Investing in the UK – pros and cons

13 Oct 2020

The latest figures from the Investment Association show that UK funds are firmly out of favour with UK retail investors. UK funds suffered net outflows in June and July of £1.1 billion and £912 million respectively. Other categories of fund proved popular over the same period, with global equity, North American and Asian funds seeing strong inflows.

The poor performance of the UK stock market this year in relation to many others has clearly taken its toll. The malaise bearing down on UK equities is all too understandable given a 20% fall in Britain’s economic output in the second quarter, continuing uncertainties posed by the coronavirus and slow progress towards securing a trade deal with the EU before October’s talks deadline. Dividend cuts expected to shave two fifths off the pay-outs of UK companies this year have also impacted a mainstay of the UK investing scene – the equity income sector.

As of the end of June, the UK accounted for just 14% of the fund assets owned by UK retail investors. One of the questions raised by this is whether some UK investors have moved out of UK funds on a permanent basis or whether we are simply seeing an effect that will pass in time. In the past, a portfolio with roughly half of its assets invested in the UK and the other half in overseas markets was commonplace. One of the reasons for this was supposedly a behavioural effect called home bias, meaning that investors favoured their home market for reasons of familiarity and a desire not to risk their money in far-flung places. Another reason for home bias has always been a desire to limit exposure to foreign currency risks.

For the average UK investor, future spending commitments will mostly be in sterling so, the thinking goes, a large proportion of their investments need to be too. This makes sense up to a point. Arguably though, investing in equities should be more about seeking opportunities to achieve growth or an income or both than currency matching. A lack of exposure to faster growing overseas markets could seriously harm a portfolio’s growth potential over the longer term, outweighing currency effects. Many investments in UK companies provide a high exposure to foreign markets and currencies anyway. Businesses like Unilever, BP and Vodafone earn a large proportion of their revenues from overseas markets in foreign currencies and some pay their dividends in foreign currencies too. Overall, around three quarters of the earnings of the UK’s top 100 listed companies come from overseas and around half do for the next 2504. So seeking a wholly sterling exposure by investing in UK companies is largely futile.

As a result of the poor relative performance of the UK stock market, many stocks now look good value. Internationally as well as domestically the market is unloved but that’s a position that could be partially resolved once the UK’s trading position with the EU becomes clearer and, in all likelihood, the coronavirus abates next year. We may also have passed through the depths of the dividends crisis, suggesting a brighter outlook for equity income investors. This week, the FTSE 100 company Ferguson – which is predominantly exposed to plumbing and heating markets in the US – said it will restore its dividend to the same level as last year.

Other UK companies with the right business models could soon follow suit. Current estimates suggest that UK equities will broadly still produce a dividend yield of more than 3% over the next year even after accounting for dividend cuts and suspensions. While down on 2019 levels, that still compares very favourably with the income achievable from government gilts and cash deposits. Even so, the recent past suggests the UK will continue to suffer stiff competition from other regions and asset classes for investors’ money. Asia and emerging markets funds offer investors access to faster growth than that available in the UK owing to growing, young populations not seen in the west.