Long, long ago in a galaxy far, far away (June 2018, here, to be exact), I noted that UK equities were a pariah asset. The influential Bank of America Merrill Lynch report stated that they were the most unpopular asset in April of that year.
The largest outflows from Lipper’s Equity UK and Equity UK Income classifications combined were during COVID (£15.9bn in 2020). Prior to this, the largest redemptions were in 2016, at £10.3bn. Those with a keen sense of recent history might be aware of the year’s significance, but there is more going on here than Brexit. Indeed, over the longer term, that’s just a blip (see chart 1). UK equity funds have been squeezed for some considerable time.
Conversely, global funds have been increasing relative to UK investors’ domestic equity holdings.[1] In 2003, Equity Global and Equity Global Income funds combined stood at £20.4m, and their UK equivalents at £95bn, so global funds were 17.7% of total combined assets. By 2021, those figures stood at £271.7bn and £268.7bn, respectively. Global funds were 50.3% of UK and global equity assets combined.
That’s quite a dramatic shift, and one that I don’t think is appreciated enough.
Chart 1: UK versus Global Fund Assets, Relative
Source: Refinitiv Lipper
UK flows exceeded global flows in the three of the four years prior to the onset of the global financial crisis—although as you can see from chart 2, the last year saw strong flows favouring global (£61.bn versus £1.4bn), and the same in the crisis year of 2007 (£1.4bn versus -£4,6bn).
However, global flows were ahead of those for the UK in nine of the 13 years following the crisis, with the biggest differential being, not the Brexit year of 2016, but 2020 (£39.3bn).
Chart 2: Annual Flows, UK & Global funds (£bn)
Source: Refinitiv Lipper
Not chasing performance
Is this driven by performance? This makes a certain intuitive sense: after all, between the global financial crisis and the pandemic, it’s been a growth-driven market, with cheap money and large tech reaping many of the rewards. The UK was disadvantaged, being a value-driven market with a small technology sector.
There may be an element of performance chasing to this, but it’s difficult to make too strong a case for it. Three of the four years prior to the GFC UK equities outperformed…and continued to outperform on an annualised basis for the five years after the crisis, albeit significantly underperforming in the crisis year of 2008. Global equity has outperformed over six of the past eight years (chart 3). Looking at chart 5, it’s been far from a one-sided game.
Instead, it looks like UK investors have been doing what advisers and consultants have been nagging them to do for decades, and that’s to rectify their overweight to domestic assets. This has been done irrespective of market conditions, and diversified global equity funds have been the main beneficiary of this trend.
As a slight coda to this, only of late have global equity income funds benefitted from this trend. Over the past five full years, £13bn has exited Equity Global Income, while the classification netted £2.1bn from the start of 2022 to the end of August.
Chart 3: UK v Global Equity Annualised Performance (%)
Source: Refinitiv Lipper
Chart 4: Equity Global versus Equity UK, 20-Year Performance
Source: Refinitiv Lipper
Where has all the money gone?
Good question—I’m glad you asked. Looking at global funds alone, it’s clear that passive funds have been a significant beneficiary, going from 0.7% of the market in 2003 to 22.4% last year (chart 5). In this respect, it’s aligned with the trend of the broader market, as trackers continue to nibble at the heels of their still-dominant active peers.
Chart 5: Active v Passive Relative TNA, Global Equity Funds Only
Source: Refinitiv Lipper
The total net asset picture masks something of a sea change around 2010: up until then, passives had never taken more than 3% of the global equity flow. From 2011, flows increase significantly, and in 2021 passives took 38.7% of global equity flows (chart 6).
Chart 6: Active v passive Global Equity flows (£bn)
Source: Refinitiv Lipper
More dramatic than the shift to passives within global, however, has been the rise of ESG across these markets. Taking the past three full years, we’ve seen net outflows from global and UK equity funds of £14.2bn and £19.6bn, respectively, while global ESG funds have attracted £54.4bn of assets. Even in the deeply unloved world of UK equity funds, their ESG variants have netted £4.6bn of assets (chart 7).
Chart 7: UK & Global ESG v Conventional flows (£bn)
Source: Refinitiv Lipper, three-year flows to 31 August 2022
Even with ESG funds coming under increasing scrutiny this year, the year-to-date flows for global and UK ESG are £10.9bn and £1.4bn, respectively.
What seems to be happening, therefore, is that UK investors are executing a strategic asset allocation realignment from domestic to global equities, and over recent years this is being done through the lens of sustainability. With the ratio of global to domestic equity now standing at 50-50, UK equities will now be a significantly smaller proportion of portfolios when other exposures such as emerging markets, North America, and Asia are taken into account.
The question, therefore, is how far are portfolios off peak global? Recent flows suggest there’s still some way to go.
[1] UK investors taken as buyers of UK registered for sale mutual funds and ETFs, with the currency of record in sterling.
This article was originally published in Investment Week.
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