UK equities are a helpful value-factor proxy. Value-based investing is a persistent driver of returns over time. But not all the time. We explore UK equities’ embedded factor tilt and how it can help diversification.
 [5 min read, read as pdf]
As we look forward to 2025, it is worth revisiting the themes and predictions of our 2024 outlook “turning the corner” to get a sense of what we anticipated at the time, how this informed our recommendations to UK adviser firms’ investment committees. Asset class performance for 2024 is summarised in the chart above. Our 2025 outlook is published separately. Subscribe to our weekly newsletter to get all our insights to your inbox (for UK financial advisers only) Steady as she slows In 2024, we anticipated a gradual deceleration in the U.S. economy, with markets pricing in the likelihood of a slight recession. In the event, the U.S. economy surprised on the upside. Growth forecasts were upgraded from 1.15% at the start of the year to an impressive 2.6% by year-end. This revision supported robust equity market returns and served as a reminder of the resilience of U.S. economic fundamentals. In summary, a resilient US economy defied expectations. What did we recommend to our clients at the outset and during the year? We took a balanced view between accepting concentration risk (traditional S&P 500) and diversified (active, sector exposures). We also recommended clients lean in to broader US equity corporate landscape via 1) Equal Weight and 2) US Small Caps exposures. By contrast, the UK had that shrinking feeling as regards economic growth, and although out of a technical recession, we are not confident of its prospects relative to the US. Pause before pivot At the close of 2023, we were focused on the Federal Reserve’s pause in interest rate hikes, noting that a rate cut was a question of when, not if. While the consensus view was that the first cut would be announced by mid-2024, we anticipated that the timing would hinge on the performance and strength of the U.S. economy. Indeed, the economy’s resilience delayed the start of what we anticipate to be a rate-cutting cycle to September 2024, when the Federal Reserve finally delivered a significant 50-basis-point cut. In fact, the eventual BoE Fed pivot came a month or two later than we had estimated at the start of the year, but we recommended our clients remain dynamic with regards to duration management. We recommended clients go strongly overweight duration in June as a good time to extend duration ahead of BoE cuts, with Fed following suit, and we saw the additional duration deliver returns on the bond side of the portfolio before attention shifted to debt supply and the UK budget later in the year, which led us to recommending to move back to neutral. The importance of portfolio resilience Our focus on resilience proved vital when it came to navigating the key macro factors in 2024: Growth, Inflation and Interest Rates. For Growth, anticipating a soft landing for the US economy, we highlighted the potential outperformance of cyclical sectors, and momentum, yield and size factors. In the event, momentum emerged as the best-performing factor, with yield and size also delivering strong returns. For Rates, we adjusted duration exposure mid-year to capture the effect of falling policy rates, aligning portfolios with a changing interest rate environment. For Inflation, which remained above target, the inclusion of liquid real assets (but to a lesser extent than in 2022) and shorter duration inflation-linked bonds, ensured continued portfolio resilience. We continue to emphasise the importance of a diversified alternatives exposure from a correlation perspective, not just in name. Our recommendation to consider Private Market Managers and Gold & Precious Metals paid off during the year – as these were the best performing asset classes for the year, outperforming world and US equities. Political and Geopolitical risks In a year of elections, we saw a change in government in the UK and in the US following Trump’s Presidential win. Both have a greater impact on bond yields and currency dynamics than equity markets, in our view. Geopolitical risks remain elevated with the Russia-Ukraine war continuing to grind, escalating conflict and contagion in the Middle East – all at tragic human cost. Conclusion Markets did indeed turn a corner in 2024, with economic growth, earnings and equity market returns outperforming expectations. With 2024 in the rear-view mirror, it’s time to look ahead to 2025. Our 2025 outlook is published separately. Henry Cobbe, CFA Head of Research, Elston Consulting  In this article for ETF Stream, Hoshang Daroga explores the Size Factor and why it might have a role to play in concentrated portfolios.
