Or are they, in fact, destroying investors’ wealth generation with out-of-date asset allocation ideas, poor regulation and over-centralisation?

Is your money in good hands with the UK’s vibrant wealth sector? Over the next two weeks I’m asking a rather
awkward $64bn question – is the UK wealth manager market fit for purpose or is it hamstrung by poor
regulation, over-centralisation and out-of-date asset allocation ideas?

A few weeks ago, talking to a specialist in the investment trust sector, I was surprised to learn that a major UK
wealth adviser has started telling some of the leading UK fund managers that over the next few years they are
downgrading their exposure to UK equities from around 25% of global equity portfolios, to somewhere closer to
the benchmark: around 5%.

The benchmark is probably a well-known one like the MSCI World or ACWI index, which currently has about 4%
exposure (yes, it really is so small) to UK equities. Initially, I thought I was heartily in agreement with this move.
Regular readers will know that I think UK investors – and their advisers – are overexposed to UK equities in
their portfolios.

My finger in the air suggests that many UK private investors are probably 25-50% exposed to UK listed equities
in their portfolios, which is in turn echoed by many wealth advisers’ model portfolios. We can even see this UK
bias in globally diversified portfolios such as Witan (WTAN) and Alliance Trust (ATST). Witan’s 21% UK
weighing is slowly reducing having changed to a more global benchmark with 15% allocated to the UK, half of
the previous level. Alliance has 12%.

Home bias
I happily accept that this UK exposure makes sense on several levels. If the adviser or investor is worried about
currency exposure and long-term playout commitments, then aligning your portfolio with sterling makes sense. It
might also make a great deal of sense at the moment, as UK equities are, structurally, undervalued and look
great value compared to the US and even continental Europe.

Lastly, for an older investor with significant income requirements, a focus on dividend-friendly UK equities is also
logical.

However, each of these three arguments in favour of UK exposure has a strong counterargument.
Currency movements, for example, tend to wash out over time, and besides an increasing number of funds
hedge out the risk of forex swings wiping out their investment returns.

UK equities do look cheap, but they may well be cheap for a damned good reason which is that they are overexposed
to sectors that are profoundly, deeply, structurally out of favour in shifting, tech-driven markets.

Lastly, the emphasis on dividend income can sometimes blind investors to the style risks they are taking: ie,
they are investing in ex-growth stocks in unloved sectors when a more rounded total returns perspective might
make more sense.

Stepping back from the to-and-fro in these debates leaves us with a modest suggestion. Sure, have more
exposure to the UK than a benchmark might give it – say 5-20% – but not much more than that.

We need new benchmarks
So, has the wealth manager done the right thing? Maybe not. I would argue that benchmarking any portfolio
against a broad index based on geographies is increasingly outdated. To understand this point let’s return to the
UK, whose FTSE All-Share index is not really a measure of the UK economy.

In reality, the All-Share is heavily global, with a substantial proportion – well over 50% – of earnings derived in
dollars. The fact that many of the biggest names in the index have chosen to list in the UK reflects board
decisions influenced by lots of factors including brokers fees, listing costs and the location of key shareholders.

The same goes for many European markets and even the US, which boasts lots of UK companies in the tech
sector. In sum, what we should be interested in is seeing through the location of the corporate listing to the
economic exposure of the earnings in an index. In that case, the UK is probably a decent way of buying global
exposure to a stream of dollar and euro earnings.

If one accepts this logic, then I think we can push the case even further and suggest an alternative strategy –
sector/thematic benchmarks. If what we are after is exposure to underlying corporate cashflows, then what we
should be focused on is the sector or cross-sector theme, such as IT and communications services for instance.

And if you want to benchmark yourself against a country – say the resurgent UK economy – then you’d switch
back to a UK Economic Exposure PLC index where all the companies in said index are heavily, and exclusively
exposed to the UK economy alone.

You’d think that there would be many of these economic exposure indices and benchmarks in existence but
there are, in fact, hardly any. The cynic might wonder whether the wealth sector is happily complicit with the
index businesses which would much prefer to push well-known, lucrative and outdated brand name indices
such as the FTSE 100 or the S&P 500.

Wealth destruction
At this point, the reader might well be asking what all this has to do with their portfolios. In simple terms, I would
argue that much of the UK wealth community has been focused on measuring their performance using the
wrong measures.

Traditional wealth managers, with their overemphasis on UK-listed stocks, have been overweight a whole
geography that has serially underperformed for more than a decade. That has helped destroy your long-term
returns.

A subgroup of wealth advisers is breaking away and thinking more globally, by cutting down UK exposure and
looking to international benchmarks. But their yardsticks are also increasingly out of date and don’t take account
of a new global integrated capital market where sectors and themes are increasingly crucial.

Getting back to our wealth adviser cutting UK exposure down to size, I’d also observe that this slow-burn
change – it’ll take a few years to implement – is going to cause havoc for many UK-focused fund managers who
might find themselves even more unloved than they currently are.

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