What percentage of your asset allocation is UK equities?

ruperts

Hi all

Trying to develop my long term passive portfolio and struggling with UK bias. I've read Tim Hale's Smarter Investing and Bernstein's The Intelligent Asset Allocator but neither contains any real analysis of the effects of a home bias.

The idea of a 'purist' approach of diversifying geographically according to market cap seems logical but impractical and perhaps unnecessary due to correlations, and there is also currency risk.

I suppose this is one of those things where there is no right answer except in hindsight, but i was just wondering what others have done and why?


Edit - this was supposed to go in savings and investments

jamiex

I allocate 10-15% for Emerging Markets, 10-15% Europe/US/Global and around 70-80% UK, depending on what opportunities arise.

I tend to choose my own shares for the majority of my UK exposure but use funds for Emerging Markets, Europe and the US.

dunstonh

What method of allocation are you using? (note, the allocation names are not fixed and you see mix and match depending on where you read. ie. some use asset allocation and sector allocation the other way around)

regional sector allocation - where you have UK equity, US equity, European etc
asset allocation - where you look at small, mid, large cap, value etc as well as region.
industry allocation - where you spread by industry rather than location.

The US market tends to be very inward looking. When you look at allocations designed for the US market, you tend to find it is heavy in US with worldwide being very light. This is partly due to US culture and partly due to taxation in the US. Models that are ported from US data tend to reflect that but use home country in place of US. Models specifically built for UK tax, charges and distribution tend to be less focused on the UK and more worldwide in nature.

As model allocations tend to use volatility to measure their risk levels, you do tend to find that the allocation to UK from Worldwide decreases as you get more adventurous. UK shares dont suffer currency risk. Overseas equities do.

ruperts

dunstonh wrote: »

What method of allocation are you using? (note, the allocation names are not fixed and you see mix and match depending on where you read. ie. some use asset allocation and sector allocation the other way around)

regional sector allocation - where you have UK equity, US equity, European etc
asset allocation - where you look at small, mid, large cap, value etc as well as region.
industry allocation - where you spread by industry rather than location.

The US market tends to be very inward looking. When you look at allocations designed for the US market, you tend to find it is heavy in US with worldwide being very light. This is partly due to US culture and partly due to taxation in the US. Models that are ported from US data tend to reflect that but use home country in place of US. Models specifically built for UK tax, charges and distribution tend to be less focused on the UK and more worldwide in nature.

As model allocations tend to use volatility to measure their risk levels, you do tend to find that the allocation to UK from Worldwide decreases as you get more adventurous. UK shares dont suffer currency risk. Overseas equities do.

Hi dunstonh

Thanks for the reply. Of the three allocation categrories you list I'd say I'm looking at a combination of the first two. I want my portfolio to consist of 20% bonds, 10% each to value, smaller companies and emerging markets, and then 50% 'global' equity.

Within the 50% global equity part, it needn't necessarily be a perfect geographical spread, i'm just looking at getting the best out of the available diversification benefits while also considering currency risk. I don't want to make a bet on stirling either way, which I think pushes me more towards a higher UK allocation, but then I fear the Japan scenario where failing to diversify away from the UK becomes very costly. I'm looking for some logic in where to find the right balance as at present I feel as though i'm just guessing.

Thanks again for any comments

bowlhead99

In my view, 'currency risk' can be a red herring. There are some things you will be buying in 10, 20, 30 years time which are ever more sourced and priced internationally.

If I want a german-built car or fridge or a Korean-built TV or smartphone or a US-engineered bit of software, I do not need to generate a specific number of pounds, I need to have maintained my purchasing power in the locations which are contributing to the cost base of the companies I want to buy from. The UK retailer who fronts these products has some power to price these locally, adjusted by his own costs of retail workers and premises, but I expect in a couple of decades years time I can get many of them delivered from source over the internet.

So basically I am already taking a currency risk - the risk that my pounds don't buy as many Won or USD or Deutsche Marks (hey, we're looking into the future) when I need to buy all those products. And actually the German car companies might have assembly done by Poles or Brazillians and the Koreans might get their components from China and Indonesia and the Americans might outsource their coding to Mexico and India. These costs of production plus a profit percentage are going to be borne by you and me when we buy. So we are living in a world where if you have 90% of your assets domestically and GBP does poorly against a basket of global currencies, you may really curse your not having investing 90% in a basket of global assets instead.

The problem with that is that maybe GBP will do well and you'll find 'keeping up with the Joneses' more of a problem when your neighbour Mr Jones invested 95% in UK companies and he can afford £15ph for someone to mow his lawns and you can only afford £12. He will always be getting his lawns cut first and to a better standard (unless you want to take up mowing yourself, which you might, and therefore avoid the problem).

