Charity focus: The obvious answer isnít always the right one
At their recent Spring Seminars, Richard Maitland, Head of Charities at Sarasin & Partners spoke about the behavioural and less obviously scientific aspects of investment management.
Achieving success in investment is thought by many to be all about maths, spread sheets, computing power and simply being brighter than the competition.
While all of these factors matter, we would suggest that they only provide part of the answer. To achieve long-term success, one needs to consider the human sciences too. Many seemingly indisputable doctoral theses have broken down in the real world of investment, and the list of spectacular investment implosions includes the names of more than one Nobel Laureate when something didn’t quite stack up under actual market stresses.
It is often said that a little information combined with over confidence in one’s own abilities is a great deal more dangerous than having no information or knowing that you are short of experience. This is particularly true in the world of investment where, in the opinion of the author, there are many more good salesmen than fund managers.
When combined with the opacity that surrounds so many of the figures quoted in the investment world, and the inability of most people to lay their hands on ‘clean’ data, we thought it might be helpful to offer some insights into the questions we are frequently asked – and often, where the most obvious answer is not the best way forward. In this quarter’s House Report, we discuss the merits of having a strategic bias to emerging markets and a specific allocation to UK equities.
A strategic bias to emerging markets?
It is hard to argue that the economies of the developed and more mature western countries will be out grown by their emerging market competitors over the next 5 to 10 years. Whether it is debt, demographics, physical or human resources, the old ‘west’ seems to be seriously disadvantaged. In fact the economic prospects of these countries have diverged even further since 2008: so surely one should embed a strategic overweight allocation to such markets within our portfolios?
We have always considered this sort of thinking has the potential for policy error and have not therefore adjusted benchmarks to give clients an unusually large weighting in emerging market equities. Statistics show that there is little short and medium-term correlation between economic growth and stock market returns. From a thematic perspective, while one wants to gain exposure to the attractive emerging market trends, this can often be better achieved by owning western and northern hemisphere companies selling into the east and southern hemisphere.
It is therefore a case of avoiding one’s first and most obvious reaction to declining western prospects and digging a little deeper to achieve the desired results. Of the 20 largest companies in a typical emerging market index (and therefore in most actively managed portfolios you might buy) half are in the oil and mining sectors. Hardly the desired outcome as these are not the types of companies to which we were trying to achieve exposure. Interestingly, many of the next largest companies have significant sales to the very markets one would be seeking to avoid. No surprises then that over the past 1, 3 and 5 years, emerging market indices have actually underperformed the rest of the world by 10.8%, 18.6% and 10.2%1 respectively. So, a permanent and strategic long-term ‘overweight’ to emerging markets is not necessarily a guaranteed path to investment success. Rather, careful analysis and investment in global (and often western-listed) companies with substantial revenues earned in the faster growing economies should offer better long-term returns.
A specific allocation to UK equities?
One of the things Sarasin & Partners is best known for is our global and thematic approach to equity selection. We are obviously not alone in thinking on a global basis as data from The WM Company clearly shows that the average segregated portfolio and multi-asset class Common Investment Funds (CIFs) have altered their equity allocations away from the UK and towards international companies significantly: since 2002, the UK/Overseas split has changed from 74%/26% to 56%/44%2.
Indeed, some charities (including clients of Sarasin & Partners) now have all their equities managed on a global basis with a much reduced UK equity allocation close to that of the index weight in the MSCI World Index.
From a corporate perspective, this makes a great deal of sense: indeed, we are on record as consistently saying that it matters much more where a company makes its profits than where it happens to be listed. So why, if given carte blanche, do we still advocate a specific strategic allocation to UK equities? For example, our Alpha CIF for Endowments Fund has a 30% neutral allocation to UK-listed stocks and a 40% allocation to the rest of the world.
Despite being embroiled comprehensively in the banking crisis (and the banking sector was a larger part of the UK market than in most other countries), followed by the UK’s largest company tripping over itself in the Gulf (BP was 7.2% of the UK FTSE All Share index on 20 April 2010 before the Macondo oil spill and its shares fell by 55% afterwards to its lowest point on 25 June 2010 to 269p) as well as enduring a pretty dreadful tech-driven collapse between 2000-03, the performance of the FTSE All-Share Index has actually matched the World ex-UK Index over the past 12 months and 10 years.
However, just because UK equities have performed well in the past doesn’t mean they will in the future: on balance, we suspect overseas equities will actually do a little better in the years ahead.
Our reasoning for maintaining the UK exposure for our charity clients is based on the opportunity to manage the shape of the return: ultimately, we think we can make at least as much money with less risk if we have a core UK equity allocation. Why?
Firstly, if you look at each of the last 10 years, although the overall result is the same, UK equities have outperformed overseas equities in 6 of the calendar years and the difference between them is often as much as 8-10%. So, there are tactical asset allocation opportunities and these are even greater if one has the ability to hedge (or not hedge) some of the overseas currency risk back into sterling.
Secondly, we find it helpful to have more rather than less of the income we receive paid in sterling (and where company executives generally are aiming to increase the sterling distribution year-on-year). Thirdly, given the make-up of the UK stock market, it is interesting that it is actually rather more geared into the performance of emerging markets than other major markets. Fourthly, we must acknowledge that we are active managers and while our UK and international equity teams have both added value over and above their respective benchmarks, they don’t always perform well/badly at the same time: we feel we can add value by having a little more/less in whichever area we are adding more alpha.
So, while it might seem slightly counter-intuitive, we feel that there is still a place for UK equities in a UK charity’s long-term endowment fund.
In next quarter’s Charity Focus we will tackle two more topical questions with counter-intuitive answers.
1Source: Lipper, MSCI World and MSCI Emerging Markets (£), gross total returns
2Source: The WM Company 31.12.12
This article first appeared in Sarasin & Partners House Report Quarter 2 2013
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Richard Maitland is a partner and Head of Charities at Sarasin and Partners.
Richard has more than 22 years of investment experience and joined Sarasin & Partners in 1992. In addition to UK equity research, Richard has led the firm’s third party funds research team, analysing specialist equity funds and alternative assets while managing portfolios for a range of charities, pension funds and unit trusts. He now focuses on managing diversified multi-asset portfolios for charities and assists in setting the firm's long-term strategic asset allocation. He is author of the Sarasin & Partners Compendium of Investment. Richard has a degree from Newcastle University and is a member of the St Paul’s Cathedral Investments Committee. He has been a visiting lecturer on investment and endowment management at the Judge Business School and the Universities of Stellenbosch and Vienna. Read more articles by this author