The world in your hands

Many investors will be aware of the concentration of capital within the UK equity market. Is that the place to invest? Richard Maitland dispels the myth of the distinction between UK and global markets

Of the 670-odd companies in the FTSE All-Share Index, the 50 largest make up 76 per cent of the total UK equity market value. But of particular importance to charity trustees is the concentration of the income stream: just 20 companies pay out 72 per cent of all UK equity dividend income.

At a time of rising inflation, it is worth noting that the companies that pay the largest dividends are not necessarily those that will grow their dividends fastest. Citigroup estimates that total UK equity market dividend growth in 2007 was 9.1 per cent, but that the dividends of the largest 20 companies grew by only 7.7 per cent, assuming spot exchange rates. As some of the largest distributions in the UK are made by the banking sector, this differential is only likely to get worse over 2008 and 2009.

At least, one might think, investing in the UK results in a reliable stream of income in a UK charity’s base currency.
Well, actually it doesn’t! By December 2007, 20 companies in the FTSE 100 index paid their dividends in US dollars.
Indeed, dividends paid by these companies are estimated to be a little over £18 billion in 2007, representing 33 per
cent of all dividends paid.

Good returns
These figures surprised many investors who felt that by owning a portfolio of perhaps 40-50 UK-listed equities, they mostly avoided currency risk and the possibility that the failure of a limited number of companies could impact
significantly on a single year’s income. Regional stock markets look increasingly imbalanced to many investors
and call into question long-held convictions about the proportions that should be allocated to UK versus overseas equities. Many UK companies now have bigger operations overseas than at home; the UK corporate sector derives more than half of its profits overseas. Most large and mid-sized companies are multinationals that are better compared with their global peer group than with a domestic stock market.

Home is where the HQ is
To complicate matters further, companies are moving their headquarters and stock market listings to jurisdictions that suit their future, not their past, or to benefit from well-regulated markets or benevolent tax regimes. Witness the recent influx of South African and Russian mining companies to the UK market.

At the same time, some regions of the world are becoming increasingly specialised in certain industries, depending on their point of economic development, natural resources or historic areas of success. So, most investors are investing globally by default, but are not necessarily aware of or managing the risks that this entails. For example, the global stock market weighting in technology companies is about 10 per cent. It is over 12 per cent in the US, but accounts for less than 2 per cent of the UK equity market. By having a significant bias to UK equities, one is unintentionally locking in a structural deficit in a growth-oriented sector.

Well built
When constructing a genuinely well-diversified portfolio, investors should focus on the degree of domestic bias that they wish to maintain. It is important to adopt a higher weighting in companies listed on international stock exchanges to increase diversification and reduce risk through active analysis and management.

The question then becomes whether one should manage a larger allocation to international listed equities in the same way one has done historically, most probably through a series of regional equity portfolios. I would suggest not. Once one has embraced a global approach to stock selection, the inefficiencies of holding a series of separately managed regional allocations can be removed.

The distinction between UK and overseas equities has become blurred. Many pension funds have adopted a
completely global approach to their equity allocation, and charity investment portfolios are following. This makes sense as taking no action doesn’t maintain the status quo: in a world that is changing rapidly around us, positive action is required to maintain prudent risk profiles and suitably diversified income streams.

Richard Maitland is a partner and head of charities for Sarasin & Partners.

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