But over time, GBP can at best presumably only be expected to do 'averagely' over a basket of global currencies from the developed and undeveloped world, so you and Mr Jones will swing back and forth. There is no particular reason that the UK market will sit at exactly number 10 in the G20 rankings, one would be taking a 1-in-20 punt to presume it will. So home weighting might be a great thing or a terrible thing, versus following the global pools of assets out there. Of course, this is complicated by the fact that the UK index you're tracking does include lots of businesses with global revenue streams; for every pound invested, less of your NAV and fewer of your dividend flows are 'home biased' than you might think.

I am invested in a London AIM-listed company whose fortunes are entirely linked to some citrus plantations in China, another in coal in Mozambique, one laying gas pipelines in Cameroon, and a biotech company trying to solve a world problem with a world market if it does. Should I count them as 'UK' in my global asset allocator? I guess that's irrelevant to you if you're only concerned with mixing together major indexes, but you can still be misled by saying BP, Shell or HSBC are heavily biased to your home country. They are a big chunk of FTSE all-share, but they really aren't tracking UK inflation.

Dunstonh makes a good point about home bias and the US. I certainly saw that when working over there; the model portfolios would just have a portion in 'international' equities, almost "home vs away" while here in the UK we think of all the different non-UK regions as being driven by quite different economic themes (and certainly the charts for Europe vs US vs Japan would agree, with that, despite them also being correlated in terms of major movements).

I suppose a US person has 50% of the world's investible developed market equities on his doorstep and can see it contains plenty of variety so is less tempted to look further afield (plus, pledging allegience to the flag every day at school, they kind of like their home country ). But the fact that a US person wants to be 50%+ US and only 10% UK, does not mean that you should take a 'home bias' cue from that and have your portfolio be 50% UK and only 10% US, or a Frenchman's portfolio should be 50% France.

So, long story short you need to consider how much overseas risk you want, which differs for a lot of people, and is very definitely confused by the fact that your future needs are not going to be met purely by the costs of UK property and council tax and individuals providing local services to you, but also by you wanting consumer products and air travel and movies and and internationally sourced vegetables and medicine.

I think

UK shares dont suffer currency risk. Overseas equities do.

is an outmoded way of looking at it, though I can understand IFAs wanting to talk to clients in those terms, because it's simple and defensible.

The alternative view, if you zoom out to a perspective of an alien or deity watching our entire planet from on high, is of largely free international trade with money, employment, goods and services flowing around the world, billions of dollars per second. One guy is standing on a pedestal in Little Britain shouting to anyone who will listen: "well you guys can do whatever you like, because MY assets don't have currency risk." The deity simply thinks "Aww, that's so cute. Poor misguided fool."

I realise I have not yet answered the question about what percentage I would use.... everyone is different. I see Vanguard's Lifestrategy 100% equity product uses 35% UK, which is three or more times greater than the UK's assets are on a world stage, but not as over-the-top (imho) as 50%. That level of home bias seems OK to me, given that more cautious people will also have a side order of GBP bonds and gilts and cash in their portfolio which drag up the home currency exposure further and add some stability.

j0nathon2

Mine goes something like:

30% US
30% UK
15% Developed Europe
10% Emerging Europe
8% Japan
7% Emerging other

Why? I like to invest in smaller companies, and this is where the heavy US comes in. In fact, it didn't start out like the above, it started higher in the UK but the smaller companies have done well. I also have no plans for the money, ever.

dunstonh

In my view, 'currency risk' can be a red herring.

I agree with you somewhat when it is mature economies. Although it does still very much exist in emerging markets and pacific region.

We do have to be careful to remember that a risk is still a risk even if the risk event doesn't seem likely. Up until 2000, no endowment had ever fell short. Complacency had set in prior to that and look what happened when a perfect storm set of events occurred.

is an outmoded way of looking at it, though I can understand IFAs wanting to talk to clients in those terms, because it's simple and defensible.

If you were putting your own money on the line when giving advice (i.e .you pay out if your advice is classed as bad) and dealing with an erratic regulator, what you think and what you do are often two different things. What you do and advise or discuss with an experienced investor will be different to that which you do with new investor or someone that doesn't really care about what they have.

Currency risk is less of a risk than it once was with globalisation but it is still a risk and it is important not to get complacent with any risk as they can come back and bite you when you least expect it. Also, it does still add to volatility. In some regions, not a lot but in others it can.

