UK equities have underperformed and sterling has been under pressure since the Brexit vote in 2016.
The FTSE100 index, with more exposure to mining and oil than many other indices, has underperformed, particularly in the coronavirus crash; following this, having less UK exposure is a popular theme, just as many wanting higher exposure to US technology stocks is not surprising after significant outperformance. But, what is the right level of sterling or UK equity exposure to have? Do you have too little?
Strategic Asset Allocation (SAA)
- Our multi asset funds have been designed specifically for UK domiciled savers – people with sterling costs and sterling liabilities. Multi asset funds for US or Japanese investors would look different, of course. One size does not fit all.
- Our funds have more sterling exposure than some competitor funds, by design, particularly at the lower end of the risk spectrum. Perhaps asking whether risk averse clients ought to be taking a lot of currency risk is useful; we would suggest most would say they should not.
- From our analysis, it makes sense for sterling-based investors, looking to beat UK inflation, to consider having exposure to UK companies that are likely to see their incomes rise as UK prices rise. In a similar vein, we include exposure to UK commercial real estate as rents typically keep pace with UK inflation.
- We believe overseas exposure, beyond that coming from the significant foreign earnings of UK large cap stocks, is also important, bringing diversification, resilience to UK-specific political risk and exposure to sectors or industries not sufficiently represented in the UK market. Non-sterling exposure – from equities or commodities – could also be beneficial at times when the pound is persistently weak, raising the cost of imported goods.
- Our modelling suggests that for sterling-based funds, investing 40-60% of our equity exposure in the UK and the rest overseas can improve risk-adjusted returns over the long term. We review our strategic asset mix periodically and currently opt for a 50/50 approach. Using a pure global asset allocation weighted by market capitalisation would have given inferior long-term risk adjusted returns (see table).
Tactical Asset Allocation (TAA)
- While we have higher UK exposure in strategic asset allocations, it is important to note that our investment approach has led us to underweight the UK market tactically for most of the time since 2012, principally due to an inferior earnings performance and a higher exposure to out of favour cyclical sectors (see chart).
- We don’t see UK underperformance as permanent, however, and we keep exposures under constant review. The uncertainties are great, but as the world economy switches back on from the corona lockdown it is quite possible the UK could outperform for a period, as miners, oil companies and financials recover some of their lost ground.
- Our latest Investment Clock Report summarises our current views.
Source: RLAM data as at 30 April 2020, returns are expressed in sterling terms. UK Relative Data shows UK FTSE All Share Total Return vs MSCI AC World Total Return Data. Past performance is not a reliable indicator of future results. Portfolio characteristics and holdings are subject to change without notice. This does not constitute an investment recommendation. For information purposes only.
Past performance is not a reliable indicator of future results. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice. Portfolio holdings are subject to change, for information only and are not investment recommendations.