• FTSE 40th anniversary – The FTSE 100 launched on 3 January 1984 and has reached its 40th birthday. There is still a cachet from membership, but the celebrations are a damp squib given the marked underperformance of the index.
• Marked underperformance – The scale of underperformance is startling and is even worse if currency adjusted.
• Multiple drivers – There are a number of reasons for the underperformance, but what is noticeable is that there was broad correlation with the S&P500 through to 2010. Economic conditions in the UK have been unhelpful, but the majority of earnings in the FTSE 100 are generated overseas, so that is only a contributing factor. Of more importance are fund flows, index constitution, tax rates, pension fund repair, liquidity and global relevance.
Does this matter? – most definitely. The poor performance of UK markets directly impacts on economic growth, tax revenue and the wealth of investors, pensioners, charities etc. Changing this dynamic is imperative – regulatory change is happening, but we believe it needs a comprehensive change of approach (to risk, governance, incentives and tax) to have a meaningful impact.
There are many reasons for the lacklustre performance of the FTSE 100 – We see these as some of the key ones:
Index composition – The FTSE 100 is weighted towards financials and resources and heavily underweight technology. The UK is excellent at innovation, but has been poor at scaling and retaining businesses as they grow. ARM is just one of many examples.
Pension funds & insurance companies withdrawing and globalising – UK pension funds and insurance companies used to be the main owners of UK equities. However, this has dropped from a combined 46% of the UK equity market in 1997, which has reduced to 4% today. This was driven by a combination of interest rates, risk aversion and regulation.
Pension repair – The prioritisation of risk over performance has resulted in vast sums being injected into pensions over the past 15 years. This has materially impacted on companies’ ability to invest in growth as well as shareholder returns.
Wealth managers – Wealth managers used to heavily weight portfolios to UK equities, but they now focus on global portfolios. There has also been regulatory pressure regarding risk appetite, which has driven allocations into so-called balanced portfolios.
Retail investors – The growth of ISAs and SIPs should have been helpful, but these also enable global allocation. As a result, we now have the anomalous situation where UK tax incentives drive investment outside the UK.
Tax changes – A plethora of tax changes have reduced the appetite for investing in equities, such as the increase in dividend tax, the reduction in CGT allowance and the changes to tax on pensions.
Corporation tax – The UK did briefly benefit from comparatively low rates of corporation tax. The increase from 19% to 25% sharply reversed this feature and means that the earnings and free cash flow of UK companies are reduced.
Liquidity – This is particularly important for US investors and stamp duty provides a real cost and friction for share trading. This means that trading in the UK is relatively unattractive compared to the US given that the UK has a 0.5% charge, whereas the US does not charge stamp duty. The growth in highly active funds has exacerbated this impact.
Market relevance – The reduction in market capitalisation of the UK market globally means it has become relatively less important for global investors. It is striking that the value of the entire UK market of £2.4tn is similar to the value of Apple. For a global investor, calling the performance of Apple is as important as calling the UK market.
Index funds – These merely follow index weightings and so the increased market cap of US companies drives higher allocations from index funds.
Focus on dividends – For much of the past decade, dividend funds were dominating the investment philosophy in the UK. This encouraged companies to increase distributions rather than invest in growth.
Dividends vs share buybacks – The US focus on share buybacks helps index performance whereas dividends are not included. This means that the total shareholder return of the FTSE 100 is under-played if just judged by index performance.
Cost of capital – The relatively low valuation of UK companies has increased the cost of capital and thus reduced the appetite and ability to invest.
IPO aspirations – There was a time when floating was an aspiration for successful entrepreneurs and companies. This has diminished in the UK due to all the costs, regulations and disclosures required in comparison to remaining private or selling out. It is notable that this aspiration is alive and well in the US,
with a long list of companies looking to float.
Russian exits – There was a period when Russian companies were keen to list in the UK and a number became constituents of the FTSE 100. The Russian invasion of Ukraine resulted in sharp declines in both Evraz and Polymetal before their ejection from the index.