If you buy a house on a flood plain with a 1 in 100 year risk of flooding and you were told that there hadnt been a flood in 75 years, you may buy it thinking its not going to flood as its been so long. However, if that house with a 1 in 100 year risk flooded just last year, would you still buy it? The risk hasnt changed. Just when the risk event actually occurred has.

bowlhead99

dunstonh wrote: »

If you were putting your own money on the line when giving advice (i.e .you pay out if your advice is classed as bad) and dealing with an erratic regulator, what you think and what you do are often two different things. What you do and advise or discuss with an experienced investor will be different to that which you do with new investor or someone that doesn't really care about what they have.

To be honest, I assumed / hoped that was the case.

As a gross simplification I'm sure the regulator is more comfortable with you telling an investor that Exxon carries extra risk because it's priced in dollars rather than BP or Shell in pounds, because zero change in the fortunes of the companies could still move the return of Exxon up or down when selling back the USD to buy pounds at a different rate. It sounds like sensible common sense and therefore quite defensible.

The reality of course is they are all operating globally in multi currencies, and affected by energy and oil prices - which are nominally priced in USD but change daily based on the price of USD against other currencies anyway. And they all have their own quirks of tax rates and regions of focus etc etc. So a nominal pricing currency is largely irrelevant in the longer term, the price should still reflect fair value.

I appreciate this is out of scope as you the advisor would not tell anyone to go buy a particular share, it's just the general concept I'm alluding to. One has to err on the side of caution, being careful how opinions might be interpreted, and presume ignorance and talk at the most basic level if it's not clear someone can handle more. But it's a shame that this might put someone off constructing a global portfolio when any movement might be as likely to help as to hinder the acheivement of the goal over a long enough timescale. I guess the answer is, someone with more risk tolerance can be offered the conversation about why everything they learned in Investing 101 was only an introduction to Investing 202.

Currency risk is less of a risk than it once was with globalisation but it is still a risk and it is important not to get complacent with any risk as they can come back and bite you when you least expect it. Also, it does still add to volatility. In some regions, not a lot but in others it can.

Yes I suppose that's the case, doubling your nominal local currency amount does not help if that currency is in a hyperinflationary economy and your pesos or shekels or roubles or yuan are not worth the paper they're printed on. I personally think the yuan is undervalued compared to where it would be if freely floating but there are others the other way around and of course anything could change over time.

While currency risk is easy to explain mathematically, it is perhaps not really worth pulling out as a general, separate, risk from being invested in a country. In developed global markets, the rate movement over time will add some 'spice' to performance which could be for better or worse and is not controllable, so I don't concern myself with it as much as I could; I just ensure I have eggs in multiple baskets and consider what I'm happy with as an overall portfolio mix, which is all personal judgement.

You'll find it difficult to look at a Europe ex-UK index fund and determine what proportion is attributable to Nestle's GBP or USD or African revenues. The more obvious question is should I have any exposure to a large multinational conglomerate like Nestle, to which the answer for me without doing any specific research is sure, conceptually, why not.

Similarly with Emerging Markets exposure, for different reasons: the currency is potentially more volatile as are the local politics, economic fragility, transparency of corporate governance etc. There are loads of risks, which may or may not be compensated for by the demographics and favourable growth arguments going forward. If the companies and their respective economies are genuinely successful, then currency movements will be nothing to worry about. Or at the other extreme, they could be least of your worries. Either way, they don't really get considered as a separate risk when I'm deciding whether I'm enough of a gambler to buy a bit more of a Thai or sub-Saharan regional fund.

jamesd

ruperts wrote: »

The idea of a 'purist' approach of diversifying geographically according to market cap seems logical but impractical and perhaps unnecessary due to correlations, and there is also currency risk.

The UK is about 8% of the global equity markets. More than that is overweight UK.

There's no perfect answer but I don't think say a common 60:40 UK:global mix is likely to be a good one for younger investors who pay regular attention to their investments, so who could react to broad trends in currency movement. For older investors who are getting close to retirement and who will buy an annuity it would be a better fit.

There are also hedged funds. Many Japanese funds hedged currency risk late last year and early this year. This isn't normally disclosed in consumer documentation, it may take contacting the fund provider directly to find out.

At the moment the broad trends seem to me to be something like this:

1. UK likely to recover slower than US, so likely to drop relative to the Dollar.
2. Reasonably comparable to Euro but starting a bit stronger, more likely to drop than rise compared to Euro, except for short term volatility.
3. Natural resources developing markets under currency pressure until there is an increase in demand. Potentially good time to buy in these areas.
4. Consumer developing markets much more mixed but perhaps under pressure or not depending on anticipated demographic changes.
5. Eventual end of QE and increases in Bank Rate may reverse all of these moves relative to the Pound.

You can also hedge currency risk yourself with currency options, futures, covered warrants or other products. If you have enough invested to make it worth doing.

But all of this assumes that you'll pay attention. If you won't, higher UK is wise.