Feature – UK equities
The trend towards pension funds diversifying out of UK equi- ties is one that sits well with Yesildag. “Pensions schemes have done quite a lot but there is more to do,” he says, adding: “Companies like us had been reasonably successful in educat- ing
pension schemes and their trustees in terms of
diversification.” Regardless of attitudes to UK-listed equities, to the future of the UK economy and Brexit, it does not make sense from a portfolio construction perspective to have so much in one mar- ket, Yesildag explains. “From a perspective of optimal diversification at the portfolio level, it makes sense to not have too much exposure to a limit- ed number of companies,” he adds.
The rationale for this broader investment approach is an obvi- ous one: restricting exposure to one geographic basket is at the opportunity cost of foregoing potential returns elsewhere. “Remember,” Yesildag says, “if you are looking at UK equities the pool is relatively smaller and tends to be in certain sectors. “So you are narrowing down your options quite a lot and cer- tain things that might happen with the big dominant compa- nies can affect your returns. So from that perspective it makes sense to be more global and investors are moving in that direc- tion,” he adds. Surrey Pension Fund is a case in point. The scheme is gradual- ly reducing its exposure to UK-listed equities. Its equity asset split 18 months ago, when the scheme had 45% in domestically-listed shares and 55% in global equities, has been rebalanced to 20% UK and 80% global, which is 60% of its total portfolio.
“Our journey is towards a reduction in UK equities,” says Neil Mason, head of pensions at Surrey Pension Fund. “We have made a gradual movement away from UK and towards global equities because we were overweight in domestically-listed shares.”
One of the reasons for pension schemes shifting away from UK equities is the kinds of stocks which inhabit British indi- ces, Yesildag points out. The FTSE100 has a strong leaning towards large telecom gi- ants. UK indices are also rich in supermarkets, banks, energy and mining companies. The fates of such UK stocks are close- ly intertwined with the fate of the global economy. “What that means is if the global economy is doing well then people tend to use up more materials that will stem from min- ing, oils or metals and the companies producing these materi- als do well,” Yesildag says. “So that’s why we get this phenom- enon that when value of sterling drops, the FTSE tends to do much better because a lot of these companies make most of their money from outside of UK.”
Thus, with a large exposure to UK equities the question arises whether that is made up of large or mid-cap companies be- cause larger entities, arguably represent a global exposure, whereas the performance of smaller companies tends to be more linked to the domestic market.
We went into this with the UK market looking cheap, it’s now looking cheaper. Emma Mogford, Newton Investment Management
Now and then So caution was the order of the day and pension schemes were reducing their exposure to UK equities and all was relatively normal. And then there was that fabled thing, a black swan event, which crept into the world with sniffles before laying waste to vast swathes of people. Such has been the impact of Coronavirus – which is like an asteroid crashing into the plan- et – that it makes sense to speak of before and after this crisis. Before Covid-19 hit the world, Surrey Pension Fund’s Neil Ma- son espied some opportunities in UK equities. “We actually saw some opportunities in the UK market before this all happened,” he says. “Those opportunities were the val- ue of the UK market relative to other markets, particularly the US. It looked undervalued compared to the US.” But since the coronavirus asteroid hit, capital markets have tak- en a battering and investors candidly admit there are whole sectors of the economy whose future looks unsure. Yet paradoxically the carnage is also a bargain-hunters para- dise. Emma Mogford, manager of Newton’s UK Income strate- gy, sees opportunities in UK equities for savvy institutional in- vestors and stresses the importance of income stocks as a wellspring of returns, noting that income funds tend to outper- form in falling markets.
“If you look at long term, over past 40 years, in the UK market dividends have made up to 80% of returns so it is an important
38 | portfolio institutional April 2020 | issue 92
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