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Home is where the heart is?

There are very few “rules of thumb” when investing, mainly because stock markets have a habit of making assumptions based on the past look quickly out of date.

“Home country bias” is the notion that investors naturally concentrate more on their local markets to the detriment of their overall portfolio’s diversification. For us here in the UK, it has long been written that a focus solely on our domestic market and opportunities listed in London also has a negative impact on long-term returns. This has certainly proven to be the case over the current cycle, with the FTSE 100 underperforming other global markets since May 2007 and the beginning of the global financial crisis.

Source: Refinitiv Datastream, November 2019

While much has been written elsewhere on the impact of the political situation since the summer of 2016, the UK had begun to lag the US long prior to the EU referendum. Since the financial crisis, sterling has consistently weakened versus the US dollar as our economy has struggled to regain its footing and interest rates have remained subdued. International shares, held in currencies like the US dollar or the euro, have therefore had a nice currency tailwind helping returns along.

In addition, global investors seeking growth have been drawn to US and Asian markets – and a wealth of technology companies revolutionising how we live our lives; Amazon, Google, Netflix, Alibaba et al. By contrast, the UK market is not particularly served by such an abundance of high quality tech names.

Looking back further however, the picture is not quite so clear. Over fifteen, ten year market periods, ending 2004 to 2018, the UK outperformed the FTSE All-World Index, a measure of global stock markets, on nine occasions. I must admit, I was a little surprised by this.

Source: Refinitiv Datastream, November 2019

So despite recent history, should we reconsider the UK? At present, a combination of metrics shows the UK stock market on its lowest valuation relative to global equities in thirty years. While it can feel uncomfortable buying assets on low valuations, as there will undoubtedly be well-publicised reasons to avoid doing so (in this case political uncertainty), lower valuations imply higher long-term returns. Therefore, it is often exactly the right thing to do.

Source: Refinitiv Datastream, September 2019

Source: Refinitiv Datastream, September 2019

It may even be said that the current discount applied to UK listed companies is largely unjustified. Many investors are aware that the average FTSE 100 company derives the majority of its revenues from overseas. However, we recently decided to go further and determine which factors have historically had the greatest impact on the performance of the UK market. The global economy (as referenced by global GDP) on average has a much greater impact than the UK economy on the earnings of domestic companies. Although Brexit can seem all-consuming to us here in the UK on occasion, as long as the wider global economy continues to tick along – most companies listed in London should continue to perform ably.

Overall, as ever, the key is to maintain a well-balanced and geographically diversified portfolio. Other major markets (in particular the US) retain structural advantages that the UK market will likely struggle to replicate into the future – for one, the quality of available companies in many sectors. However, part of a disciplined investment process is being prepared to look for out-of-favour areas within your portfolio and rebalance into these as a means of generating strong longer-term returns. At present therefore, it can pay to stay local.

Alastair Clark, Research Executive to the Chief Investment Officer

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