Is there a hidden hazard lurking in your funds? Investors may not have realised the full extent of their UK exposure.
There are plenty of investment risks on the horizon, with the US-China trade war, Brexit uncertainty and sluggish growth in Europe arguably the biggest, but UK investors have an ingrained bias that poses another potential problem.
It has pretty much become a consensus view among experts that UK equities look attractive from a valuation standpoint. But as the calls of “buy, buy, buy” grow louder, there’s a sound reason why UK investors in particular should tread carefully.
Hidden UK risk
The fact is that most, if not all, investors will already have a sizeable amount of exposure to the UK. This is not a new observation, nor does it come as a complete surprise, but investors may not realise the full extent of their UK holdings.
First, let’s deal with why home bias has become a well-established phenomenon, and consider how exposed UK investors are to their home market. Home bias exists in part because of the familiarity factor. Investors feel more comfortable investing in companies they understand or have at least heard of. In some cases, UK investors will own shares in UK businesses whose products and services they use personally.
A tendency to favour home shares has also been fuelled by the historical perception that international shares are difficult to access. Another factor is concern over political and currency risk, on which more later.
Charles Schwab, a US wealth management firm, found in a survey (albeit with a small sample size) last year that 74% of UK retail investors with at least £25,000 in disposable assets invest mostly in the UK. To put that in context, the UK has a 5.9% weighting on the MSCI World index.
Elsewhere, Mercer, the pensions consultancy, puts the proportion held by UK investors in UK shares at 25-40%. Hannah Goldsmith, a financial adviser, says that in her experience between 40% and 60% is typical. She adds: “Too much home bias results in a lack of diversification. If you lived in Germany, would you have 40% in the UK? No, you wouldn’t.”
Added to that, the UK market is highly concentrated, and this increases risk for home market-heavy portfolios. According to MSCI, the index provider, the five largest UK companies represent 30% of its UK index. As Bruce Stout, manager of Murray International IT, points out, the FTSE 100 index has a heavy weighting to banks and commodity stocks, while other sectors, including technology, have little or no representation.
“Those who stick to their home market are not maximising the opportunities out there,” he says. He adds that home bias is a bigger problem for some countries than others. “In the US you can buy pretty much anything you want, as all sectors are well-represented.
But in Japan you wouldn’t be able to buy an oil company.”
Research by Vanguard, published in February, supports the idea that sticking close to home has its disadvantages. The firm points out that “domestic equities tend to be more exposed to the narrower economic and market forces of their home market, while stocks outside an investor’s home market tend to offer exposure to a wider array of economic and market forces”. It adds: “These differing economies and markets produce returns that can vary from those of an investor’s home market.”
Best-performing stockmarkets since 1988
|Region||Number of times best performer|
|Europe ex UK||4|
|Asia Pacific ex Japan||5|
Note: *Data only available from 1994. Source: Aberdeen Standard Investments
How non-UK sectors are exposed to the UK
|IA fund sector||UK weighting median %*|
|Global equity income||15|
|40-85% shares multi-asset||29|
|20-60% shares multi-asset||26|
|0-35% shares multi-asset||29|
Note: *We calculated the median average rather than the mean to remove outliers, as FE Trustnet did not have data for every fund in each sector. Source: FE Trustnet, April 2019
As a consequence, home market bias increases risk. Vanguard notes that the 17 countries it examined (including the UK) have been more volatile over the past 30 years than the MSCI All Country World index. James Norton, a senior investment planner at Vanguard, says: “UK investors instinctively think that overseas adds risk. But it’s the exact opposite, as there is much more variety in terms of the sectors and industries that can be accessed, which reduces risk and makes a portfolio more diversified.”
Moreover, the UK market has become progressively more global in nature over this three-year period, and more than 70% of FTSE 100 earnings are generated overseas. As Ben Yearsley at Shore Financial Planning points out, the blue-chip index is not really a play on the UK. He says: “I’ve always taken the view that balanced investors should have broadly 50% of their investment pot in the UK and 50% outside. There is no real reason for this, but instinctively it feels about right. Your long-term liabilities (housing, care, pensions and the like) are in the UK, so you should have a reasonable proportion in your home country and currency.”
