Ever since the UK voted to leave the European Union in the summer of 2016, global investors have looked upon the UK as a pariah stock market with almost continual and indiscriminate selling. A recent survey by Bank of America Merrill Lynch of over 200 global fund managers, found that the UK was the least favoured of the global markets, with a net 28% underweight. Fundamental valuation analysis doesn't seem to have played a part in this judgement, with a sentiment-driven approach linked to the expected impact of Brexit being much more likely.
The UK weighting in a global context is quite minor, as it represents 4.75% of the MSCI ACWI Index, so decisions by global managers to allocate away from the region can be easily reached. This option is not as readily available to the UK investor, where UK allocations have historically tended to be up to 40% for a balanced portfolio. The question is, what are the implications of this home market bias for UK investors?
UK Revenues & Global Factors
A typical UK investor is likely to have exposure to the FTSE 100 index, which is a market capitalised, weighted index of the leading companies listed in the UK. This is not the same as gaining exposure to the UK economy, as the London stock market has long been a place for foreign companies to raise capital and list their shares. This is due to ease of raising capital, the strong legal and regulatory framework and the depth of the capital market. The current market comprises a range of global companies that generate most of their revenues, not from the domestic UK economy, but from global overseas markets. This includes the likes of the oil stocks majors, BP and Royal Dutch Shell, the global drinks company Diageo, and the mining companies BHP Biliton and Rio Tinto. Many of these companies have no UK revenues and are driven by global factors, rather than domestic consideration. To gain exposure to the domestic UK economy, investors may be better looking to mid or smaller cap stocks.
Positioning in a Portfolio
There are many reasons why private investors tend to have a bias to their home market. It makes sense to limit the currency risk and to provide protection against local inflation by having a higher weighting to UK equities. The UK has historically been one of the least volatile stock markets globally and so can be used to dampen risk in the equity element of a portfolio.
Although the Rfolios models have a strategic asset allocation to UK equities, we have the flexibility to take large overweight or underweight positions if we see value, or if the risks are appropriate. Currently, the UK market is one of the cheapest major stock markets in the world and consequently allows us to gain exposure to a number of quality, global stocks at attractive valuations and a host of undervalued UK domestic companies.