Over the past few years there has been a flow of institutional capital out of assets denominated in pound sterling and into euro and dollar denominated alternatives as investors took shelter from Brexit uncertainty. Many private British investors may also have realigned their portfolios to insulate them against Brexit risk and funnelled more capital towards European and U.S. assets. Investment Association figures show investors took £1.03 billion from UK equity funds over the first half of 2019. £457 million of that, around 45%, was reallocated to North American equity funds.
Betting which geographies or currencies will prosper or struggle over any given period is of course far from an exact science, which makes global diversification a generally sensible strategy. But with the pound at its lowest level against the euro in a decade and very close to its dollar low too, is there are argument for cashing in on euro and dollar assets?
Even discounting the falling value of the pound, European and U.S. equities have outperformed Brexit-bruised UK equivalents in recent times. But when currency movements are priced in the disparity becomes stark. £10,000 invested in the S&P 500 at the beginning of the year, cashed in now, would realise a return of roughly £2353. If it had been invested in the MSCI Europe index £1271. The same sum invested in the FTSE 100 as markets opened after the beginning of 2019 and sold now would generate a return of £820.
An 8.2% return before fees is by no means a poor performance. It is a result of a bounce back from the stock market correction that took hold from autumn 2018 and saw valuations take a significant hit in the run-up to the end of last year. But it’s still nowhere near as good as the 12.7% return of the MSCI Europe and especially the 23.5% return from an S&P 500 investment.
Many analysts believe the relative underperformance of UK stocks since the Brexit referendum result in 2016 means they now have very attractive valuations compared to what the same money buys in the USA and Europe. Many also believe that presents a strong argument for realigning portfolios back towards UK equities. The argument is that especially the USA has shown very strong gains, which could mean a fallower period ahead. UK equities on the other hand could be expected to make ground up the moment there is more clarity around Brexit.
That theory is based on an assessment that the fundamentals of London-listed companies, especially the big boys of the FTSE 100 that earn their revenues internationally, are not obviously weaker than those of European and U.S. peers. So their poorer performance is put down to investor jitters around investing in the UK and sterling assets while Brexit casts a long shadow of uncertainty. Once that’s removed, even to an extent, UK equities should see their valuations more closely reflect their fundamentals.
So realising now gains from investments in European or U.S. equities, turbo charged by the falling value of the pound once converted back into sterling, could make sense. Especially if these gains are reinvested in cheaper sterling-denominated UK equities. Of course, that paying off relies on London-listed stocks recovering ground lost on U.S. and European peers over the next few years and not remaining in the doldrums, which could happen in worst case Brexit scenarios.
But keeping money in European or U.S. equities, or moving more into them from UK assets, could backfire if a pound sterling recovery takes hold. That would be compounded if UK equities then have a catch-up period on their dollar and euro-denominated peers. Which, combined, adds up to a solid case why now could be a good time to pick up more UK exposure. Especially if that is achieved by reinvesting returns realised on dollar and euro-based assets.