further outflows.

For long-term investors, this may represent an opportune moment to build positions selectively in high-quality UK companies poised to benefit from eventual economic stabilisation and potential M&A premiums. However, caution is warranted, as the broader narrative for UK equities still leans heavily on external validations rather than intrinsic growth.

Investors should monitor fiscal policy, macroeconomic developments, and market dynamics closely to gauge whether the UK’s deep discounts can evolve into sustainable value creation.