Read the full article  [5 min read, open as pdf]
Why does the UK equity allocation decision matter so much The difference between the best performing and worst performing multi-asset discretionary investment managers has largely been a function of one key decision: to what extent have they had a UK equity home bias? Home bias means having an above index-weight in your domestic market. Academic research on home bias tends to be written from a US perspective, so its conclusions are less relevant for UK asset allocators. Within equities, the performance differential between the US and UK has been so extreme over the last decade or so , that this has been the singlemost important decision that has impacted portfolio performance – far more so than any active or passive debate, or active fund selections. For financial advisers that rely on third party asset allocation providers, the decision has been made for you, and your clients’ portfolio performance becomes a function of your chosen risk profiling tool. For the last decade or so, multi-asset portfolios that have had a low or no UK equity home bias have performed best. Those that have a high bias have performed worst. Choose your strategic asset allocation carefully To show this, see the chart below which shows the “Capital Allocation Line” linking the UK Risk Free Rate (SONIA) to a) world equity risk-return (represented by an index-tracking ETF), b) UK equities risk-return (represented by an index-tracking ETF), and c) a 80/20 allocation between the two. The risk-return for a 20%, 40%, 60%, 80% and 100% equity/cash portfolio would sit on each Capital Allocation Line with increasing increments of volatility (as percentage equity risk broadly translates to the proportion of annualised equity volatility). Portfolio performance is broadly a function of which Capital Allocation Line a portfolio’s Strategic Asset Allocation has been constructed around. When reviewing multi-asset managers, it makes sense to do so relative to these Capital Allocation Lines. Fig.1. Multi-asset portfolios are built with no, partial, or high home bias [see pdf version] Given the stark relative performance between portfolios built with a high bias and those built with no bias, it’s no surprise that UK institutional investors and UK wealth managers have been gradually deallocating from their home market. Adding to the UK market’s woes, its weight in global equity indices has also been shrinking. UK equities in a multi-asset portfolio The gradual relative shrinkage of UK equities within global equity indices is well documented. The decline has become more noticeable since December 2019 as the tech rally started to gain pace. UK listed companies now make up approximately just 4% of the global equity benchmark. Put differently, the largest US technology company is today worth almost the same as the entire FTSE 100. It wasn’t forever so. UK equities have shrunk from representing about 10% of global equities (developed and emerging markets combined) as recently as 2011. The shrinkage is a function of simple maths. A far greater number of the rest of the world’s listed companies (predominantly the US) have grown their earnings (and hence market capitalisation) far more than the UK’s listed companies. As a result, the UK’s relative size has shrunk. The problem is now being compounded by the number of large, listed companies shrinking further as some move their listings to the US to obtain a better valuation, and others being acquired and becoming privately owned. To reverse this trend, London needs to remain an attractive destination to base, list and grow companies from around the world. UK wealth managers have been de-allocating gradually UK discretionary investment managers have been deallocating from UK equities as they removed their “home bias.” In 2000, approximately 70% of a “balanced” portfolio’s equity allocation was in UK equities based on MSCI PIMFA (formerly FTSE APCIMS data[1]), compared to 33% today. This allocation is determined to be reflective of PIMFA’s member firms by an index committee including representatives from leading UK wealth managers[2]. The chart below shows the UK equity proportion or “home bias” used in UK wealth management benchmarks based on MSCI PIMFA and FTSE APCIMS data, and an estimate of the UK equity allocation within global equity index funds. Fig.2. UK wealth managers have gradually reduced their home bias over time [see pdf version] How much is enough? In our work with UK financial advisers and wealth managers, we found a range of opinions. We have always considered a UK equity allocation of 30-50% to be too high, even though that was often the existing default for firms using third party asset allocation models and the largest UK wealth managers