Taking a global approach to charity investing
UK charities’ allocation to overseas equities and bonds has recently overtaken their exposure to UK equities and bonds, according to a survey which was conducted among leaders and decision-makers in the UK charity sector. The survey found that total allocation to overseas assets reached 39% while UK assets were at 38%. These are the lowest levels of allocation to UK assets in the six years since the survey has been running.. As recently as 2018, UK assets exceeded overseas assets by 44% to 36%.
Historically, the asset allocation of charities’ investment portfolios has tended to entail a significant bias towards domestically listed securities. The UK market constitutes just over 5% of the FTSE All-World equity index, way below the charity sector’s current overall exposure to its home market, but charity trustees have typically seen attraction in keeping a much higher proportion of assets “close to home”.
News flow in recent months may have been dominated by Brexit, and of course most recently coronavirus, while trade tensions – most notably the continuing dispute between the US and China – have continued to drive investor sentiment. However, the longer term trend has been towards greater global integration, both in economic and financial-market terms, as recent decades have seen significant changes including the collapse of communism, the creation of the European Union and the growth of technology.
As a result, it is impossible to consider capital market developments in the restricted context of individual countries or regions. A global approach provides crucial perspective on the investment landscape as a whole, helping the investor to identify key long term trends, and to try to make dispassionate comparisons between companies in the UK market and in other markets around the world.
Equities in a globalised world
So, what are the arguments for investing with a bias to the home market? Charities exist to spend, and typically favour a dependable return (income) to permit that. The current UK equity market yield of around 3.8% compares favourably with the 2.2% on offer from world equities, thus UK equities carry attraction.
Many charities invest for total return, i.e. they are agnostic in terms of income versus capital gain, but for many the higher reliability of an annual income over more volatile capital performance holds attraction, and a number of strong global businesses paying attractive levels of dividend are to be found listed on the London Stock Exchange.
Additionally, as the UK market represents an internationally diverse source of revenues and profits, UK investments can afford global exposures and diversification while preserving familiar corporate governance standards. To illustrate this point, it is useful to look at some of the constituents of the UK’s FTSE All-Share index, which represents the substantial majority of UK listed shares by market capitalisation. While these companies are, on paper at least, based in the UK, in reality many of the biggest businesses are global with the majority of their revenues coming from abroad.
For example, insurance group Prudential, following the demerger of its UK and Europe business M&G, now operates primarily in Asia. Another index heavyweight, consumer goods company Unilever, whose brands include food and personal care products, offers its products in almost 200 countries. Meanwhile, some of the most high profile names in the minds of UK consumers, and indeed the biggest companies globally in terms of market capitalisation, are US based businesses like Amazon and Apple. The country in which a company’s shares are listed in many cases has little to do with the sources of its revenues and profits.
These attractions require further investigation. A further factor to consider is the concentration of industry sectors. A small number of oil and gas companies, for instance, constitute around 12% of the UK’s FTSE All-Share index, compared to about 5% of the global FTSE All-World. Moreover, they pay 16% of the UK market’s annual dividend income and represent a risk to a charity’s investment income if corporate performance or a mishap (such as BP’s Macondo well disaster) leads to those dividends being cut.
The financial sector represents around 27% of the FTSE All-Share but around 21% of the FTSE All-World. This could result in unintended concentration risk for those investors with a significant bias towards the UK market, both in terms of total return and dividend income. In 2007 around 20% of all dividends paid out from UK listed equities, representing over £13 billion, came from the banking sector. However, the fallout from the global financial crisis resulted in the total payout more than halving in 2009 and 2010.
Volatility of returns is rightly a concern for investing trustees, and analysis shows that, for the sterling investor, total investment returns from overseas equities have been higher than those from UK equities over the last three, five and ten years, but slightly more volatile. What is interesting, however, is that the part of that return most typically spent (i.e. the income) has been significantly less volatile from a global portfolio over the same time periods. This is particularly the case if we extend the analysis over a longer, 15-year, period, which includes several years prior to the financial crisis when banks had greater dominance over the UK index.
Environmental, social and governance
In addition, with climate change and environmental concerns increasingly in the spotlight, it is unsurprising that a growing number of charities are seeking to pursue a sustainable investment approach. In this context, the bias of the UK market towards mining stocks and fossil fuels may mean there is less scope to identify businesses which are innovating to provide solutions to environmental challenges.
Environmental, social and governance standards undoubtedly vary, but they are as likely to do so between one sector and another, or one company and another, as between one region or country and another, and to be understood fully they need to be evaluated on a global basis.
For instance, while emerging markets in particular are often challenged on their accountability, high level corporate scandals are far from rare in developed markets such as the US and Europe. There are also a growing number of emerging market companies which are trying hard to improve their business and ethical practices in order to make themselves more attractive to global investors.
Opportunities are global
It is helpful when investing to use a dynamic thematic framework to help identify structural growth opportunities as well as investment risks. For example, a rapidly growing middle class is significantly changing the consumer sector in emerging markets such as China and India. Rising incomes are bringing more and more people into urban centres, with millions more people hoping to live lives defined by convenience, choice and consumption. This creates investment opportunities across areas including health care, education, and online services such as food delivery.
Of course, rapid urbanisation also brings with it significant environmental challenges, but even here there is potential for innovation, such as in the potential for much more energy-efficient air-conditioning systems. A global investment approach provides greater potential to access such growth and innovation.
Global approach by asset class
While we have so far discussed equity investments, I would contend that there are also arguments for a global approach across other asset classes. Lenders to government entities have traditionally received fixed, positive rates of interest, but such is the perceived risk associated with other assets that investors in many sovereign bonds, including those from the UK, are facing prospective returns at levels well below inflation.
However, marked divergence is to be anticipated in the fortunes of regions and currencies, and in the interest rate environment in different economies. Such divergence provides plentiful opportunities for the bond investor with the flexibility to diversify away from their domestic market and invest around the world to generate attractive returns.
The aspiration to match the currency denomination of assets with the “base” currency of future spending may be one of the reasons most frequently cited by charities for their bias towards domestic assets. However, currency risks are not necessarily aligned with an investor’s geographic exposure, and there can be flaws for UK based investors in seeking to use domestically listed assets to meet their spending requirements (not least owing to their resulting exposure to non-sterling overseas revenues and earnings).
Historic perception challenged
Charity investors have traditionally stayed closer to home for a number of reasons, and the UK market remains attractive as a point of access to global investment opportunities and as a source of income. The historic perception that exposure to non-UK equities adds risk or volatility to an overall portfolio is increasingly being challenged, as is the contention that domestic investments offer greater comfort in terms of accounting standards and corporate governance.
It does make sense for charity investors consider investment choices in their true global context, and to recognise the merits of that wider global context and opportunity set. Charity investors appear to be embracing this more global approach to investing. A global approach to portfolio construction has long been intuitive in a globalised world, as it should allow investors to achieve a superior risk-adjusted return to that available from compartmentalised, country or region-specific approaches.
