The Shrinking UK Stock Market: A Threat to Domestic Investors

The UK stock market is facing a significant challenge as foreign takeovers increase while IPOs continue to decline. According to data from Peel Hunt, 30 UK-listed companies received takeover bids averaging £1 billion in the first half of 2024, a sharp rise compared to the average of £443 million for 27 takeovers in the first half of 2023​. Although these takeovers provide a short-term uplift to stock prices, they are causing anxiety among UK fund managers. The removal of high-quality, listed companies is reducing the pool of available stocks for investors, particularly in sectors that already have limited representation.

One of the main drivers behind this wave of acquisitions is the relative undervaluation of UK-listed companies. For example, the FTSE 100 is trading at a P/E ratio of 15.1x, while the S&P 500 stands at a much higher 26.8x​. This valuation gap has made UK companies attractive to foreign buyers, particularly from the US, as evidenced by the recent acquisitions of firms like Spirent and Centamin​. However, for UK fund managers, the challenge comes in finding suitable domestic replacements once these companies exit the market.

London’s IPO market has seen a steep decline in recent years, exacerbating this problem. Only nine IPOs have taken place in 2024 so far, compared to 19 in 2023 and 119 a decade ago​. This shrinking pipeline of new companies is further eroding the overall quality of the market, leaving fewer options for investors. In turn, this makes it harder for fund managers to reinvest the cash generated from takeover deals.

MY ANALYSIS

The current wave of foreign takeovers, while profitable in the short term due to the high premiums paid by buyers, poses a significant long-term risk to the UK stock market. The reduction in high-quality, listed companies not only limits investment options but also threatens the diversity of the market, particularly in critical growth sectors like technology. The FTSE 100 is heavily weighted toward traditional industries like banking and energy, which trade at lower multiples. This sector composition makes it harder for the UK to compete with markets like the US, where technology dominates​.

The decline in IPOs is equally concerning. The UK has gone from 119 IPOs in 2014 to just nine so far in 2024​. A vibrant IPO market is critical for a healthy stock exchange, as it introduces new companies and innovations that can drive future growth. The current lack of new listings means that fund managers are left with fewer quality assets to invest in, increasing the risk of over-concentration in certain sectors.

Moreover, the decline in UK pension fund allocations to domestic equities is making it even harder for the UK market to recover. UK pension funds have reduced their exposure to UK stocks from 53% in the 1990s to just 6% today​. This shift toward global equity exposure reflects broader trends in the globalisation of investment strategies, but it also signals declining confidence in the UK market’s ability to deliver long-term growth.

In my view, policy intervention is necessary to reverse these trends. The UK government’s recent changes to listing rules are a step in the right direction, but more aggressive measures are required. For instance, encouraging UK pension funds and institutions to reinvest in domestic equities could provide much-needed liquidity and support the recovery of the UK stock market. Without these interventions, the market will continue to shrink, and high-growth firms may increasingly look to list overseas.

For investors, small and mid-cap stocks, which are trading at historically low valuations, present an opportunity. With many of these companies trading at around 9-10x earnings​, they could lead the market recovery once capital begins to flow back into UK equities. However, investors should remain cautious, as the broader market remains vulnerable to external shocks and continued outflows.

Conclusion

The UK stock market is at a critical juncture. While foreign takeovers offer immediate returns to shareholders, the long-term implications of losing high-quality companies without adequate replacements could have far-reaching effects on market liquidity and investor choice. The lack of IPOs is compounding the problem, leaving fund managers with fewer options for reinvestment. Although UK equities remain undervalued compared to global markets, a concerted effort from policymakers and institutional investors is needed to reinvigorate the market and restore confidence. Without this, the UK risks becoming a much smaller player in the global investment landscape, reducing opportunities for both domestic and international investors.