ClockWise: In praise of UK equities

UK equities have had a strong start to 2025 so far, outperforming global and US equity indices. The US market has been dominant recently, providing two consecutive years of 20%+ returns.

A new year could be giving way to a new narrative though. We have long been proponents of a healthy allocation to UK stocks in a diversified strategic allocation. In this current market environment, we also hold an overweight allocation to the UK on a tactical basis, as the region could be set to continue recent outperformance.

We design multi asset strategies for UK investors to maximise the level of real returns for a given level of risk. We aim to increase risk-adjusted returns by diversifying broadly including assets such as commercial property and commodities within the strategic asset allocation. A further strategic choice is a bias towards UK equities.

Many multi asset funds invest in equities on a market capitalisation basis. These global indices are heavily biased towards the US market – which now accounts for 68% of the FTSE World equity index, whereas UK equities make up less than 4%. In contrast, our strategic equity mix currently has 20% in UK equites, 70% in global equities and 10% in emerging markets. The active decision to have a higher weighting in the UK is made for the following three reasons:

Diversification

In our view, a higher UK weight improves diversification by sector. Global equity indices are heavily exposed to the expensive US technology sector. Blending with UK equities, with their higher allocation to defensive and commodity-sensitive sectors, results in more balanced exposure (Chart 1).

Chart 1: Sector weightings for global equities vs our 20/70/10 regional mix

Source: FTSE, RLAM, as at February 2025. Global Weights showing the GICS sector weighting for FTSE World Index, 20/70/10 weights showing the GICS sector weighting for 20% of FTSE All Share Index, 70% of FTSE World Index and 10% of MSCI Emerging Markets Index.

Valuation

We believe that UK stocks offer very good value, in part due to its sectoral mix. The cyclically adjusted price-earnings ratio, popularised by Robert Shiller at Yale University, for the US market is above 35x – a level only exceeded before the 1929 crash, during the dot com bubble and in late 2021. The UK market valuation at 15x is around its 30-year lows, at less than half the multiple of the US market (Chart 2). On a five-to-ten-year view, valuation is often cited as the best predictor of future returns.

Chart 2: Cyclically adjusted price-earnings ratios

Source: Barclays, RLAM as at January 2025. The cyclically adjusted price-earnings (CAPE) ratio, also called Shiller P/E ratio, measures the price of a stock index relative to its past 10 years earnings, adjusted for inflation.

Inflation resilience

UK equities have historically tended to outperform global equities in a rising inflation environment, most likely due to a consistently lower exposure to bond-sensitive growth sectors. Table 1 compares equity returns across periods of rising and falling UK inflation since 1969. The results highlight that over the long run, UK equities have provided similar returns to global equities but with a more consistent pattern, irrespective of the inflation backdrop. Global equities have posted their best real returns when inflation is falling, struggling when it is rising, as we saw in 2022.

UK equities have historically tended to outperform global equities in a rising inflation environment, most likely due to a consistently lower exposure to bond-sensitive growth sectors.

Table 1: Annual return in excess of Inflation (UK RPI)

Source: Bloomberg, LSEG Datastream, RLAM, as at February 2025. Indices used with returns classified into rising and falling inflation regimes based on trends in annual retail price inflation. Data from December 1969 to December 2024.

Past performance is not a guide to future performance.

The characteristics that make the UK attractive strategically are also generating a positive view tactically at present. The country remains inexpensive versus peers on a range of valuation measures while higher exposure to commodity-sensitive sectors, along with a weaker pound, is providing a tailwind for corporate earnings. Markets have been rewarding these factors, lifting UK shares higher in relative terms (chart 3). The last time we had a consistent overweight was in 2022, when the UK turned out to be the best performing developed market.

The country remains inexpensive versus peers on a range of valuation measures while higher exposure to commodity-sensitive sectors, along with a weaker pound, is providing a tailwind for corporate earnings.

Chart 3: UK vs World Equities

Source: LSEG Datastream, RLAM, as at 27 February 2025. UK equities shown by FTSE 100 in sterling terms and World Equities shown by MSCI AC World Index in local currency terms. Both indices calculated on total return basis.

For professional investors only.  This material is not suitable for a retail audience. Capital at risk. This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.