Various data points highlight the reduction in demand for UK equity funds in recent years.
But is this trend a healthy realignment reflecting the reality of the world we live in, or are advisers and their clients missing a trick by neglecting the home market?
The scale of the desertion can be seen in figures from the Investment Association, which show that £20bn has been withdrawn from UK open-ended funds by both institutional and retail clients in the 2024 calendar year, while the number of open-ended funds focused on UK equities dropped from 357 at the end of 2022 to 309 at the end of 2024.
The data is even more stark in the investment trust world, more the preserve of the private and advised client than the institutional one, where the number of trusts solely or principally focused on investing in UK equities has fallen to 49, from 55 three years ago.
Those trusts have combined assets of £19.79bn, compared with £22.8bn three years ago.
The UK equity market now comprises just 4 per cent of the MSCI World Index, and Paul Niven, who oversees £60bn of assets across a broad range of multi-asset mandates at Columbia Threadneedle, says with the index weighting being so low, “it’s not worth, as a multi-asset investor, having a specific allocation to the UK market, instead we think about it on a pan-European basis”.
Niven is a fund and equity buyer, but the providers themselves have been taking a similar view, since January 1 2025, Invesco has abolished its UK equity desk, with those employees becoming part of a wider European equities team.
The company cited the level of outflows as the reason for making the change.
Mike Coop, chief investment officer for EMEA at Morningstar, says two sets of factors have combined to mean demand has been reduced for UK equities.
He says the first is the waves of political uncertainty that have dominated the national narrative since 2016, with Brexit, multiple prime ministers and the potential for Jeremy Corbyn to have become prime minister and seek to implement a radically different policy agenda all reducing the appeal of the UK market.
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For stocks with a market cap of between £1-250mn there is an average of two analysts covering each stock.
Structurally, he says many defined benefit pension schemes had substantially overweight exposures to UK equities, but in recent years, particularly as schemes moved to define contribution, moved away from the overweight positions and typically now have an allocation that is around 4 per cent, or the market weighting in global indices.
That means such pension funds are not underweight the UK market, but rather are content to have the market weighting only.
The only new UK equity fund, open or closed-ended to have come to market over the past three years is the Onward Opportunities investment trust, run by Laurence Hulse.
The trust is just £33mn in size, though trades at a premium to its net assets right now, indicating that there are more buyers for the trust than sellers right now, but fund manager Laurence Hulse says the general decline in demand for UK equities can be seen in the weaker ecosystem in which smaller company fund managers operate.
He says: “Some research we saw from the London Stock Exchange shows there is an average of just 1.2 sell-side analysts [brokers] covering UK shares with a market capitalisation of below £100mn, and some of those stocks are covered by two analysts, so some will be covered by none at all. And for stocks with a market cap of between £1-250mn there is an average of two analysts covering each stock. Liquidity is the worst it has ever been in the UK small-cap market.”
Such weak liquidity hinders the capacity for successful smaller funds to grow, as smaller companies funds that grow in size will have to take bigger stakes in the companies in which they invest, and if there is little liquidity they may not be able to sell such a large holding if they need, or want to.
The dearth of demand for UK small caps, and the consequent drop in analyst coverage, may be explained by two factors: the first is the merger of a number of specialist small-cap brokerage firms in London, such as Panmure Gordon and Liberum, which merged in January 2024.
Firms combining to save costs reduces the number of analysts, so such mergers are both a symptom and part of the problem; they merge because their revenues are declining as clients do not buy UK small caps in the quantity they used to, but are also a part of the issue as merged entities employ fewer analysts and produce one list of recommended stocks.
The other challenge with analyst coverage is the Mifid II rule that prevented fund managers from accepting ‘free’ equity research from brokerages.
In the past, brokerage firms distributed research to fund managers without any formal charge, but in the hope or expectation that the fund manager will use the services of said brokerage when buying or selling stocks.
The Mifid rules forbade this, and a number of small-cap brokerages announced redundancies.
But what about the large caps?
Ben Yearsley, investment director at Fairview Consulting, says he has much less allocated to UK equities than was the case in the past, but has not reduced the exposure more recently.
He says a persistent issue with the UK market is the prevalence of income, rather than fast growth stocks, with the latter a feature of the US market.
Yearsley adds: “The other factor that hasn’t been around for a decade or more is the fact that bonds offer decent returns again – for most of the past decade equities were the only income play, that’s simply not the case any more.”
Higher bond yields reduce the relative appeal of income from equities.
Niven says he regards the UK market as being a place to invest in when wanting to reduce risk in an equity portfolio as the FTSE is overweight defensive sectors, “but given how strongly equities have performed in recent years, defensive sectors have not been that appealing, and the UK is not really the place to be from a growth perspective”.
What do the clients think?
Yearsley says that over the past decade clients have become “more comfortable” with increased allocations to overseas equities.
Simon King is chief investment officer at Vermeer Partners, a wealth management firm. His UK exposure is predominantly through buying direct equities, rather than other firms funds, except in the case of smaller companies.
He says it has been a “gradual process” to highlight to his clients the merits of investing in overseas shares.
King says: “UK clients, particularly older ones, have been used to their assets being invested in the UK and it has been a gradual process to point out the attractions of investing in international stocks and funds. Clients are less focused on whether they hold direct stocks or funds.
“We prefer direct due to our ability to gain more precise exposures and lower costs. The main issue in my view is that the UK is too small to be relevant to a lot of big international investors and therefore outflows will continue even if the market looks cheap.”
David Thorpe is senior investment editor at FT Adviser
