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Considering your allocation to UK equities
From a global perspective, the UK market is very small indeed
Jamie Beard
Associate Investment Consultant
As far as its role on the global equity market stage is concerned, the UK can be compared to a once-prominent actor whose star power and influence has waned, now reduced to a minor scene or two while others dominate the limelight. Those viewing from the gallery could almost be forgiven for overlooking the UK altogether.
Allocations to UK-listed companies within market capitalisation-weighted global equity indices have declined consistently over time. At the end of last year, the UK’s weighting in the MSCI All Country World Index had roughly halved from its level 10 years ago. Other indexation approaches – such as GDP weighted – lead to a similar conclusion, namely that UK equities represent a diminishingly small proportion of the global market.
31 December 2002
31 December 2012
31 December 2017
31 December 2022
30 September 2023
Source: Morningstar, MSCI
At the end of last year, the UK’s weighting in the MSCI All Country World Index had roughly halved from its level 10 years ago.
Consistently cheap, but infrequently cheerful
So, why does this actor now have so few good lines (of stock)? The UK’s quiet but steady shuffle into the wings has been well-documented and is attributable to several factors, not least the poor relative returns generated by UK-listed companies compared to their global counterparts over the last two decades. Recent years have also seen a sharp decline in firms choosing to list in the UK, as well as an increasing number deciding to actively leave the UK stock market altogether and re-list elsewhere, particularly in the US.
UK investors with an equity portfolio whose UK equity allocation is greater than its share of global markets can be considered to have a portfolio with a 'home bias'. Nowadays, that means any portfolio with a UK allocation higher than about 4%.
Today, the relative cheapness of the UK market is frequently cited as a prime reason for maintaining a home bias. And of course, over the last 10 calendar years, the UK market has regularly appeared to offer good value compared to the rest of the world, in particular the US. Using a monthly price-to-earnings measure to compare the FTSE All Share index with the MSCI ACWI, the UK appeared cheaper during 96 of those 120 months, or 80% of the time. On a price-to-book measure, the UK market looked cheaper during every single month.
Price-to-earnings: UK vs Global
Source: Morningstar
UK investors with an equity portfolio whose UK equity allocation is greater than its share of global markets can be considered to have a portfolio with a 'home bias'. Nowadays, that means any portfolio with a UK allocation higher than about 4%.
Sadly, the UK market’s apparent inherent value potential has remained just that – unrealised. In Sterling terms, the All Share underperformed the MSCI ACWI by 118% from 2013-2022. The valuation argument for favouring UK equities is certainly taking its time to come to fruition, and it could take longer still (if it ever bears fruit at all).
Rolling Returns (1-year): UK vs Global
Evaluating an allocation to UK equities
Overweighting any market means you have a greater-than-normal exposure to its characteristics, for better or worse. So, the biases inherent in that market need to be carefully considered. Relative to a market-capitalisation global index, the financials, consumer staples and energy sectors possess a heavy presence in the UK; by contrast, technology stocks are a rarity, forming only ~1% of the FTSE All Share compared to ~22% of the global universe.
Furthermore, the UK is strongly biased towards ‘value’ companies. Over the last 10 years, this has driven underperformance compared to the rest of the world, as investors have increasingly favoured growth, in particular platform / disruptive technology firms over legacy sectors. It is reasonable to expect these biases will make a material difference in the future too, so investors should consider whether they possess significant conviction in the merits of these biases before committing to an overweight position.
A home equity bias can be detrimental because it increases concentration risk and limits investment opportunities. This can ultimately frustrate an investor's long-term financial goals.
Proponents of a UK home bias may point to the way in which many of the FTSE 100’s multinational constituents are 'global' in nature. However, the broader market, represented by the All Share index, does not exhibit this trait, with the UK market being significantly less diversified than its global counterpart: the 10 largest names in the MSCI ACWI comprise 18% of the index while the equivalent figure for the FTSE All Share index is 40%.
And diversification doesn’t just play out at the security level. A heavy domestic allocation opens investors up to country-specific risks, such as political instability, regulatory changes, and localised economic downturns. An investor who is already highly exposed to an economy as a consumer, and potentially as a worker too, should consider whether they want to deliberately double-down on that exposure through their investments. Yes, it is undoubtedly true that idiosyncratic risks are associated with any market. However, a virtue of a well-diversified portfolio is that it should spread exposures across regions to mitigate their impact.
By dedicating an oversized proportion of financial resources to UK companies, an investor is ignoring (or under-appreciating) the other 96% of opportunities available to them.
Furthermore, by dedicating an oversized proportion of financial resources to UK companies, an investor is ignoring (or under-appreciating) the other 96% of opportunities available to them. Ultimately, investors benefit from holding shares in the ever-changing group of the globe’s best companies, not just the local champions.
The argument for having a long-term UK exposure that is materially higher than its global market capitalisation weighting is weak.
As investment tastes and fashions have changed, the UK, once an A-lister, has seen its influence fade amongst an increasingly powerful global cast. Sure, this actor still warrants the occasional moment of applause (indeed, over 2022 the UK market performed relatively well). But theatregoers who pay undue attention to one actor may find they leave the theatre in regret, having not paid sufficient attention to most of the show’s grandest scenes. Investors retaining an overweight to the UK equity market should evaluate how confident they are that their favoured actor will be back in the starring role, and soon.
Conclusion
While a domestic equity market bias may offer familiarity and comfort, it can reduce returns for several reasons. Investors should check that any biases are indeed intentional.
