Have you ever wondered why there has been such a marked pick-up in the amount of UK businesses that have been bid for in recent years? This year is no exception, and has been an extremely active one, with a record number of deals in the first half of 2021.

And there is no sign of this momentum slowing. Earlier this month, Meggitt, the UK-based aerospace and defence equipment supplier, received a bid from Parker Hannifin in the US at a whopping 71% premium.

That has since been followed by another takeover approach, this time from US group TransDigm, potentially with an even higher offer.

What is most striking is Parker Hannifin's expectation of the return it could potentially deliver on the transaction. With mergers and acquisitions (M&A) usually a zero-sum game between buyer and seller, this deal has made us stop to ask - what is really going on with the UK stock market?

Steep discounts across the board

How is the M&A market for UK listed shares so hot, while global asset allocators tend to show such indifference toward the market? We see a number of reasons, with the most obvious being that the UK lacks large cap technology companies in its benchmark.

Clearly, this would provide partial explanation as to the relative undervaluation. However, there is another less obvious reason: fund flows.

Since Brexit, and its five-year reign of uncertainty over everything from the hard currency status of sterling to the trade relationship with Europe, the asset class has suffered large and sustained outflows.

Global investor allocations to UK equities have almost halved since late 2015, and the asset class has seen 25% cumulative outflows since June 2016, according to Refinitiv Lipper data. The impact on the UK stock market has been profound, leading to an underperformance (in US dollar terms) not seen since the early 1970s.

Remember, the 1970s were a period of stagflation (slow economic growth and rising inflation) when the country was often in a state of emergency, culminating in the “Winter of Discontent”.

We would highlight that the relative “cheapness” of the UK stock market compared to other developed markets such as the US and Europe is more persistent and pervasive than commonly understood.

The cheapness is not just a function of ”value” versus the “growth” styles of investing, or lack of exposure to top-performing technology companies.

While this is some of the story, it does not explain the steep discount across sectors/industries versus both the US and Europe (see first graphic, below) causing acquirers to congregate as a flock around the UK.

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