Sizing the UK “home bias” in your equity allocation

The UK equity market has underperformed the US and Global Equity over the long-term.  How much should UK investors allocate to it?

UK Equity Home Bias: How Much is Enough?

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Sizing the UK “home bias” in your equity allocation

By Henry Cobbe CFA, Head of Research, Elston Consulting

The relative earnings growth, and multiple expansion of the US tech sector has made it the bedrock of equity market growth since the financial crisis.

Whilst many have written about the extreme concentration of tech within the US equity market, this has also impacted regional weightings within a broad global equity market index, such as MSCI All Countries World (which includes developed and emerging markets, hence “global”.  On our analysis, products tracking this index had a 52% allocation to the US in 2015, a 56% allocation in 2020 and a 62% allocation today.  The figures for the MSCI World (which is developed markets only) are even more pronounced.

It effectively means that the US is the main determinant of global equity performance.  If the US performance sneezes, whether the rest of the world coughs or sneezes is basically inaudible.

For a long time, many UK private client managers have shied away from the far higher multiples (both relative to history and relative to the languishing UK market) in the US and favoured a UK “home bias” – giving it a higher weight than the index would suggest owing to greater familiarity.  But those US higher multiples have been supported by powerful earnings growth that has been less pronounced in the UK.

From a performance perspective, UK-oriented managers have been penalised for this view ever since the financial crisis year after year.  The exception was 2022, when the UK’s “dull” make up of value-oriented equities proved to be more inflation resilient: a great time to have been overweight.

The absence of earnings growth or multiple expansion means the importance of reinvested dividends is key to total returns for the UK equity market.  Comparing the FTSE All Share Price Index (broadly sideways), and the FTSE All Share Total Return (broadly up) since the end of the global financial crisis suggests that 42% of total returns come from reinvested dividends, on our analysis.  That yield focus within UK equities remains key to underpinning returns and explains the popularity of both active and index-tracking UK Equity Income funds.

There has been a lot in the press recently about how to reinvigorate the UK equity market, and how to encourage people to invest.  The irony is that the lack lustre nature of the UK equity market is nothing to do with investor behaviour, or the make up of indices (which just reflect relative size) and everything to do with a lack of large scale growth companies being formed in the UK and deciding to list in London.  One of the largest global fin-tech successes headquartered in London – Revolut – is struggling to get a banking licence in the UK.  So why would it chose to list here, when the time comes?

For the UK equity market to recover its mojo, it needs politicians and civil servants to lead the way in supporting a growth agenda.  It should make London the most attractive listing venue for companies in the UK, the EEA and particularly that demographic behemoth that is the Commonwealth.  Without that energy, the UK market will continue its relative decline.

Based on the same analysis as above, the UK represented approximately 6.5% of global equities in 2015, 3.7% in 2020 and just 3.3% today.  The UK’s relative shrinking, is because the rest of the world is growing more.

So what should a UK allocation look like?  We considered this extensively when we developed our Elston Multi-Asset Indices – our range of indices reflecting 20%, 40%, 60%, 80% and 100% equity allocations designed for GBP investors.  Across the board, within the equity allocation, we set a 20% UK and 80% Global split.  This was to reflect the fact that it was the mid point between “no home bias” (0% additional UK allocation) and a “high home bias” (~40% additional UK allocation, based on our research).  So we saw this as a reasonable “neutral” position against which MPS and multi-asset fund managers could elect to go over- or under-weight.

We like the UK equity market within a multi-asset portfolio as a “useful diversifier” relative to US equities.  Since Brexit, the UK equity market has decorrelated from US and Global Equities.  Now UK equities move oppositely to US equities.  Their performance is the ying and yang of each other, which means that combining them gives true diversification.
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The decision of how to split global and UK equities has been the most important determinant of portfolio performance within the equity component of a multi-asset portfolio for the last decade or more.  We expect it to remain so.