Should we be concerned about London's shrinking stock market?

Should investors be worried about the shrinking British stockmarket. London seems to be losing influence - both within Europe and versus New York - reducing investor choice. From more than 2400 UK listed public companies in 2015, the number has shrunk to fewer than 2000 today. Already, it has driven many wealth managers and their clients to increase international exposure, cutting UK investment, in turn accelerating the exit of capital and corporate listings from the UK. But for investors focused on UK shares, is the trend really a problem – how much choice is needed for an individual portfolio of shares?

In most countries, investors tend to favour their own domestic stockmarket. Though partly driven by emotion, cost and convenience, there is some justification for this ‘home bias’. It can give more comfort with investment risks, visibility on how a business is doing and reduce currency risk. For British investors in particular, home bias did not previously mean much loss of opportunity. The London market has historically attracted many big global businesses with easily traded shares. Those international groups gave investors access to growth around the world.

But Brexit triggered fresh thinking, with other European exchanges stepping up their competition for London’s business. The Pound has became more volatile and Britain’s economic growth is slower. That sparked the first wave of selling UK shares, but recent trends seem to be driven by the increased pull of the US for capital raising. New York primary listing is drawing London-listed businesses, particularly groups with big North American exposure. Often a share price rises when there is the prospect of a move to New York listing, as comparable US businesses are typically valued more highly.

Added to this has been unhelpful UK regulation, making fund managers focus overly on liquidity, and placing a disproportionate burden on smaller and medium sized companies. Second tier companies now attract less stockbroking research and find it harder to access investors. The challenge for UK investors is that over the long term medium sized companies have tended to grow faster, particularly if they are in a niche area propelled by technology or changing consumer tastes. And there has been a marked slowdown in new stockmarket listings to replace the ones that are taken over or move off the Stock Exchange.

Belatedly, the Government plans reform, recognising that the UK is not in a position to set tougher standards for the rest of the world. In sustainability regulation, in particular, the UK is at odds with Europe. Other countries are also now stepping back from the complex rules the UK has on investment research. Unfortunately there is little sign of change in British regulatory ambition, which has placed more restrictions on the London market; exchanges with flexible standards seem to be attracting the biggest companies.

This is concerning for the London stockmarket but change creates opportunity for investors. Relocation to the US has boosted some share prices, as has the recent wave of UK company takeovers. There is value for investors in spotting this arbitrage between listing locations, or seeing the gap between a depressed share price and corporate value on a takeover. And, if too much favourable emotion was once attached to British shares, that has certainly reversed now. Bids for some successful UK mid-caps suggests material undervaluation.

We can expect the Government to try to improve competitiveness, possibly by incentivising some big UK institutional funds to invest more in Britain. The solution might also involve recognising that quality investment research underpins a healthy capital market. It supports growth and helps the British economy to allocate capital effectively, but the burden needs apportioned fairly. Investors should not expect the pendulum to swing back quickly but meanwhile can benefit in many cases as companies move off the Exchange. There is still enough choice for investors in the London stockmarket.

A version of this article was published in The Herald on 10.6.2023

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