UK Outlook: The Radical Centre

The UK public markets have faced significant headwinds in recent years, marked by political instability, sluggish economic growth, and a retreat of investor capital. However, there are signs that 2025 could bring an upswing for the UK's financial landscape, driven by regulatory shifts, infrastructure spending, and a growing recognition of the undervaluation of UK assets. Senior Fund Managers, Mark Costar and James Lowen have offered valuable insights into the factors that may shape this turning point for UK markets.

Emerging Stability: A Turning Point for UK Politics and Economics

For a long time, the UK has been considered a ‘favourite underweight’ for global investors. Mark Costar, Senior Fund Manager of the JOHCM UK Growth and JOHCM UK Dynamic strategies, attributes this to the turbulent political climate that began with Brexit, which led to years of uncertainty, changing leadership, and lack of investor confidence. "Brexit started off the bad news, but then we’ve had a revolving door of Prime Ministers" Costar reflects, highlighting how these political disruptions made the UK an unattractive destination for investment.

However, Costar believes that the UK may now be emerging from this period of political instability, with greater stability on the horizon. "We’ve retreated back to the centre, and the relative certainty that that may now yield going forward could prove beneficial for UK markets." The stabilizing political climate, coupled with improving economic conditions, could potentially reverse years of persistent outflows from UK equities.

James Lowen, Senior Fund Manager of JOHCM UK Equity Income, adds another perspective, noting the challenges posed by sluggish productivity growth. Nevertheless, he believes that the UK’s political environment is showing signs of improvement. “There’s a lot of pressure on politicians to reverse the issues we’ve been talking about,” Lowen states, suggesting that such pressure could lead to policy changes that encourage more investment in UK markets. One key issue is the low allocation of UK pension funds to domestic equities, which has declined significantly in recent years due to de-risking strategies. This trend, according to Lowen, could soon reverse if policymakers take action to encourage greater pension fund investment in UK assets.

Under Attack

One of the most striking characteristics of the UK public markets in recent years has been the significant undervaluation of UK companies. Both Costar and Lowen have observed a growing wave of mergers and acquisitions (M&A) activity targeting UK firms. Lowen notes, "Well, it feels like we’re under attack. There is a feeding frenzy of M&A activity this year. We've had 45 companies leave the UK market. That’s the highest in 15 years, and there’s been bids for £160 billion of our market cap." The extent of this M&A activity underscores how undervalued many UK companies are in the eyes of potential acquirers.

Lowen’s own fund has not been immune to this trend. "I’ve got 60 stocks: I’ve had 6 bids for this year, 4 consummated, and 2 warded off." This is the highest level of M&A activity he’s seen in 20 years, indicating that UK companies are increasingly being viewed as attractive targets for foreign investors. The undervaluation of these stocks, combined with generally strong operating performance , is driving this surge in takeover activity.

Costar adds to this sentiment, saying, "We keep coming back to the UK because there are world-class disruptive businesses here that have really strong structural growth optionality, but they're trading at table-thumping discounts." He notes that his strategy has also received multiple bids for UK stocks this year, including two at triple-digit premiums, which further illustrates the significant undervaluation of the market. “It’s not just what the valuation is on the spreadsheet, it’s cold, hard cash validating that undervaluation,” Costar adds, pointing out that international investors see the UK market as offering unique opportunities at attractive prices.

A Climate of Change

The rampant M&A activity has also spurred concerns within UK boardrooms, as many companies fear they will be acquired at undervalued prices. Lowen explains that during meetings with management, there is often a focus on the issue of undervaluation. "The last 10 minutes of each meeting after we’ve talked about the operational performance… is why is a share price so low?" he says. This discussion often leads to considerations around share buybacks, capital allocation, and other strategies to release hidden value within the company.

There is a palpable fear that companies will be taken over cheaply, which is leading to proactive measures by management teams to fend off potential bids. Lowen highlights a specific case where a company was offered a 67% premium for its shares, but the bid was rejected by shareholders. "It’s now trading 20% above that and we still think it can double," he points out, illustrating how trying to buy assets too cheaply can lead to missed opportunities for potential acquirers and a strong case for disciplined ownership in UK markets.

Building the Future

Amid these challenges, the UK government is placing significant emphasis on infrastructure development, which could offer much-needed support for the economy. Lowen highlights the government's commitment to investing over £320 billion in infrastructure over the next five years. This spending, focused on projects that have a multiplier effect on the economy, could significantly boost growth and provide opportunities for private sector investment.

Costar also points to the changing regulatory landscape, which may help to accelerate growth. The UK has long been burdened by onerous planning regulations, which have stifled development in areas like housing and energy infrastructure. However, Costar sees hope in recent efforts to reform these regulations. For example, the UK government is planning to build 1.5 million new homes over the next five years, a significant increase from historical levels. “These planning levers will help drive and accelerate growth in the UK,” Costar notes.

Green Lights Ahead

The outlook for the UK public markets in 2025 is cautiously optimistic. As Lowen puts it, "valuations are flashing green," with many UK stocks trading at deep discounts compared to their US peers, presenting significant opportunities. He adds that positive corporate news flow, along with rising earnings, cash flows, and dividends, is contributing to investor confidence. Costar echoes this sentiment, noting that the UK market remains "a tremendous hunting ground" for finding mispriced stocks with strong growth potential. With these favourable conditions, the UK market is well-positioned to keep recovering in 2025.

The views expressed are those of the portfolio managers as of the date of this piece (11 December 2024), are subject to change, and may differ from the views of other portfolio managers or the firm as a whole. These opinions are not intended to be a forecast of future events, a guarantee of future results, or investment advice.

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