Why The UK Stock Market Continues To Be Takeover Central

1st May by Mark Simpson

15 comments 1955 reads

There is an undeniable trend in UK markets for takeovers of listed companies, and it is easy to see why. Of the roughly 800 UK stocks with a positive EBITDA, the median EV/EBITDA is 10 versus 15 for the 3000 such companies in the US market. There are some fundamental reasons for this mismatch in valuation.

Pension Fund Flows

One of the biggest reasons for this disparity is a dramatic shift away from UK Equities being owned by UK Pension funds. The Capital Markets Industry Taskforce (CMIT) reports that this is due to two trends. Firstly, UK pension funds have shifted away from owning equities into bonds, as this chart from CMIT shows:

This is primarily because Defined Benefit pension funds, almost all of which are now closed to further accrual, have been de-risking, which involves selling equities and buying bonds.

Secondly, pension funds have increasingly been given a global mandate when investing in all assets, including equities. Defined contribution schemes, which are now the norm, tend to offer their members global trackers rather than UK trackers. This makes logical sense for clients. However, the knock-on impact on UK equity allocation is stark. With the proportion of assets invested in non-UK equities remaining reasonably constant, the shift to bonds has almost entirely come at the cost of UK equity allocation. This has dropped from over 50% in 1997 to around 6% in 2021. Such a shift cannot occur without impacting valuations.

Retail Fund Flows

With pension funds net sellers over the last few decades, the record of retail investors taking up the slack is mixed. Unfortunately, we are a flighty bunch. Here are the cumulative retail flows to UK equity funds over the last decade from The Investment Association:

These rose significantly between 2013 and 2015 and again in 2020 and 2021. However, 2022 and 2023 have been terrible and given back almost all the cumulative inflows over the previous decade. The data so far for 2024 isn't looking any better, with £1.8bn of outflows in January & February.

Part of this may be the logical response to pension funds' selling. No one wants to step in front of a freight train. However, this has been a multidecade trend that didn't stop retail inflows into equity funds a few years ago. The recent net outflows…

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Mark

1st May

Excellent report. Thank you

intuitive6191

"Despite the recent number of offers in the UK market, it can be hard to get data on takeovers. The reason is that acquired shares disappear from databases such as Stockopedia or Google Finance once delisted"

This has been discussed many times before and I think is seen as a shortcoming. If Stockopedia wants to do similar takeover analysis again in the future, it might be useful to manually save a stockreport of the target company on the day of a proposed takeover?

Same for any increased offer etc.

Epitychia

Excellent report. Anecdotally a lot of takeovers seem to be with firms that have a stock rank in the 80s, unfortunately I usually only invest in companies with a 90+ rank. So I have missed out on these takeovers.

jonno

Fabulous piece Mark. Much I didn't know.

Thank you.

Trident

Very good article.

I wonder also if the ageing population factors into the move to Bonds, because unless corrected pension providers will tend to use the 'glide path' to switching from theoretically riskier equity into bonds, as the pension holder creeps towards retirement age.

Much has been made of this recently suggesting it is denying ageing pension holders from boosting their holding from racier equity returns.

Mark Simpson

Thanks. Shows how hard it is to predict which specific companies will be taken over. I wonder if having a 90+ StockRank is likely to require reasonable Momentum. In most cases, acquirers pounce when the share price is weak and the two rarely overlap.

WarrantStar

To my mind it would be beneficial if the UK government would take a carrot and stick approach to encourage UK pension funds to hold UK shares. This could be done in a tapered fashion so that the higher the percentage of the funds assets which were shares, the more benefit the fund would receive. I'm not talking about a massive switch away from bonds, but rather an attempt to move to a slightly more balanced situation. Does anyone now how other countries deal with this?

mikebianchi

Nice work Mark the figures are stark, something needs to change. We need a proper Conservative Government, take a risk get a reward like it used to be. The near demise of CGT, divs hammered just sends the wrong message, its all so disappointing we have been badly let down. I'm also BTL owner it seems like they are trying to get rid of decent private landlords, why ?

NK104

All very interesting but has anyone told The Pensions Regulator. It's not that DB schemes wanted to have less in equities. The Regulator has effectively bullied everyone into the same derisking journey. I think pension schemes would laugh at the total lack of joined-up thinking if tax relief was conditional on investing in UK equities.

NK104 I do agree that the government needs to have some joined up thinking about this.

ezlifeme

the government needs to have some joined up thinking about this

Never going to happen (with any government)

2nd May

I would imagine a good few of the takeover targets have something wrong with them that purchasers think they can improve. Tclarke (LON:CTO) had been pointed out previously as having excessive director costs and fancy headquarters. Strip those out and they could be a 90+.

Threepeat

Thanks Mark. Very educational so a lot I didn't know

The Phoenix

The banana skin in 2022 though Trident was most of the bonds on the glide path were long dated gilts/corperates that lost 15-20% plus over the year, its become aparant to me that if you want to get into bonds you should be in short dated especially with the yield curve inverted at the moment so the compression uplift to price should also come at the short end.

With regards to long dated bonds again personal opinion is you might as well be invested in equities rather than that area as the risk is similar but the upside far less.

marigold

3rd May

They are hammering all small businesses, including landlords, because they seem to favour the corporations. Government policy is increasingly driven by the corporate sector and pressure groups not the actual citizens that vote for them.

Why the UK stock market continues to be takeover central

Pension Fund Flows

Retail Fund Flows

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Mark Simpson

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