A number of MPS providers offer the choice of whether to introduce ‘home bias’ into a portfolio. Until recently, the right choice was, unequivocally, not to have a home bias, as UK assets languished relative to their global peers. However, the arguments for and against a home bias have changed, and the decision may be more nuanced today.
A home bias has been a significant drag on investor returns for much of the past decade. The S&P 500 has delivered an annualised total return of 14.2% for the past five years, versus just 5.7% for the FTSE All Share. While the UK has had its upsides, such as strong income generation, investors that have looked globally have fared far better.
Recent performance has been more even. In 2022, Vanguard launched its MPS Classic and Global options. The Vanguard LifeStrategy MPS Classic has a tilt to the UK in both the equity (25%) and fixed income (35%) segments, while the Vanguard LifeStrategy MPS Global 100% Equity takes a global approach. Over the past 12 months, the global option is still ahead, but only by about 0.4% (18.2% versus 17.8%).
Home advantage
The usual argument for a home bias is a risk-based one. Investors tend to have better knowledge and information on their home market and are more comfortable with the companies that end up in their portfolio. Foreign assets may bring currency, political or governance risks. There has been a view that UK-based retirees will ultimately need their income in sterling, therefore it is good practice to have a higher weighting in sterling-based assets.
Home bias is still quite common. A recent survey found that 25% of the average balanced model portfolio is still made up of UK investments. Private bank Coutts had maintained a home bias on its portfolios until May of this year, when it announced plans to move around £2bn worth of client funds out of the UK and into global funds.
However, many of the structural arguments for a home bias have disappeared. Even if someone is investing in UK-listed companies, they will often be exposed to global revenues, so are still seeing currency risks. Governance structures in developed markets have become more homogenous, so there are fewer risks in investing outside the UK.
Then there is the problem of the increasing marginalisation of the UK’s stockmarket. Dzmitry Lipski, head of funds research at interactive investor, said: “Both the number and size [market capitalisation] of UK companies have declined over the last few decades. In the 1990s, the UK accounted for more than 10% of global stockmarket indices such as the FTSE All-World index but is now under 4%.
“Institutional investors such as insurance and pension funds have been gradually reducing home bias within equity allocations and jointly held a total of 4.2% of UK-listed shares in 2022, the lowest on record. Their holdings in UK shares have fallen since 1997 when the two sectors held a combined 45.7% [Source: Office for National Statistics, Ownership of UK quoted shares: 2022].”
There has been plenty of debate on whether this will change. The UK market has been fighting persistent outflows for much of the past decade. A recent Calastone report showed no signs of this easing, with outflows of £666m in September.
See also: Are the negative flows from UK equity funds justified?
The group pointed out that all other major geographically-focused fund sectors saw inflows in September. This chimes with data from the Investment Association (IA) that saw UK All Companies sector drop another £630m in August, after outflows of £654m in July.
However, fund managers report growing interest. Victoria Stevens, manager on the Liontrust Special Situations and Liontrust UK Smaller Companies funds, said that while there is some “sitting on hands” in anticipation of the Autumn statement, there are signs flows are ticking up. She says institutional investors in particular appear to be recognising the opportunity in low valuations.
She added the UK still looks very cheap on a range of measures, with measures of cashflow versus intrinsic value suggesting the UK is 19% undervalued.
Certainly, private equity and corporate buyers, plus the companies themselves, are taking an interest. The UK market has been supported by a wave of M&A and buyback activity, including bids for high-profile groups such as Rightmove, Hargreaves Lansdown or the Post Office. This is helping to support prices and has been the catalyst for a nascent revival in UK stockmarket performance.
There is also the income factor. Nick Kirrage, manager on the Schroder Income fund, pointed out the UK has the highest total return yield (ie dividend yield and buyback yield). This is currently about 8% per year.
See also: Calastone: Equity funds suffer first monthly outflows since October 2023
If this much is coming back to investors each year, he said “it is much harder to lose money”. He added he is excited about domestic UK companies at the moment, with “lots of deep value hiding in plain sight”. He gave the example of NatWest, which is up over 50% for the year-to-date.
If this argues for a higher allocation to UK equities, the environment is also more supportive for UK bonds. UK bonds have proved far more popular with investors: UK gilt funds saw £59m of inflows in August, on top of £160m in July, according to the IA. The Sterling Corporate Bond sector saw £404.3m in July (although some outflows in August). The Sterling Strategic Bond sector saw inflows of £731.5m in August.
Natural diversification
A final note is that a home bias is one way of creating some natural diversification in a market-cap weighted portfolio. The Vanguard global portfolio is about two-thirds weighted to the US. Within that allocation, it is about one-third weighted to information technology and has the usual high weights in companies such as Apple, Microsoft and Nvidia. This is not unique to Vanguard, but a feature of all market-weighted global portfolios.
The risks this introduces are well established. Over the past decade, that has been a risk worth taking, but concentration is now at multi-decade highs.
A recent report by Morgan Stanley said: “Concentration at the end of 2023 was 27%, approaching the prior peak of 30% in 1963. The lowest concentration over this time was 12% in 1993, and the level was 14% as recently as 2014.”
Introducing a home bias is one way of tackling this risk and reintroducing diversification – the naturally-defensive UK is a natural foil to the technology-heavy US.
A home bias is not likely to be the poisoned chalice it has been for much of the past decade. UK markets look better value, and there are tentative signs of a revival in interest from institutional buyers, even if retail buyers are proving slow to come round. Equally, investors need to consider the risks of the alternative at a time when the US is on the cusp of a divisive election.