that govern the reference benchmarks above. Whilst intellectually we can (and did) make the case for no home bias[3] (consistent with other institutional investors and consultants), we found that adviser firms in the retail market (and indeed their end clients) would be more focused on the FTSE 100 and would want and expect to see a range of UK-focused funds in a portfolio. Furthermore, whereas the well-known SPIVA®[4] studies evidence that in highly efficient markets (such as the US) it is challenging for active managers to persistently outperform the index, the same studies show that in less efficient markets (such as UK small-caps), active managers can persistently outperform the index[5]. On this basis, we alighted on a target 20% UK equity allocation as a mid-point between a high bias of 40% and no bias (index weight). Twenty’s plenty Deciding what UK equity allocation to have is a key part of a strategic asset allocation discussion for investment committees of wealth management firms and financial adviser firms alike. For those that rely on third-party asset allocation models, the decision is made for you. A benchmark where the strategic asset allocation is constantly changing can be a challenge to evaluate long-run performance as the framework is always changing. In our multi-asset indices for GBP-based investors[6], we therefore use this static 20% UK home bias equity allocation as a “neutral” for the entire index history and going forward. This means that our benchmark has a consistent (unchanging) framework, that creates a theoretical “neutral” allocation, which UK managers and advisers can either adopt or allocate against. Whilst customising an index to reflect one view won’t keep everybody happy, the failure to cutomise an index to incorporate a UK equity home bias could create even greater controversy as some managers have found out[7]. Interestingly the proposed £5,000 UK ISA Allowance would make up 20% of a total £25,000 ISA contribution, so we remain comfortable with a 20% UK equity allocation within our multi-asset indices. UK equities as a diversifier Whilst US and World Equities have persistently outperformed the UK equity market, we think the UK equity market is looking interesting once again not just from a valuation perspective, and not necessarily from a returns perspective, but primarily as an equity portfolio diversifier owing to its decorrelation from the US. The structure of the UK equity market (low valuation, value/yield bias, old-world defensive sectors such as energy, mining, healthcare) is so different to the structure of the US equity market (high valuation, growth bias, new-world technology sector concentration), that they complement each other rather well as a diversifier. Recall 2022, the inflation shock from the Russia/Ukraine war and related sanctions meant that the UK equity market was up, when the US and hence world equities were down. Similarly this year, the UK equity market has frequently moved inversely to the US and World equities. Fig.3. US and World Equities move lock-step, UK equities do not [see pdf version] Whilst US and World equities move lock-step, the different return “pattern” for UK equities makes it an interesting diversifier from a portfolio construction perspective: The measure of “true diversification” is correlation. By combining lower correlated assets, the risk of the whole can be less than the sum of parts. Long-term and short-term correlations both matter When building long-term strategic asset allocation models, asset allocators look at long-term risk, return and correlation structure (either forward-looking estimates or historical data) and refresh this every few years. Using 10 year historic data as at end 2023, the US and UK correlation to world equities is 0.97 and 0.80 respectively. However to understand current market conditions and how portfolios are actually behaving, it is also important to look at short-term correlations. Using rolling 1 year correlation data, the US and UK correlation to world equities is 0.97 and 0.61 respectively. Hence a portfolio built using long-run estimates will look very different to one built using short-run estimates. This is why we believe in an adaptive approach to asset allocation that considers both long-run and short-run, risk and correlation structure. Fig.4. Long-run and short-run correlations are similar for the US but different for the UK [see pdf version] The changing nature of UK equity correlation As US equities make up a growing concentration of world equity indices, it is unsurprising that the short-run rolling 1 year correlation between US and World Equities remains consistently high (they move lock-step, as discussed above) and in line with its long-run figure. By contrast, the