Another argument for having a home bias is that there is no currency risk. This has become even more important, according to Ben Willis, head of portfolio at Chase de Vere. He says: “For UK investors in overseas markets, currency management is increasingly playing its part in investment returns.”
But the longer the timespan investors have, the less of an issue currency risk becomes. Vanguard’s research supports this conclusion. It found that from the start of 2000 to the end of September 2018, the difference between hedging or accepting currency volatility was marginal.
Stout also believes the currency argument is a distraction. He points out that since 1988 the UK stockmarket has, in sterling terms, only been the best-performing stockmarket twice (in 1990 and 1996) against five other main markets: North America, Europe ex UK, Japan, Asia-Pacific ex Japan and Latin America. He says: “There’s a common perception from a currency point of view that an investor needs a disproportionate amount in their home market, but this does not ring true.”
On the surface, it seems, the fund management industry also believes home bias is what investors want and need (as the table above shows). Research by Money Observer, using FE Trustnet data, has found that a typical cautious fund in the IA mixed investment 0-35% shares sector has a 29% weighting to the UK, measured by the median average. The other multi-asset sectors also carry sizeable UK exposures: mixed investment 20-60% shares averages 26%, mixed investment 40-85% shares 29% and flexible investment 23%. This could be a reflection of fund managers sticking to what they know. While this is not a bad thing, it potentially leaves investors more exposed to the UK market than they realise.
Moreover, investing in a global fund may also carry a chunky weighting to the UK. While the typical fund in the IA global sector only has an 8% weighting to the UK, some funds with ‘global’ in their name have considerably more, for example: Jupiter Global Value Equity (34%), Lindsell Train Global Equity (27.7%), Guinness Global Money Managers (25.8%), Investec Global Situations (25.4%) and Schroder Global Recovery (25.1%). Some active funds have a ‘value’ focus, so the current big positions to the UK will reflect the opportunities the managers see.
The passively managed Vanguard LifeStrategy 100% Equity fund also has a sizeable weighting of 25%, despite Vanguard acknowledging that home bias is a potential problem. Five years ago the weighting was cut from 35%. Norton says home bias is used to arrive at a sensible balance. He adds: “This takes into account investors’ preferences for a home bias based on familiarity, and a global market cap weight that we believe is a good starting point for all investors.”
The same pattern follows for the IA global equity income sector. The median average, at 15%, is higher than for the global sector, reflecting the high dividend-paying nature of the UK market relative to most other markets. But funds such as Schroder Global Equity Income (35%), Veritas Global Equity Income (25.3%) and Trojan Global Income (24%) have notably more than that in the UK.
That’s why investors who have a sizeable position in UK funds need to look under the bonnet to determine their true overall UK exposure from the global funds they invest in, and also to spot duplicate holdings.
Care also needs to be taken with bond funds. While sterling corporate bond funds sit in a UK sector, don’t make the mistake of thinking other bond funds with a more unconstrained remit have minimal exposure to the UK. The average fund in the IA strategic bond sector has a UK weighting of 39%. High-yield bond funds and global bond funds have less, at 18% and 7% respectively.
Best routes to active global exposure
The BMO fund, managed by Jamie Jenkins and Nick Henderson, invests in firms making a positive contribution to society and the environment, while avoiding those with damaging or unsustainable businesses practices.
James Thomson, manager of the Rathbone fund, cut his UK exposure down from 25% following the Brexit vote in June 2016.
At the time, he reasoned (correctly) that there were too many uncertainties over how the UK’s divorce proceedings with Europe would pan out.
As a result, he decided to take advantage of his global remit. Thomson looks for easy-to-understand businesses able to control their own destiny.
Artemis Global Income, managed by Jacob de Tusch-Lec, a value investor, makes a point of intentionally keeping UK exposure to a minimum, in order to give UK investors global income by geography.
Murray International’s manager, Bruce Stout, does not view the UK market as attractive. He focuses on defensive businesses that he has great confidence will be able to continue to deliver earnings and dividends, and that are attractively priced.