Important information: The value of investments and the income from them can go down as well as up, so you may get back less than you invest.

The latest figures from the Investment Association show that UK funds are firmly out of favour with UK retail investors. UK funds suffered net outflows in June and July of £1.1 billion and £912 million respectively. Other categories of fund proved popular over the same period, with global equity, North American and Asian funds seeing strong inflows1.

The poor performance of the UK stock market this year in relation to many others has clearly taken its toll. The malaise bearing down on UK equities is all too understandable given a 20% fall in Britain’s economic output in the second quarter, continuing uncertainties posed by the coronavirus and slow progress towards securing a trade deal with the EU before October’s talks deadline.

Dividend cuts expected to shave two fifths off the pay-outs of UK companies this year have also impacted a mainstay of the UK investing scene – the equity income sector2. As of the end of June, the UK accounted for just 14% of the fund assets owned by UK retail investors3.

One of the questions raised by this is whether some UK investors have moved out of UK funds on a permanent basis or whether we are simply seeing an effect that will pass in time.

In the past, a portfolio with roughly half of its assets invested in the UK and the other half in overseas markets was commonplace. One of the reasons for this was supposedly a behavioural effect called home bias, meaning that investors favoured their home market for reasons of familiarity and a desire not to risk their money in far-flung places.

Another reason for home bias has always been a desire to limit exposure to foreign currency risks. For the average UK investor, future spending commitments will mostly be in sterling so, the thinking goes, a large proportion of their investments need to be too.

This makes sense up to a point. Arguably though, investing in equities should be more about seeking opportunities to achieve growth or an income or both than currency matching. A lack of exposure to faster growing overseas markets could seriously harm a portfolio’s growth potential over the longer term, outweighing currency effects.

Many investments in UK companies provide a high exposure to foreign markets and currencies anyway. Businesses like Unilever, BP and Vodafone earn a large proportion of their revenues from overseas markets in foreign currencies and some pay their dividends in foreign currencies too.

Overall, around three quarters of the earnings of the UK’s top 100 listed companies come from overseas and around half do for the next 2504. So seeking a wholly sterling exposure by investing in UK companies is largely futile.

As a result of the poor relative performance of the UK stock market, many stocks now look good value. Internationally as well as domestically the market is unloved but that’s a position that could be partially resolved once the UK’s trading position with the EU becomes clearer and, in all likelihood, the coronavirus abates next year.

We may also have passed through the depths of the dividends crisis, suggesting a brighter outlook for equity income investors. This week, the FTSE 100 company Ferguson – which is predominantly exposed to plumbing and heating markets in the US – said it will restore its dividend to the same level as last year5. Other UK companies with the right business models could soon follow suit.

Current estimates suggest that UK equities will broadly still produce a dividend yield of more than 3% over the next year even after accounting for dividend cuts and suspensions6. While down on 2019 levels, that still compares very favourably with the income achievable from government gilts and cash deposits.

Even so, the recent past suggests the UK will continue to suffer stiff competition from other regions and asset classes for investors’ money. Asia and emerging markets funds offer investors access to faster growth than that available in the UK owing to growing, young populations not seen in the west.

Meanwhile, America continues to lead the world in the technologies of now and the future, areas underrepresented in the UK equity market. Companies able to deliver secular growth like Amazon, Apple, Microsoft and Tesla clearly remain highly prized in a world where the growth of others has been severely curtailed.

Alternative investments in real assets like commodities, property and precious metals also have their attractions, not least, because they tend to offer diversification opportunities away from shares and bonds.

The UK accounts for a surprisingly small 3.6% of the MSCI World Index, meaning that UK retail investors still have a home bias, albeit, not as great as it once was7. That may be fine, because investing purely on the basis of the relative sizes of international markets would mean investing around 59% of an entire portfolio in the US. For many UK investors, such a commitment to America and the dollar might feel uncomfortable compared with keeping their investments closer to home.

It will be the case that some investors hold direct investments in UK shares alongside funds, using the latter only to gain a foreign exposure. That means actual levels of exposure to the UK could be far higher than that suggested by the latest fund data.

However, it will be interesting to see whether or not UK investors allocating just 14% of their portfolios to UK funds is sustained over the longer term. Given the persistence of home bias as well as the potential for bargain hunters to increase their exposures to the UK once the economic outlook settles, it may be that we have just about witnessed the nadir for fund allocations.

How much investors allocate to UK equities will vary greatly depending on individual circumstances and investing ambitions. Funds too display a range of allocations, especially where fund managers select their investments based on a company’s prospects wherever the business is based and are relatively agnostic about the country weightings of a global index.

Global equity funds featuring on Fidelity’s Select 50 list currently show a range of allocations to the UK. The Fidelity Global Dividend Fund, for example, which focuses on accessing high quality income streams from around the world, has a 17% exposure to the UK, while its largest weightings are in the US (32%) and Europe (27%).

The Rathbone Global Opportunities Fund, on the other hand, has only a 6% exposure to the UK but a 62% weighting in the US and 22% exposure to Europe. The Fund’s growth style and large positions in American technology companies go some way to explaining a high US exposure.

Sources:

1 Investment Association, 03.09.20
2,6 Link Asset Services, Q2 2020
3 FT, 24.09.20
4 FTSE Russell, May 2017
5 Ferguson, 29.09.20
7 MSCI All Countries World Index, 31.08.20

Important information: The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Select 50 is not a personal recommendation to buy or sell a fund. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

Topics Covered

Active investing; Funds; Investing for incomeMarkets; SharesUK

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