Can UK investors sow the seeds of economic growth?

In my May letter, I cover:

• UK growth challenged by demographics

Unsupportive demographics constrain the UK’s growth economic potential, despite a strong financial heritage.

• Green shoots emerging for productivity-led improvement

While the composition of the UK equity market differs significantly from the US, rising AI adoption among UK firms is beginning to support productivity gains.

• We remain overweight equities

We are global investors: we believe the UK has a part to play in investment portfolios, but we also value global diversification. Within global equities, we have a preference for emerging markets.

The value of investments, and the income from them, can fall as well as rise and you may not get back what you put in. Past performance should not be taken as a guide to future performance. You should continue to hold cash for your short-term needs. This article should not be taken as advice.

The UK represents a conundrum for investors.

On the one hand, the UK has a long-standing reputation as a global financial centre. At Coutts, we’re reminded of this every day: we have stood proudly on the Strand in London since the 1690s, putting our clients’ capital to work.

On the other hand, despite a grand tradition of financial leadership, the UK does not typically invest substantially in itself. Capital expenditure by businesses is low versus the US, and UK individuals are inclined to be savers, not investors.

How is this panning out for the UK economy, and are there any signs of change?

Demographics working against UK growth

In its simplest terms, economic growth is a function of population growth and productivity. Demographics matter, and they are not on the UK’s side.

The UK fertility rate has fallen to record lows, with the total fertility rate in England and Wales falling for the third consecutive year in 2024 (the most recent data), down to 1.41 children per woman. Data from the National Records of Scotland show that the overall fertility rate in Scotland has dropped to 1.25, with Scottish birth rates reaching their lowest levels since records began in 1855. These rates are significantly below the ‘replacement level’ of 2.1 – the birthrate required for population stability.

In the past, the UK population has been bolstered by immigration – an emotive subject, and it’s likely immigration levels in the UK have peaked for the foreseeable future.

The overall picture for demographics – an ageing population with fewer people in the future – is already a reality in other economies. Japan, China, Germany and Italy all face a variation on this dynamic.

With population growth not supporting the UK economy, can productivity weigh in?

The crop mix: inside the UK equity market

Productivity is typically driven by investment in the real economy, such as infrastructure or new technologies. There are some structural issues holding back the UK in this regard. Not least, the composition of the UK public equity market, which is not especially exposed to high growth sectors like technology, where investment could boost growth.

Take the most commonly cited market index for the UK: the FTSE 100. The technology sector accounts for less than 1% of the FTSE 100 index. In the US, technology and technology-adjacent shares account for around 40% of the S&P 500 index. 

However, it’s worth noting that many UK-listed companies – including a large proportion of those represented in the FTSE 100 Index – are effectively global businesses, which are merely domiciled in the UK. The outlooks for these companies are more likely to be influenced by changes in the global economy than events in the UK economy.

At Coutts, while we invest with a worldwide scope, we do have positions in UK equity markets. In recent years, it’s been our view that the most exciting opportunities in UK equities have been in the more domestically focused parts of the market. As a result, our UK equity exposure has been tilted away from global energy and pharmaceutical companies and tilted towards more domestic sectors, such as consumer discretionary and financials.

Seeds left unsown: capital is not being put to work

To grow, UK businesses need investment, from themselves and from capital markets. But there is a stumbling block here: the UK is a nation of savers, not investors.

The UK population is very good at setting money aside, even in a challenging inflationary environment. Not every household in the UK has spare capacity within its budget, but on average almost 10% of household disposable income in the UK goes towards savings, according to figures from the Office for National Statistics (ONS). For context, the equivalent US figure – according to the St. Louis Federal Reserve – is just 4%.

However, these statistics do not separate out saving from investing – two quite different undertakings.

Based on my professional experience on either side of the Atlantic, I can attest anecdotally that there are sharp cultural differences in investing. Don’t just take my word for it, the statistics back this up too: in the US, 58.1% of households have equity market investments. Estimates of how many UK households are actively investing vary widely, but are consistently lower. It’s widely accepted that capital market investment rates (outside of private pensions) in the UK are low, possibly as low as 8% and likely the lowest among the G7 nations.

Besides the wider economic dynamics, a reluctance to invest has potential knock-on effects for personal wealth in the UK, as would-be investors can miss out on the compound growth that investing in financial markets can bring. 

