The UK market’s recovery has been driven by the biggest names on the FTSE 100 – but that concentration may be opening up opportunities elsewhere. Here, David Smith, fund manager of Henderson High Income, explains what he sees are the most interesting areas of the market today.
Much has been written about the concentration of the US equity market (a small number of stocks driving a large share of returns) given the dominance of the biggest US technology companies, often referred to as the “Magnificent Seven”.
But the UK has faced a similar issue that has received far less attention.
Despite the FTSE All Share returning 47.0% over the four years since the end of 2021, when interest rates began to rise, the gains have not been evenly shared. Performance has been heavily skewed to the very top of the market. The 20 largest UK companies returned 73.1% over that period, compared with 27.1% from the next 80 largest companies and a surprisingly weak 9.0% from the FTSE 250.
It’s easy to see why the largest companies have done so well. They are dominated by banks, which have become more profitable as interest rates moved higher; defence companies, which have benefited from heightened geopolitical tensions and increased commitments to defence spending; miners and energy names supported by stronger commodity prices; and pharma companies that have delivered sustained earnings growth and strong new drug pipelines.
The consequence is that those 20 companies now account for almost 60% of the UK market – a level of concentration that creates vulnerability if any of those supportive conditions were to reverse.
What’s notable is that, even with the UK market starting to perform better after years in the doldrums, valuations, in other words, the prices investors are paying relative to company earnings, still look reasonable: broadly in line with long term averages and cheaper than many overseas equity markets. Yet the real story sits beneath the surface, particularly in the mid cap space.
At the end of 2021, FTSE 250 companies were paying lower dividends than the FTSE 100, despite being more expensive. Today, that has flipped – mid‑caps now offer higher income than the UK’s largest companies. This is a rare setup that has occurred only three times historically: in 1992, when the UK exited the European Exchange Rate Mechanism (ERM), during the TMT boom (when investors chased fast‑growing technology stocks and largely ignored dividends), and at the depths of the great financial crisis (GFC) in the late 2000s.
It’s understandable why investors have preferred large, multinational businesses amid subdued UK economic growth and political uncertainty. But the UK economy has started the year better than expected, and further interest rate cuts remain likely. For income investors, this opens up opportunities in mid‑caps where dividend yields are attractive, balance sheets are strong and payout ratios (the proportion of profits paid out as dividends) remain healthy. This backdrop shows why UK mid‑caps are becoming harder to ignore.
Henderson High Income Trust invests in a diversified selection of both well-known and smaller companies with a heavy tilt toward UK stocks. Learn more about the trust and its portfolio here: Henderson High Income Trust | Janus Henderson Investment Trusts