short-run 1 year correlation of UK vs World Equities is not stable. We can see two clear periods of material disconnect. One following Brexit and the second following Covid and subsequent related inflation shock and the marked by divergence between tech-oriented US market and value-oriented UK market. The chart below is why we are currently positive on the UK equity market. Not just on valuation grounds, not just as a region- or sector-based diversifier, but as a genuinely less correlated market. Its lower correlation to World Equities, unlike the US, enables risk-based diversification within a portfolio’s equity allocation. Fig.5. UK Equity has become less correlated with world equities increasing its diversifier status [see pdf version] For a defensive approach, think dividends The UK equity market returns are underpinned by dividend generation. Looking at the returns of the FTSE All-Share Index Total Returns (which includes reinvested dividends) and the FTSE All-Share Price Index (which assumes dividends are paid out and not reinvested), we can see that reinvested dividends represent 41.6% of cumulative total return of the UK equity market from 2008 to 2023 (see below). This should prove even more defensive in challenging markets. Fig.6. FTSE All Share: Total and Price Return and reinvested income contribution to returns [see pdf version] Summary Whilst there have been significant recent outflows from UK equity funds, perhaps investors are missing one key consideration: that of decorrelation. Having more than one global equity fund provides no diversification from a risk perspective. They will likely move broadly in tandem, regardless of which active manager, and regardless as to whether its active or passively managed. But pairing a global or US equity fund with a UK equity fund introduces true (risk-based) diversification within the equity portion of a portfolio because of the UK’s low correlation and very different and sometimes opposite return pattern. [1] This is the current version of a long-standing index series currently called the MSCI PIMFA Private Investor Indices. The original FTSE APCIMS Indices were renamed FTSE WMA Private Investor Indices in 1q14. The WMA transferred its Private Investor Indices to MSCI from 1st March 2017, and they were renamed MSCI PIMFA Private Investor Indices on 1st June 2017, following the merger of the Wealth Management Association (WMA) and Association of Professional Financial Advisers (APFA). We have combined the asset allocation history of the above indices to create a single time-series. [2] The MSCI PIMA Private Investor Indices have an asset allocation determined by its index committee that aims to ensure that the asset allocation is reflective of its member firms. The index committee includes representatives from Canaccord Genuity Wealth, Investec Wealth and Investments, Rathbones, JM Finn, Brooks MacDonald, Killik & Co, Close Brothers, Evelyn Partners, Quilter Cheviot and others. For more information, see https://www.pimfa.co.uk/about-us/pimfa-groups/private-investor-indices-committee/ [3] See our July 2020 article https://www.elstonsolutions.co.uk/insights/home-equity-bias-is-irrational-and-has-been-penalised-uk-investors [4] See our October 2021 article https://www.elstonsolutions.co.uk/insights/understanding-spiva [5] See our December 2022 article https://www.elstonsolutions.co.uk/insights/are-active-managers-improving [6] See https://www.elstonsolutions.co.uk/our-indices.html for more information [7] https://www.peelhunt.com/news-insights/articles/selling-down-the-uk/  Hoshang Daroga explains to ETF Stream why he likes S&P500 Equal Weight ETFs going into the second half of 2024.
Read the article 
Momentum does not care about sectors, themes, or valuations. In this article for ETF Stream, Hoshang Daroga explores the Momentum factor.
Whilst the original Fama & French research isolated 3 factors (Market risk (Beta), Size and Value) that were found to be persistent drivers of returns, research has since evolved to look at other factors such as Quality, Yield, Momentum and Minimum Volatility. Read in full  For investors wanting a differentiated approach to implementing a global equity exposure, what are the options?
Read the full article in FT Adviser  Central Banks' policy rates are expected to pivot towards cuts in 2024 with a material impact on asset class perspectives.
 [5 min read]
2022 was a reminder of the importance of dispersion within equity markets. It turns out this lesson remains relevant in 2023 but with very different - almost opposite - themes. Read the article in FT Adviser  [5 min read, open as pdf]
 NMA speaks to investment consultant Henry Cobbe about positioning equities for higher inflation using sector and factor equity investing.