But it’s not only individual savers who aren’t investing. Companies in the UK do not have a culture of investing in themselves in the same way as, for example, US technology giants. 

Green shoots: where progress is emerging

The UK population may not be channelling its savings into investments, but there’s still cause for optimism.

If you’ve read my letters before, you know that we see real growth potential through AI. This is more than just a technology sector story – it has the ability to transform productivity across the economy.

US equity market performance has been better than the UK in large part because US companies overall have been more productive and more innovative. In the UK, there is growing evidence to suggest that AI is beginning to have an impact on company productivity, as businesses incorporate AI into their operations.

Some estimates point to a productivity boost of more than 10% in the UK through AI implementation over the past year, and the path for AI productivity gains could be non-linear – accelerating rather than moving at a steady pace. If this is true, then it’s plausible that investors are currently undervaluing the pace of change and productivity growth that AI can support for UK businesses.

What we’re cultivating: our core investment views

We’re global investors, with positions diversified across asset classes, sectors and regions. Our priority is always to look for compelling investment opportunities – wherever in the world they emerge. When it comes to harnessing growth trends, such as those around AI, we find potential in diverse global regions, particularly emerging markets.

This diversification not only creates access to a wider world of opportunities, but can also provide resilience when any single shock dominates the headlines. The past few weeks in the Middle East have provided a timely reminder of the value of diversification alongside a robust investment process.

Our Anchor and Cycle process aims to harvest attractive risk premia, while also leaning into favourable economic growth and earnings fundamentals.

Below, we recap some of our highest-conviction investment views.

Bonds offer limited appeal; our preference remains equities

Interest rate cuts in the UK and Eurozone are still largely expected to begin in 2026, but we remain cautious about placing too much weight on these forecasts, especially as central banks continue to assess the potential inflationary consequences of developments in the Middle East. Even before the current conflict, we were measured in our outlook for bonds, reflecting their limited diversification benefits versus equities alongside a backdrop of structurally higher inflation.

While markets have been unsettled in recent weeks, the global economy entered this period from a position of resilience. Our proprietary analysis continues to point to an economy in an ‘expansion’ phase, a backdrop that has historically favoured equities over bonds. As a result, we continue to expect equities to deliver stronger returns than bonds over time.

Diversification through gold and ‘liquid alternatives’

With diversification a central pillar of our portfolio construction, we have selectively increased exposure to alternative assets, including gold and liquid alternatives, in certain portfolios.

We hold a modest overweight position in gold. Demand has been underpinned by central bank buying and a broad base of investors, although gold did not consistently fulfil its traditional safe-haven role during March’s heightened geopolitical environment. We retain our positive view on gold, while also stressing the importance of building multi-asset portfolios that are designed to perform across a range of potential outcomes through broad diversification.

Liquid alternatives have, meanwhile, delivered strong relative performance versus both equities and bonds. These strategies can offer greater flexibility and downside control, though they remain suitable only for specific investors.

Emerging markets: attractive valuations alongside powerful growth themes

Earlier this year, our regional analysis identified a renewed set of opportunities within emerging market equity markets, marking a shift after several years of more limited prospects. Historically, equity markets in these regions have tended to perform well during phases of economic expansion and recovery. In line with our expectation that the global business cycle is moving towards an expansionary phase, emerging market economies appear well placed to benefit.

Emerging market equities are further supported by strong technology ecosystems in markets such as South Korea and Taiwan. Valuations also remain attractive relative to the US, alongside encouraging earnings growth, particularly in areas such as semiconductor exports linked to ongoing AI investment.

In a nutshell: We favour equities over bonds and enhanced diversification through gold and liquid alternatives. We also maintain an overweight allocation to emerging market equities to capture growth opportunities into 2026.

Over the long run, investment returns are often driven by real growth in the economy. All else being equal, a sustained period of real economic growth drives up investment returns across asset classes. It’s our view that we are in the foothills of a sustained period of productivity-led economic growth.

This is not only potentially fertile ground for investment returns, but could also help to address the great challenges of our day, such as high levels of government debt and deficits, social inequality and the increasing challenges presented by difficult demographics.

Yours sincerely,

Fahad Kamal

Chief Investment Officer