More UK companies are talking about moving their listing to the US (Ashtead is the latest to propose a move). The valuation gap to the US has become larger (Exhibit 1). And only a small proportion of this is due to sector distribution; every sector in the UK is on a double-digit P/E discount to its US counterpart sector (Exhibit 2). This discount is of course a Europe-wide phenomenon, but the gap between the UK and US is especially large.

US companies are far more profitable, but even relative to ROE, the UK market trades at a low multiple vis-a-vis other markets; the UK has roughly twice the ROE of Japan but a similar Price-to-Book (Exhibit 3).

A lack of allocation to UK equities by long-term domestic capital (pensions/insurance funds) and by households is a large reason for the discount, we think. Only about one-third of the UK equity market is held domestically, compared with over 80% in the mid-1990s.

Assuming we do not see fund flows into UK stocks, there are only so many ways to try to narrow the valuation gap to the US – relist, take-private (where valuation gaps are lower), be taken over or do more buybacks (if you think your shares are under-valued). We are seeing all of these happen. Indeed, UK equity supply is shrinking both via a lack of IPOs and a rise in buybacks/take-privates (Exhibit 4). We expect all four strategies to continue. But, of course, these create their own momentum, shrinking the UK market further and reducing total trading turnover.

As we discuss in our Portfolio Passport, UK-listed companies are very international. Exposure to North America for FTSE 100 is in aggregate 29%, which is higher than UK exposure (22%) or Europe-ex UK (16%) (Exhibit 5). There are plenty of opportunities for UK stocks to re-list. That all being said, smaller stocks would find themselves tiny within the context of the much larger US market, while bigger stocks that hope to be in the S&P 500 would have no guarantee of inclusion and would likely face a long wait until it happened (the decision is committee-based).

In order to stem this migration and reduction in equity supply, there would need to be more allocation to equity by UK-based capital, in our view. This is something that both the current and previous governments have recognised, but material policy action has been lacking. Household savings flows are almost entirely into cash/deposits (Exhibit 6).

DB Pension funds have deserted equities (not just UK), and given aging beneficiaries and asset-liability matching rules they are unlikely to return to equity, in our view. Government plans to merge local authority pension funds could be a helpful move, but much depends on their willingness to take risk and allocate to UK equities. The good news is that DC pensions are growing (Exhibit 7) and the flows into these are larger than in DB – but the allocation is still conservative given the age of these beneficiaries (Exhibit 8).

It will take substantial commitment to reverse the outflow from UK equities that has been happening since the 1990s. Changing rules for insurance companies, reducing subsidies for allocating to cash/bonds and increasing those for allocating to equity could all be part of any remedy, in our view.