Listen to the podcast  [5 min read, open as pdf]
 [5 min read, open as pdf]
With low growth, soaring inflation and spiking interest rates, advisers need to rethink the definition of risk. Focus on volatility is focus on the “wrong problem”. Instead, advisers should focus on preserving purchasing power (mitigate inflation risk) to protect client outcomes. That requires a fundamental rethink around traditional definitions of risk, asset allocation and diversification. For full article including charts, open as pdf  [5 min read, open as pdf]
The “great rotation” to Value began towards the end of 2020 as inflation fears came into focus. It has been rewarded. Since Dec 2020, the MSCI World Value factor has delivered +21.43% returns to 25th February 2022 compared to +7.70% return for Growth factor and +14.78% for the parent MSCI World index (a traditional market-cap based index), all in GBP terms. If we look back further at relative performance since end 2007 to 25-Feb-22, we can see that Value’s underperformance relative to Growth is still material. Over that period, Growth returned +369% (11.54%pa), compared to +179% (7.52%pa) for Value, and +268% (9.63%pa) for traditional market-cap based world equities, in GBP terms. On this basis, the re-rating of Value, relative to Growth, has room to run in the face of a persistent inflationary regime. Read full article with charts Watch our CISI-accredited CPD on an Introduction to Factor Investing  [3min read, open as pdf]
Value/Income bias for inflation protection In our 2022 outlook, we explained why inflation will remain hotter for longer and will settle above pre-pandemic levels. Within equities, we outlined our rationale for being overweight Value-factor equities with an Income bias to shorten equity duration. This built on our May 2021 view on UK equity income providing a helpful inflation hedge. The rapidity and severity of market movements against the prospect of faster-than-expected inflation and greater-than-expected interest rate tightening have only served to reinforce these views, as reflected by performance. Whereas world equities have struggled year to date, UK equities have been a relative bright spot. Within UK equity index exposures, indices that focus on dividends (with an inherent value bias), over size (market cap) have delivered best results. Our Smart-Beta UK Dividend Index [ticker ELSUKI Index] has delivered positive returns YTD ahead of more mainstream UK equity indices, driving the absolute and relative returns of the VT Munro Smart-Beta UK Fund, which is benchmarked to this index[1]. Read full article as pdf [1] Note & Commercial Interest Disclosure: Elston Indices is the benchmark administrator for the Freedom Smart-Beta UK Dividend Index, to be renamed the Elston Smart-Beta UK Dividend Index with effect from 1st March 2022. The VT Munro Smart-Beta UK Fund is benchmarked to this index.  [5 min read, open as pdf]
In our 2022 outlook, we explained why inflation will remain hotter for longer and will settle above pre-pandemic levels. Advisers should consider how to adapt portfolios for inflation across each asset class – equities, bonds and alternatives. Research demonstrates how different asset classes exhibit different degrees of inflation protection over different time-frames. Equities therefore provide a long-term inflation hedge.
In this article, we explore how to adapt portfolios for inflation within and across each asset class: Equities, Bonds and Alternatives. For full article, read as pdf  [3 min read, open as pdf]
2021 in review Our 2021 market roundup summarises another strong year for markets in almost all asset classes except for Bonds which remain under pressure as interest rates are expected to rise and inflation ticks up. Listed private equity (shares in private equity managers) performed best at +43.08%yy in GBP terms. US was the best performing region at +30.06%. Real asset exposures, such as Water, Commodities and Timber continued to rally in face of rising inflation risk, returning +32.81%, +28.22% and +17.66% respectively. 2022 outlook We are continuing in this “curiouser, through-the-looking glass” world. Traditionally you bought bonds for income, and equity for risk. Now it’s the other way round. Only equities provide income yields that have the potential to keep ahead of inflation. Bonds carry increasing risk of loss in real terms as inflation and interest rates rise. Real yields, which are bond yields less the inflation rate, are negative making traditional Bonds which aren’t linked to inflation highly unattractive. Bonds that are linked to inflation are highly sensitive to rising interest rates (called duration risk), so are not attractive either. How to navigate markets in this context? The big three themes for the year ahead are, in our view:
See full report in pdf Attend our 2022 Outlook webinar 
Inflation is proving more persistent than transitory. In an inflationary environment, Value style investing has the potential for continued outperformance relative to other factors. For UK fund investors, actively managed funds with a value-oriented philosophy, UK equity income funds with an inherent value bias and Value-factor index funds/ETFs offer ways of increasing allocation to Value within a portfolio. Read the article (5 min read) Watch the webinar 
The era of quantitative easing programmes have had a distorting effect on markets since the 2008 financial crisis has given value investors a torrid time in the past decade. The near-constant sugar-rush of liquidity has served to de-link valuations from underlying fundamentals prompting a huge bias towards growth. While pockets of investors have been braced for a long-expected correction that has never really materialised, the recent sharp increase in inflation may constitute an inflection point of sorts. In inflationary periods and when interest rates rise, the time horizon for future discounting shrinks, leaving equities exposed. Income-yielding shares have an inherent value-bias, owing to the types of company that pay steady dependable dividend). This provides a measure of inflation protection both in absolute terms and relative to nominal bonds. Read the full article Watch the webinar |
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