The Week: Is the UK index fit for purpose?

The UK market is facing an assault from private equity, which is picking off the best companies at the bottom and top of the market. How can it improve?

  • Listing rules have left British companies vulnerable to private equity takeovers
  • Private equity is going from strength to strength, raising new capital
  • The risk is that UK investors are left with an unattractive rump of shares after private equity has cherry-picked the best

It is clear that part of the unpopularity of the UK market has not simply been around Brexit or the pandemic response, but around the construction of the UK market. Stringent governance rules have seen exciting new companies list elsewhere in the hunt for greater flexibility.

But this is not the only problem. Increasingly, the best companies in the index are being cherry-picked by private equity groups. Schroders chief executive Peter Harrison bemoaned the current listing rules in an interview with the Financial Times this week, saying that they had left British companies vulnerable to private equity “raids”. The tax deductibility of debt was also a problem, he said. Regulators needed to take note.

Certainly, private equity appears to be going from strength to strength. In the first six months of the year, private equity bids for UK-listed companies reached their higher level in two decades. This was capped at the weekend by SoftBank-owned Fortress announcing a £9.5bn deal to acquire Wm Morrison, Britain’s fourth-largest supermarket chain.

At the other end, it has long been the case that companies are staying in private hands, so private equity is scooping up all the exciting younger companies as well. Private equity is raising more capital – as seen with the planned Bridgepoint flotation - which will give it more firepower.

The risk is that institutional investors get access to all the exciting companies coming through from the bottom and the best companies that have been carefully selected from the index, leaving an unattractive rump of poorly performing companies in the index, which is the focus for many retail investors. This is already happening to some extent, but policymakers need to try and stop the rot.

What’s the solution? Harrison said that a recent government-backed review, which called for an overhaul of the listing rules, was a good place to start. This planned incentives such as dual class shares, which are preferred by entrepreneurs because it leaves them greater flexibility to run the business as it grows. This type of structure is already available in the US and China. He also called for greater retail investor access to private equity opportunities. This is already happening as many investment trusts bump up their private capital weightings.

This will go some way to address an entrenched problem. The UK market needs to be able to sell itself on more than just its cheapness and its recovery potential. It needs to offer access to best of fast-growing British companies as well.