Beagles: Investors won’t allocate to UK unless…

Christopher Johnson: There’s no denying that uncertainty dominated investing in 2024, but the FTSE 100 remained surprisingly resilient and even beat expectations. Several factors contributed to this, notably the return of M&A activity in the UK market. But should investors be worried about the fall in the UK share market? To discuss all this and more, I’m joined by Clive Beagles from JO Hambro Capital Management.

Clive, thanks so much for being here with me.

Clive Beagles: Leisure.

Johnson: So my first question for you is: should UK equity fund managers be concerned about the rate of takeovers in the UK?

Beagles: Well, I don’t know if worry is the right word. I mean, at the end of the day, we’re in the business of trying to make profits and money for our customers. And clearly, a series of takeovers at substantial premiums crystallizes that kind of upside potential, if you will. So, in the short term, I think it helps the returns. But clearly, if the rate continues, on the current trajectory, there is a danger that in 10 years we will not have a market. So in that regard, I don’t think it’s—it’s not healthy in that sense.

But having said that, I think it’s highly unlikely. Because I think at some point the pace and trajectory of acquisitions will slow because I think prices will adjust. The UK trades at such a discount to any other developed market. That’s why we see so many mergers and acquisitions. And I think at some point, maybe when the flows have slowed down, which seems to be starting to happen, or maybe when fund managers’ views on what they think is an acceptable takeover premium, I think they start to increase little. Look at some of the more recent activity, a few offers are being rejected by major shareholders. So I think that process is already starting to happen. The rating gap is starting to close. People’s expectations about the type of premiums they should be able to expect are increasing. So I don’t think the markets are coming down to nothing.

I think what would be equally interesting – if we had a high-profile bid for a very large company in the UK, what would be the attitude of the new government? Especially if it was perhaps in one of the most controversial areas. If BP, hypothetically, if BP was auctioned off by Exxon, obviously the whole industry was one that was hardly at the top of the agenda for the politicians’ love list. But I suspect that surely BP will be considered part of Britain’s crown jewels and how on earth should we allow that to happen and all that sort of debate. So let’s see what happens from here.

Johnson: And what are the solutions, do you think, or are there policy solutions that can be made to make the City of London a more attractive place to list? Or do you think that would come naturally?

Beagles: Yeah, I’m not sure it will come naturally. I think they might need something more legislative than that. I mean, I think, on the one hand, obviously we went through a period of a lot of uncertainty. You mentioned in your introduction that we have had five prime ministers in six years; we had a Brexit referendum to deal with and so on. And I guess that didn’t help. We also cannot lose sight of the fact that all developed markets have underperformed the world index due to US exceptionalism. So maybe if we’re past that phase, maybe there’s an element of other markets that could catch up. Because really, when we look at discounting, most people look at the UK versus the US.

That said, the one very hot topic of debate that I don’t think people talk about enough is the whole issue of internal allocations to UK equities and the fact that the UK has the lowest allocation — it has the lowest allocation to its equities . domestic equity markets and whether the government could force allocations to be higher, particularly for tax-advantaged packages, be it individual pensions or corporate pensions. And I’m thinking, look, let’s see what happens, but it wouldn’t be a huge surprise to me to see some kind of backlash to the mandate, because I don’t think — people won’t — it doesn’t. I feel people will do it voluntarily.

Obviously, every other stock market in the world has much higher domestic allocations, and when we get into that philosophical debate about how the country benefited from giving someone a tax break in terms of investing in retirement for themselves, to invest in Nvidia or Amazon. or Microsoft, the country didn’t really benefit from that. So whether that comes immediately after the Budget or whether it comes at the end of next year when a new pensions act is being discussed, I don’t know, but I think that’s quite likely the direction to go.

Johnson: And can the FTSE 100 hit record highs by the end of the year, do you think?

Beagles: Yes, I mean, it can. I mean, we’re not that far off, are we? It would only be 2%, 3%, 4% of where we are today. So I think there’s a reasonable chance. Obviously, at the moment, we have uncertainties in terms of the conflict in the Middle East and so on that we can deal with, and none of us can predict how that will play out in a kind of a week, two weeks, even and on a three-month basis based on until the end of the year. But clearly, the market remains relatively modestly valued.

I think in saying that, I would suggest that there is probably more upside in the 250 and the small limit than the 100. They are further below their previous peaks. We’re going to have an environment where interest rates are going to come down, with inflation close to 2%, and I think the more inward-looking parts of the market, which are those indices, are more likely to be the beneficiaries. The FTSE 100, as you know, is rather dominated by international companies.

Johnson: One could argue that investors are getting too used to, perhaps, the sugar high that M&A provides to their portfolios? Is this a fair assessment?

Beagles: I don’t think so. I don’t think so. It doesn’t feel like there is much euphoria around UK equities. I certainly wouldn’t describe it as a sugar rush. The only change maybe has been that persistent outflows seem to have slowed down in the UK, but actually we haven’t – look at our fund and I think it’s similar to a number of other equity funds more Great Britain from Great Britain. in the market, the outflows have stopped, but the money has not started coming in yet. People are still more likely to tell you what Nvidia’s share price is and what it’s done in the last three weeks than the share price of any FTSE 100 company we could choose to mention.

Johnson: Do you see UK dividend paying stocks doing better next year than this year?

Beagles: Well, I think this is part of a larger debate around value versus growth as an investment style. And obviously we’ve had a period where growth stocks, including the big tech stocks in the US, but actually growth stocks in other parts of the world have had a much stronger performance because we’ve had more than a decade of interest zero effective and zero interest rates meant people could use low discount rates to value future earnings streams, and as a result, growth stocks benefited from that. I suppose we are in a more balanced environment now. Interest rates have risen. Now they will go down a bit, but they won’t go back to zero. I think in this environment I think investors need to look for a more balanced way across different parts of the market. In that regard, I think historically, value has performed very well over the very long term, but has underperformed over the last 15 to 20 years.

So I think, clearly, we have a very strong view that this should be part of somebody’s portfolio, but I think a lot of people who have just been — market participants who have only been in the market for the last 10 or 15 years . I really saw the point. It was all about capital growth rather than thinking that dividends could be 40%, 50%, 60% of your total return. You look at a fund like ours that has a yield close to 5%, you have that and then the opportunity to get capital growth on top of that. And it’s a dividend stream that grows, it’s not a static stream, it’s not like buying a government bond. Our fund turns 20 this year. On average, our dividend distributions have grown by nearly 10% per year. So you have a useful initial yield which then has the potential to grow. This combination of features should be really attractive in today’s environment.