Why UK shares deserve a second look after Brexit

Ten years on from Brexit, and seven Prime Ministers later, investors have delivered their verdict on the UK stock market. Since the referendum, hundreds of billions of pounds have flowed out of UK equity funds, London’s share of global stock markets has shrunk, and Wall Street has left the FTSE 100 trailing in its wake.

Yet, that may be exactly why UK shares deserve another look. Comparing the performance of the London market with the S&P 500 over the past decade seems on the surface to justify the prevailing negativity. But it is a more nuanced story than it looks. There are good reasons to be positive on the UK equity market, and it earns its place in any balanced portfolio.

• Need that next level of support? Fidelity’s financial advisers can help with savings, investments, retirement and pensions

If you had invested £100 in the FTSE 100 on referendum day, it would be worth £164 today. Not a fantastic return over ten years, and significantly less than the £354 you would have if you had directed the same amount at the S&P 500. You would have fared even worse if you had plumped for the more domestic FTSE 250 mid-cap index. Here your £100 would have turned into just £135. Please remember past performance is not a reliable indicator of future returns.

The differential is less pronounced if you factor in dividends because the UK has always paid a higher income than its counterpart over the pond. With re-invested dividends, £100 would have turned into £239 with the FTSE 100. That compares with £419 in the US benchmark and £178 for the UK mid-caps. Better, but still a significant level of underperformance.

• Get the latest market updates, ISA news and pension insights by email

Correlation is not causation, though. Brexit is the obvious culprit, but the reality is more complicated. Some of the factors that have held UK shares back were already in place. By 2016, pension funds were already reducing their exposure to domestic shares in favour of global mandates. The composition of the UK market was already out of line with investors’ preference for growth and particularly technology stocks. Brexit may have amplified these factors, but it was pushing on an open door.

The UK market was already out of favour and experienced steady but relatively modest outflows in the four years to 2020. Since then, however, the trend has accelerated. Cumulative outflows over the period as a whole amount to $160bn, according to Morningstar. That’s a stiff headwind.

What is striking about investors’ growing lack of interest is the sea-change it represents for a market that has historically had a strong home bias. At the time of the referendum, UK shares represented 40% of the most equity-heavy (80% plus) category of funds. Today the share is just 18%. By contrast, North American shares have risen from a 30% share to 50%. UK shares represented 10% of the value of the global benchmark 20 years ago. Today, the weighting is just 4%.

Asset managers have lost interest in running UK funds. Ten years ago, there were slightly more new UK funds launched than were closed. Since 2018, the traffic has been strongly the other way. In the last decade, 380 UK equity funds have closed with just 200 being launched, again according to Morningstar.

It is not too hard to pinpoint the reasons for both the underperformance and the outflows. Largely, it is a sector story. The US has a heavy weighting to the areas of the market investors want exposure to - technology, communication services and online retail. Between 2010 and 2025, tech contributed half of the US market’s total return, but just 2% in the UK, where the tilt has been (and remains) to more defensive sectors like energy, banks and materials.

That, in turn has been reflected in a very different split in the drivers of return in the two markets. The UK has benefited more from dividend income than either valuation expansion or earnings. In the US, even excluding the Magnificent Seven stocks, higher valuations have been the principal driver, with dividends the smallest contributor.

Look over a shorter period, however, and the story is different. Over five years, again with income re-invested, the FTSE 100 has turned £100 into £177, only just shy of the £190 delivered by the S&P 500.

That similar performance, despite the continuing popularity of US tech stocks, reflects a few different trends which continue to favour the UK. First, there has been a rotation from growth to value stocks, as rising interest rates have reduced the relative attraction of unproven future earnings and cash flows. Cash-generative UK stocks look more compelling when bond yields are higher.

Second, the UK’s exposure to commodities and energy shares has been a positive in an environment of higher natural resource prices. Third, banks (another big UK overweight) have benefited from higher interest rates, as have the UK’s big dividend payers.

Perhaps most importantly, however, investors have started to warm to the UK’s much cheaper valuations. British shares are around a third cheaper than their US counterparts. While the gap has narrowed from nearly 50%, that is still compelling. And a steady stream of takeovers (mainly from US and European companies) proves that corporate buyers are prepared to act if public markets will not assign the right value to listed companies.

With this week’s tech stock wobble once again pointing to the fragility of the AI-led bull market, investors are looking increasingly to pair capital preservation with a late-cycle search for capital gains. The UK clearly has a role to play in that kind of diversification. As and when the tech bubble starts to deflate, the relative resilience of the UK’s old economy stocks will appear increasingly attractive.

The first decade after Brexit has been defined by a derating of UK assets. Ten years on, British shares are among the world’s cheapest. If the uncertainty in Westminster starts to abate after this summer’s changing of the guard, the appeal of UK shares will become even more apparent.

This article was originally published in The Telegraph.

Got a burning question you want to ask? Why not drop us a line. Click here to ask your question.

• Read: How ISAs will change in 2027
• Read: Do I own SpaceX without realising?
• Read: How to retire at 45, 50, 55 or 60

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.