UK equities have been notoriously out of favour with both domestic and international investors for several years. Although the FTSE 100 has rallied in recent times, it is difficult to tell whether the tide is finally turning.
All we know for now is that investors have been consistently withdrawing money out of UK equities, with £8bn of outflows in 2023 alone.
Given that investment trusts are listed on the London Stock Exchange, investors might wonder whether – and if so, how – it impacts their holdings.
For Anthony Leatham, investment companies research analyst at Peel Hunt, the lack of popularity for UK equities particularly affects the 92 investment trusts that make up part of the FTSE 250, the UK mid-cap index.
He explained: “They can be affected by flows into passive vehicles such as trackers and ETFs, which are often more pronounced during volatile periods, when the index swings sharply in one direction and can sweep all stocks along with it.”
UK small- and mid-caps have been more affected by the exodus out of UK equities than their large-cap peers, which has caused some to worry that the asset class may be incrementally disappearing.
Leatham believes, nonetheless, that the share price of investment trusts should reflect the performance of their holdings in calmer market conditions, regardless of the underlying asset class.
However, Emma Bird, head of investment trusts research at Winterflood, warned that the decrease in global asset allocation towards UK index tracker funds will continue to act as a headwind for investment trusts, which together account for roughly 8% of the FTSE All Share.
Investment trusts have a different natural investor base compared to ‘normal’ UK equities, predominantly composed of domestic retail investors. This nuance means that they have not been as adversely affected by the shift away from the domestic market by UK pension schemes and the lack of interest in UK equities among foreign investors.
James Carthew, head of investment companies at QuotedData, said: “What we don’t have is a general problem of UK investors wanting to asset allocate away from the UK, because the investment companies market is set up to allow them to do that.
“Neither are we suffering from overseas investors shunning the UK, as they were never buyers of investment companies in the first place. One of the great failures of our EU membership is that there was never a proper single market for investment – so Brexit made no real difference to the investor base for investment companies.”
Yet, Bird stressed that UK-focused investment trusts, which account for nearly 10% of the investment trust sector’s net assets, will be more impacted by the unloved nature of UK equities.
Carthew also pointed to an issue specific to investment trusts and unrelated to their listing location, namely the competition of ETFs, open-ended funds and large partnership structures.
While discounts should, in theory, incentivise investors to favour investment trusts over other pooled investment vehicles, this is not what is happening in practice.
Carthew said: “We can only speculate as to why, but we feel that it is a lack of awareness of the opportunity amongst retail investors, the cost disclosure issue amongst professional investors (which we are hoping that the government/FCA will address) and the consolidation of wealth managers.”
The later factor means that most investment trusts have become too small and not liquid enough for wealth managers.
For instance, investment management firm Quilter Cheviot recently revealed having a preference for investment trusts with at least £250m of assets under management and considering anything below £200m as sub-scale.
According to data from Peel Hunt, it means that 120 out of approximately 300 investment trusts are technically uninvestable for Quilter Cheviot.
Carthew added: “Some investment trusts have tried to address this through mergers but we feel it is likely to be insurmountable, unless the clients of those wealth managers feel that they are missing out on opportunities and take their business elsewhere.”
Bird concluded that it is still unclear what the catalyst for a re-rating will be, but she expects M&A activities, interest from private equity firms and regulatory development incentivising increased investment into the UK stock market to play a positive role.