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As a senior adviser at Engine AI and Investa, and with experience as the former chief global equity strategist at Citigroup, my career has offered me a unique perspective on the ever-changing world of investments. Years ago, a colleague wisely advised me, “The job of an investment banker is to hang out where the money is.” While it sounds straightforward, the most effective advice often is just that.
If you’re wondering where the money is not these days, look no further than UK active equity funds. Since 2016, an eye-popping £150 billion has been withdrawn from them, as determined by Goldman Sachs.
This mass exodus isn’t without reason. The underwhelming performance of the UK equities market has nudged investors to seek better returns elsewhere. High costs and mediocre results have naturally driven many towards more affordable passive funds. Additionally, a long-standing domestic bias has gradually given way to a broader gaze onto international markets.
As defined benefit pension schemes matured and turned to Liability Driven Investment strategies – strategies that closely align funds’ income with their pension commitments – we saw a sell-off in UK equities in favor of gilts. This shift was quickened by both regulatory adjustments and changes in accounting. Even Gordon Brown’s 1997 decision to eliminate the dividend tax credit had consequences, not to mention Brexit.
In pursuit of the lucrative Yale-model returns, pension and endowment funds began redirecting capital to alternative investments like real estate, infrastructure, hedge funds, and private equity.
Interestingly, these patterns have echoed in the US as well. Morningstar data indicates that the rise of passive investing has led to only 37% of U.S. equity fund assets being actively managed, a steep fall from 60% in 2015.
The significant takeaway here is that active equity managers, even in the US, have been the major losers of capital in recent years. These managers, typically keen to buy into IPOs, find themselves short of funds. While passive funds have attracted inflows, they seldom dive into brand-new issues, as they can only invest once a stock is part of the index they follow. This trend has inadvertently stifled the IPO market, a side effect of the growth of passive investing.
For a vibrant new issuance market, there’s a clear need for capital to flow into active equity funds. In the UK, the outflows have been relentless. Meanwhile, the U.S. has seen some equity inflows, mainly into passive, not active, funds. This shift has buoyed tech titans in the S&P 500, yet left fund managers who can seize the next new venture on the sideline. This dual trend illustrates the curious disconnect where U.S. indices reach fresh peaks while IPOs remain stalled.
In contrast, India presents a different scenario. There, a buoyant stock market is matched by active fund engagement with an uptick in new issuances.
In the UK, there’s been considerable reflection regarding the dwindling equity issuances. Several voices have advocated for policy shifts aimed at redirecting domestic savings back into local stock markets. If most investments land in passive funds, a revaluation of large-cap UK stocks seems likely. This revaluation may deter companies from considering U.S. listings, but reviving the local IPO scene will require channeling capital into hands more willing to invest in new issues.
The shift of funds into private equity has bolstered their acquisition capabilities, simultaneously deflating public stock markets and offering economical acquisition targets. However, there’s a limit here, as private equity also depends on a robust IPO market to return capital to investors. With active managers of public equities dwindling, this exit route is narrowing.
An alternative solution might be for companies to remain private, bypassing the trials of public listings and sidestepping the short-term volatility of stock prices. The private market is awash with capital. David Solomon, Goldman Sachs’ CEO, recently underscored this, noting, “If your company is thriving and growing, think carefully before going public, as it will alter its course—especially considering the ample private capital available today.”
The continuous outflow from public equity markets has significant ramifications. There are fewer new stock issues, and more are being retired, reducing the available investment pool. While some view this “de-equitisation” as a troubling sign, I see it as a crucial response to a drop in demand, especially through active funds. Ultimately, this reduced supply can bolster stock prices.
My initial career focus was as a UK strategist, serving active UK equity managers as my primary clientele. As they faced increasing outflows, I realized it was time for a change and thus transitioned to a global focus. While this move extended my career, I should have pivoted to private markets—that’s where the real capital resides.
