A personal view from Ian Stewart, Deloitte’s Chief Economist in the UK. To subscribe and/or view previous editions just google ‘Deloitte Monday Briefing’.

While equity indices power ahead, the global supply of equities is shrinking. The disappearance of equity through share buybacks and leveraged buyouts exceeds new public listings. In the past listing on a public exchange offered the principal route to new funds for larger businesses. Today there are a host of alternatives. Private equity, sovereign wealth funds, infrastructure funds, family offices and late-stage venture capital all compete with public markets. The equity market is no longer the default route to scale for growing businesses. An increasing proportion of the corporate sector is privately owned. A number of major tech companies, including SpaceX, Stripe and Open AI, remain private.

What is driving de-equitisation, the shrinking of public equity markets?

The cost of finance is one factor. Between 2009 and 2022, US short rates averaged just 0.6 per cent, one-sixth the rate prevailing in the previous 20 years. Low interest rates mean that financing a business with debt is cheaper than with equity. That created an incentive for businesses to switch from public equity markets to debt-financed private markets.

The costs and burdens involved in listing – which include listing fees, quarterly earnings calls and mandatory disclosures – add to the attraction of the private route. For technology start-ups seeking to safeguard intellectual property, private investors offer patience and a willingness to burn cash. Start-ups now commonly receive multiple funding rounds, providing pre-IPO liquidity for employees and founders.

Nowhere is the shrinkage of public equity markets more apparent than in the UK. Schroders estimates that the number of companies listed on the main market of the London Stock Exchange fell by about 75 per cent between the 1960s and 2022. Research by New Financial shows that since 2012 an average of 125 companies have left the UK stock market every year, mainly as a result of companies going private or acquisitions by overseas firms.

The UK market has been affected by the switch to private markets seen elsewhere. But other factors are also at work. Demand for UK equities from domestic institutional investors has flagged in recent decades. UK pension funds and insurance companies, once the main holders of UK equities, have diversified into overseas equities and alternative assets, such as hedge funds, real estate and infrastructure since the 1990s. Then, from the early 2000s, regulations designed to better match the assets of defined benefit (DB) schemes to their future pension payments, led to DB schemes significantly increasing their holdings of government bonds.

Heavier weightings in overseas equities, alternative assets and necessary government bonds squeezed DB schemes’ holdings of UK equities. The average allocation by DB schemes to UK equities collapsed from over 50 per cent in the 1990s to just 2 per cent in 2022.

But this process of diversification is a two-way street. Diversification by overseas investors from their own markets has led to a significant increase in foreign holdings of UK equities. Roughly 60 per cent of all UK equities are now owned by overseas institutions and individuals, up from 33 per cent in 2000 and just 8 per cent in 1963. The UK equity market has a more geographically dispersed and global customer base than ever. Overseas institutions have replaced UK pension and insurance companies as the major owners of UK equities.

DB schemes are shrinking in importance and currently have fewer than 1m active private sector members. But defined contribution (DC) pension schemes have 18m active members, and, as a result of pension auto-enrolment, their numbers are growing. Annual contributions to DC schemes are twice those going into DB schemes. DC represents the future of UK pension provision. Crucially, DC schemes make significantly higher allocations to equities than DB schemes.

Will the growth of DC schemes create a new, natural buyer of UK equities? That depends on the perceived attractiveness of UK equities to these schemes.

Today the US is the most popular major developed equity market. In the last 30 years returns from US equities have been more than twice as high as those from euro area or UK equities. Part of this relates to the strong performance of tech shares, which account for perhaps one-third of the US equity market, a far greater share than in the UK or the euro area. Europe has tech companies, including ASML and STMicroelectronics, but nothing that matches the scale of the likes of Meta, Apple or Alphabet. Investors’ love affair with technology has a distinctly US flavour, with US tech stocks significantly outperforming their European and Asian peers in the last decade. After a multi-year bull market US equities account for a remarkable 70 per cent of the MSCI global developed market equity index. You can understand why investors around the world want exposure to US equities. 

The UK equity market, with its reliance on energy, mining, financial services, telcos and utilities, lacks the tech component that has powered the US market. Even outside tech, US stocks command higher valuations than their UK or euro area peers. This helps explain why some London-listed UK businesses, including biotech firm Abcam and packaging firm Smurfit Kappa, have moved to the US market. Investors are simply more optimistic about prospects for future growth and returns from US-listed companies than their European peers.

This has left UK equities looking cheap relative to US equities and, indeed, euro area equities. The discount on UK equities relative to their US peers has rarely been so large. But just because something appears to be cheap doesn’t mean it will make money. Financial history is littered with examples of apparently ‘cheap’ assets that keep getting cheaper.

Markets can and do change direction. Witness the stellar performance of Japanese equities in the last two years after decades in the doldrums or the fall from grace of Chinese equities since 2021. The UK macro picture, with growth returning and inflation in retreat, looks better than it has for some time.

I will leave the prognosticating on equity markets to others. What is clear is that the shrinkage of public equity markets and the growth of private capital have transformed corporate ownership. That looks here to stay.

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