Catalyst: an agent that precipitates an event or change

There has been a lot of coverage recently on the ongoing ‘dismal’ performance of the UK equity market and what the likely causes may be, with one particularly well-known investment manager making the headlines by referring to the UK as ‘a backwater in 21st century equity markets’ no less.

We have written several times previously about what appears, to us at least, to be the incredible value on offer in the UK equity market which, despite all the negativity, remains a top 10 pool of equity capital globally. At c.$3 trillion of value, and full of world leading business franchises, we do not intend to repeat the argument in this piece, suffice to say we still firmly believe it to be the case.

Instead, given we have been asked the question numerous times recently, the purpose of this note is to look at what might be the ‘catalyst’ for this supposedly fantastic value to be realised. We start by confessing that we really dislike the word ‘catalyst’ as it relates to investing. In our experience catalysts are rarely identified in advance and usually only ‘obvious’ with the benefit of hindsight.

That rather large caveat aside, are there legitimate reasons for optimism going forwards or should we accept our inevitable backwater fate and move on? For sure, the list of reasons why performance has been so dismal is lengthy and includes the tortuous Brexit process, political instability, lack of dynamic growth companies, relentless selling by UK domestic institutions (particularly pension funds), quality companies choosing to list overseas, UK focussed retail funds seeing non-stop outflows (22 months and counting according to Calstone) and on and on.

With such significant headwinds it is little wonder that relative performance has been so poor. Whilst that is true over a long period, shown on the chart below as the MSCI UK relative to the MSCI All Country World index over the last 20 years, what is perhaps less well observed is the consistent, albeit still modest, pick up in performance in recent years as shown at the end of the chart.

The fact that MSCI UK has been outperforming since late 2021, despite the relentless negativity towards anything and everything UK related is, at the very least, interesting. Perhaps some of those headwinds we have endured are, at the margin, starting to ease, or possibly already fully discounted now they are front page news.

But what if this trend persists for another year or so? Will ‘momentum’ turn in favour of the UK? Will technical analysts start buying the UK? Could performance chasing lead to inflows and beget more outperformance? Perhaps it all seems wishful thinking right now but that, generally, is how investment trends typically start. Of course, if it were to transpire there would be the inevitable chorus of ‘it was so obvious’ – such is the way with hindsight bias.

One notion we have a great deal of sympathy for is that alternative market participants, such as overseas corporates and private equity funds, are already recognising and acting on the incredible value opportunities available in the UK. Perhaps this trend, should it persist, will convince others of the outstanding bargains they have hitherto been missing. Following a short hiatus in mid/late 2022, activity appears to be firmly back in 2023 as the chart below, from Numis, highlights. Nearly $16bn of confirmed or potential deals already in 2023, typically at large premiums to the prevailing share price, notwithstanding headwinds such as rising interest rates and a mini banking crisis in the US.

To be clear, we take no pleasure in seeing our publicly traded companies taken private on what, in many cases we are sure, is still an undervalued basis. However, we can certainly understand why it is happening and while the value opportunity persists, we suspect the trend will continue.

To conclude this short piece, we do not really know or frankly care that much what the catalyst(s) may be to see improved performance from the UK equity market in the years ahead. Maybe it will be the multitude of recent headwinds ceasing to be so. Perhaps the M&A activity at material premiums to prevailing prices will persuade investors. Or maybe it will be nothing more than improving performance that convinces people. Then again, it could be something entirely different altogether.

What we do feel confident in saying is that there is significant value in broad swathes of the UK equity market, and we firmly believe that value ultimately prevails. We entirely reject the notion that the UK represents anything like a ‘backwater’ but rather has faced some very material, largely cyclical, headwinds over recent years that has left sentiment unbelievably depressed. Whilst we, alongside everyone else most likely, cannot necessarily spot the catalyst, we can most definitely spot the opportunity. We are sure that, one way or another, others will do likewise – eventually.