The role of an investment banker is fundamentally about being present in financial hotspots. However, significant capital is currently moving away from UK active equity funds, with around £150bn withdrawn since 2016, as reported by analysts.
This shift can be attributed to various factors. UK equities have underperformed, leading investors to seek better returns in other markets. The high fees associated with active management have driven capital toward more affordable passive funds. Additionally, a historical bias toward domestic investments has sparked a move towards international equity markets.
As pension funds evolved, adopting strategies focused on matching income with liabilities, many sold off UK equities to invest in government bonds, a transition propelled by regulatory and accounting changes. The elimination of the dividend tax credit in 1997 and the impact of Brexit have further complicated the landscape for UK equities.
Institutional investors, including pension and endowment funds, have increasingly favored alternative assets such as real estate, infrastructure, hedge funds, and private equity over public markets.
Similar trends have emerged in the US, where passive investment has surged, resulting in only 37% of equity fund assets being actively managed, down from 60% in 2015. Consequently, active equity managers, traditionally significant participants in initial public offerings (IPOs), have seen a depletion of funds, while passive funds, which can only invest in stocks post-inclusion in indices, have seen inflows without new issuance engagement. This discrepancy has led to a disconnect between rising stock indices and stagnant IPO activity.
In contrast, India continues to witness a robust equity market characterized by a vibrant issuance environment, largely driven by flows into active funds.
In the UK, discussions about reviving the equity issuance landscape have intensified, with calls for policies to redirect local savings into domestic stocks. However, if capital continues to flow into passive funds, it may not necessarily revitalize the IPO market, as it could lead to a revaluation of existing large-cap stocks instead. Policymakers will need to ensure that capital is directed to fund managers more inclined to invest in new issues to stimulate this market.
Additionally, private equity funds have capitalized on the outflows from active public equity funds, using these resources for acquisitions while simultaneously putting downward pressure on stock market valuations. However, a thriving IPO market remains essential for the private equity model to ensure returns to investors. As the number of active public equity managers declines, the viability of this exit strategy diminishes.
Considering these trends, companies might find it advantageous to remain private, avoiding the challenges of public listings and fluctuations in share prices. The availability of substantial capital in private markets supports this strategy. Leaders in the industry have recognized the benefits of maintaining a private status, emphasizing the need for caution when transitioning to public markets.
The ongoing capital outflows have profound implications for public equity markets, resulting in fewer new share issuances and an increase in share retirements, effectively reducing the investment pool. While some may view this trend as negative, it may serve to stabilize share prices by addressing decreased demand, particularly from active funds.
Having spent the early part of my career as a strategist focused on UK active equity managers, the notable outflows prompted a pivot to a global perspective. In retrospect, a move toward private markets could have been more advantageous, as that is where substantial capital is currently concentrated.
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