Growth investing has been the dominant investment style since as far back as 2007, and the UK’s value-oriented market has missed out on the accompanying gains. Investors around the globe sought the high returns of growthy sectors such as technology rather than the slow and steady pace of old-school areas, such as financials and industrials that saturate the UK market.
Tech companies have been the focal point for the growth wave and markets with a large allocations to the sector such as the US have led by a colossal amount. The S&P 500 with its 30.7% exposure to tech soared 759.7% since 2007, while the UK’s FTSE All Share trailed four-times as far behind with a total return of 182.4%.
By comparison, tech accounts for a mere 1.3% of the FTSE All Share’s market capitalisation, with just 17 technology companies operating in the 553-strong index. Instead, value sector such as financials, banks and industrials account for over a third (35.6%) of the market.
A substantial £38.9bn has been removed from funds in the Investment Association’s three UK equity-dedicated sectors over the past three years as investors migrate to growth-led markets, and Pictet senior investment specialist Rupert Howard does not anticipate a reversal in this downward trend unless value comes back into vogue.
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“The UK does definitely suffer from the construction of its market,” he said. “It is one of the major developed equity markets that has no technology, at least in the large-cap space.
“Obviously there’s been a huge amount of emphasis on growth that’s been tech-led, so the UK has missed out on that. We have great quality companies and a lot of banks, but they are very cyclical and typically sit in the value space – not the growth space.
“You would need to see a big rotation into value to justify making any big bets in the UK. If you’re worried about growth and think that’s an area that is going to be on the back foot, then there are definitely opportunities in the UK. We saw that in the first half of 2022 when the UK was by far the best performing market.”
UK’s unique composition is also its greatest advantage
Growth investing’s long-running hot streak has not been without it’s bumps. When markets were hit with soaring inflation and rapidly rising interest rates in 2022, the tech-heavy S&P 500 was especially vulnerable, tanking 8.3%. The UK, on the other hand, thrived, with its value-heavy FTSE 100 index climbing 4.7% throughout the year.
The US quickly returned to overtake the FTSE 100, but this period of market uncertainty goes to show the UK is the first port of call for investors when they want to diversify, according to J.P. Morgan global market strategist Hugh Gimber. And with high volumes of investment into tech pushing the US to lofty overweights within most portfolios in recent years, the UK could be an attractive area for those looking for diversification.
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“The UK market is value orientated, and during a period when technology has been outperforming, it’s been really difficult for the UK to keep up. You could have seen things going well with the UK economy, and still the FTSE 100 would have struggled to keep up with the US,” Gimber said. “But the discounts we see on offer in the UK are starting to look much harder to justify.
“The expectations for the tech sector this year are clearly very high, so the valuation you’re paying for those punchy earnings expectations is extremely high. If you’re looking for a market that can offer you some diversification against the US leadership, the UK sector compositions start to look a lot more attractive.
“When global equity investors are looking for regional diversification, they want a market that has a different sector makeup, and so that UK versus US comparison becomes clearer.”
Can the UK realistically foster a globally competitive tech sector?
Despite an absence of a tech presence in the large-cap space, the UK is not without its technological innovators. In fact, the UK has given birth to some of the world’s most disruptive tech companies over the past decade, with startups such as Darktrace and DeepMind driving significant developments in artificial intelligence.
But while the UK has nurtured these world-leaders in their early stages, it has been the US that has reaped the rewards once they become profitable. DeepMind was nabbed by Alphabet in 2014 and its share price has soared 523.6% since, largely thanks to its dominance in AI. Similarly, Darktrace removed its UK listing last year to pursue a higher market value in the States.
And there are plenty more examples of promising UK start-ups moving to the US once they enter their growth stage. The problem in almost all cases, Gimber said, is a lack of demand in the UK that the US and it’s large capital markets can provide to support that growth.
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“The UK doesn’t have an issue when it comes to innovation. We’re very good at fostering unicorns, so innovation isn’t the problem, nor is the financing – it’s demand that’s lacking,” he explained.
“The visibility on your opportunity set within the UK market is too small, and that’s therefore limiting companies built here from wanting to continue to growing here. We are building great technology startups, but we’re not providing the long-term demand.
“The UK economy is relatively small compared to other parts of the world, so if you don’t have strong trading linked with regional partners, it’s going to be very difficult to provide that kind of demand. We’re seeing a different approach from this Labour government in its approach to the relationship with the European Union.”
The UK government has launched new initiatives to encourage growth in the tech sector, namely driven by prime minister Kier Starmer’s desire to capture market share in the fast-growing AI industry. Tech giants in the US have so far led in this nascent field, but Starmer said the UK “will not sit back passively and wait for change to come” as he unveiled the AI Opportunities Action Plan. Chancellor Rachel Reeves went as far as to say that schemes to connect the UK’s technological hubs – Oxford and Cambridge – will create “Europe’s Silicon Valley”.
Yet the UK should not be trying to replicate the US market, according to Gimber. Its much smaller capital markets cannot compete for a start, but ultimately, the UK’s differentiated composition is its unique selling point. The UK offers global investors something very different from the US, which is an advantage rather than a headwind.
“There’s no easy solution here. Some of the recent steps that have been taken are the right ones, but the UK economy is only ever going to be a small proportion of GDP,” Gimber said.
“But that’s not to say the UK equity market should try and become tech heavy. We should celebrate the differences, because if every market looks very similar, the opportunity to diversify would go down. The fact that the UK market does have a different composition is actually one of its standouts.”
UK equities will never be exciting
The UK may provide ample opportunity for those seeking to balance out their concentrated portfolios, but it will never capture the imagination of long-term investors in the same way as US equities can, according to Simon Edelsten, partner at Goshawk Asset Management. Tech behemoths in the US promise to be at the forefront of global innovations, whereas the UK’s old-school companies are comparatively dull.
“When you look at the largest companies in the UK, they don’t have inspiring long-term growth stories to tell,” Edelsten said.
“The trouble with UK value stocks is that they have a run every now and again where they go from being on a silly valuation to a less silly valuation, but they won’t go any further unless they can find some growth. And the trouble with things like banks is they can’t come up with new products every few years, whereas technology companies obviously do.”
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And just because investors globally are seeking diversification, it doesn’t necessarily mean they’ll be gravitating towards the UK – almost every other equity market looks undervalued when compared to the US, Edelsten added. The UK isn’t unique in that it’s cheap, and many other markets are offering higher growth potential for undervalued prices.
“[UK equities] are proving to be a diversifier to some extent because these old economy stocks are doing perfectly well share price wise – not necessarily commercially – because the valuation gaps are so big,” Edelsten said.
“Things like British banks have been going up over the last couple of years, but not because they have good long-term prospects. It’s just because the valuation has gotten so low that they can only really go in one direction.
“Technology shares in the US have gone up a lot for a long time now, so surely this is a good time to get some balance. But you’ve got to do it with your eyes open. The big British companies may all look quite cheap, but the potential for them to grow is still challenging.”
This story was written by our sister title, Portfolio Adviser
