Model Portfolio Review: UK’s troubles call for change of direction

The unloved UK market continued to underwhelm in the third quarter, prompting a rethink for some of our model portfolios. 

The UK equity market lagged international stock markets in the first half of 2018, and it was the same story in the third quarter, with the FTSE All-Share index posting a loss of 0.8 per cent. In contrast, the FTSE World index returned 6.2 per cent in sterling terms.

While the underperformance of UK equities may whet the appetite of more contrarian-minded investors, as far as our model portfolios are concerned, it was a big factor behind eight of the 12 falling short of their relevant FTSE UK Private Investor index benchmark in the three months to 1 October.

On a six-month view, though, the picture is brighter, with 10 of our models beating their benchmarks. More importantly, over longer time horizons our models continue to more than hold their own thanks to astute fund selection, with 11 of the 12 portfolios outperforming on a five-year view.

Over the quarter the one growth portfolio that outshone its benchmark was Bravo, our medium-term growth, medium-risk portfolio. Two global funds fuelled Bravo’s performance. Fundsmith Equity and Fidelity Global Dividend returned 5.7 and 5.3 per cent respectively over the quarter. Bravo returned 3.1 per cent, ahead of the FTSE UK Private Investor Growth index return of 2.9 per cent.

Our income funds generally fared better, with India (up 2.4 per cent) and Lima (up 1.8 per cent) gaining an edge on the FTSE UK Private Investor Income index, which returned 1.5 per cent. Hotel returns were in line with the index.

India, our growing income, medium-risk portfolio, also saw its global fund exposure pay off. Over the quarter Henderson International Income Trust returned 4.9 per cent and Artemis Global Income gained 3.8 per cent. It was a similar story in the case of Lima, our growing income, higher-risk portfolio, which also holds Artemis Global Income.

A bigger helping hand, though, was provided by Schroder Oriental Income IT, which gained 5.5 per cent over the quarter. That was an impressive feat against a volatile backdrop for Asia and the emerging markets, owing to an escalating trade war and strong dollar. It was therefore not much of a surprise to see the Veritas Asian and Baring Eastern Trust funds in the bottom two positions out of the 48 funds held across our models, with losses of 6.4 per cent and 5.6 per cent respectively.

Overall, it was a challenging quarter, with 17 holdings in the red. At the other end of the table, global funds were big winners, with eight out of the top 10 performers operating with an overseas equity remit. Private equity trust Pantheon International was the best performer in the quarter, having gained 6.4 per cent. It benefited from reporting a 4.4 per cent increase in net asset value per share in August.

Brexit concerns remain at the forefront of investors’ minds, leading many investors to shy away from UK equities. As a result, the UK market has fallen behind other global indices as investors have recycled their money into businesses listed overseas. Figures from the Investment Association for the first two quarters of 2018 show that global funds were the most popular category among retail investors.

In the third quarter UK growth and income funds lagged their global counterparts, in line with a wider trend playing out over the past year or so. However, it is worth pointing out that various UK funds have put in a good show over the period, with CFP SDL UK Bu­ffettology and Schroder Income the star performers, returning 20.2 and 12.3 per cent respectively on a one-year view.

Nevertheless, in this review the UK weightings across our models caused performance to cool versus the respective private investor benchmarks, as our models have notable ‘overweight’ positions to UK equities. With this in mind, and also the prevailing uncertainties over how Brexit will pan out, we have taken some UK equity exposure off the table and recycled the proceeds into global equities.

Please click for bigger version of table

A table showing how funds have been performing in the model portfolios


Growth portfolios: Medium risk

This has led to swapping Witan IT with F&C Trust (formerly Foreign & Colonial) in both Bravo and Charlie. While both operate on a global scale, Witan has a third of its assets in the UK, whereas in contrast, F&C has just 6.6 per cent in the UK. We are fans of its dynamic asset allocation approach, including its exposure to private equity. The net dividend yield is low, at 1.5 per cent, but dividend growth is reliable and progressive, averaging 3.7 per cent a year over the past five years.

In addition, we have decided to remove the HSBC FTSE All-Share Index tracker in Bravo in favour of Artemis Global Growth, which has achieved Money Observer Rated Fund status in every year since 2014. During the annual review, we will consider replacing the trackers in the other two portfolios where passive investments are held (Delta and Echo).

One potential downside to reducing the UK weightings in some portfolios is the prospect of a sterling recovery, which will play out in the event of a Brexit deal being reached with the EU.

However, as things stand, there is a real possibility of a negative outcome and either side walking away from the negotiating table without an agreement. In such a scenario, the pound will weaken further. Such currency moves are notoriously difficult to predict and prepare for. In any case, the FTSE All-Share is heavily influenced by non-sterling earnings (a positive influence on the index when sterling is weak, and vice versa), so the influence of a stronger pound would have been minimal if the tracker fund had been retained.

As a result of the changes, Bravo’s UK equity weighting falls from 39 per cent to 25 per cent, while Charlie’s new weighting will be 31 per cent, down from 37 per cent. This puts both portfolios’ UK exposures closer to the Private Investor Growth index, which has a 21 per cent weighting. But, in the case of Alpha, the shorter-term, medium-risk growth portfolio, we have decided to stick with our choices, and for this model we are comfortable with the 35 per cent weighting to UK equities.

Eagle-eyed readers will also notice a new name in our Charlie portfolio, but this is only due to a rebranding at Old Mutual Global Investors, part of which is now known as Merian Global Investors. As a result, Old Mutual Global Equity is now called Merian Global Equity. The fund is also held in Echo.

A table showing how growth portfolios lag benchmarks


Growth portfolios: Higher risk

We have opted to hold fi re on making any changes to our higher-risk growth portfolios, but we are keeping a close eye on a couple of funds on performance grounds.

In Echo, our higher-risk medium-term growth portfolio, LF Miton UK Value Opportunities is a concern. On a three-month view, the fund was the fourth-worst performer out of all the funds in our models, having lost 2.9 per cent, while its one-year return was also disappointing, at just 2.5 per cent. The fund is also held in Charlie.

Baring Eastern and Miton UK MicroCap Trust are also struggling for form over three and six months. Both are held in Foxtrot. In the case of Baring Eastern, the macroeconomic backdrop has been unkind, but we will nevertheless be looking for performance to improve in all three of the funds mentioned above at the annual review. Elsewhere in Foxtrot, Old Mutual UK Mid Cap is now called Merian UK Mid Cap.

On page 2: income portfolios and new portfolio weightings

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