A lack of exposure to US equities and an overreliance on the UK has caused global funds to underperform the MSCI World and by extension passives during the past decade, according to market commentators. 
The average IA Global fund has underperformed the MSCI World benchmark by 31.38 percentage points over the past 10 years, data from FE Analytics shows. The sector is one of the largest in the Investment Association universe.
This gap has been stretched substantially over the last five years, with the benchmark beating the average fund by 24.58 percentage points, mainly thanks to the outperformance of US equities.
Performance of indices over 10yrs
Source: FE Analytics
Premier Asset Management’s Simon Evan-Cook (pictured) said: “We’re very wary of sectors with tricky benchmarks and the global is one because you’ve got that large weighting to US equities.
“I think the problem in terms of the underperformance is, you could argue, that they [funds] haven’t been correlated enough to US equities.
“What you don’t want is having the very largest thing in your benchmark outperforming because the chances are you haven’t got an overweight to it. When it outperforms the index looks very clever and you look pretty silly.
“That’s the dynamic that has been hurting that sector for the last seven or eight years.”
Currently, the MSCI World index has a 59.2 per cent weighting to US equities, while the average fund in the IA Global sector has 43.38 per cent in the country’s stocks.
Meanwhile, the S&P 500 has been the best performing sector over the last decade, returning 179.20 per cent to investors, as the graph on the following page shows.
This is again particularly noticeable over the last three years, with the S&P 500 returning almost triple (70.97 per cent) the amount of the next best performing MSCI Europe ex UK (26.59 per cent).
Evan-Cook said: “I have a lot of sympathy for why they [global fund managers] have not had enough correlation to US equities, because in all that time US equities have still looked quite expensive on long-term valuation measures, but that hasn’t stopped them from rallying.”
Performance of indices over 10yrs
Source: FE Analytics
Daniel Adams, senior investment manager at Psigma, adds that funds have been particularly underweight the FANG companies (Facebook, Amazon, Netflix and Google) as well as the ‘expensive defensives’ that have proven so popular this year due to falling bond yields and investors’ flight to safety.
He said: “I think a lot of people on valuations will probably be slightly underweight the US instead favouring Europe and other areas, and particularly within that very much underweight the FANG trade.
“Also this whole expensive defensive trade, which I think a lot of people have been underweight and I think that’s continued for the last few years.
“So that combination of expensive defensives, underweight FANGs and then marginally underweight the US relative to the benchmark means they have probably underperformed over the last couple of years.”
Additionally, global funds have been overweight the UK, the worst performing sector over three years and the third worst performer from the previous graph.
Over 10 years, the FTSE All Share has returned 76.03 per cent, 103.17 percentage points less than the S&P 500, yet global funds on average have a 14.93 per cent weighting to the UK, as opposed to the 7.02 per cent weighting found in the the MSCI World.
Premier’s Evan-Cook said: “They’ve been too correlated to UK equities so I would put a large part of the blame of that underperformance on the doorstep of UK equity exposure.
“When you’re running a global equity mandate for UK investors then you’re likely, rightly or wrongly, to have a UK bias so you might end up 20-25 per cent in UK equities when your benchmark has only got 6 or 7 per cent.”
Psigma’s Adams adds that this has been due to the lack of income available to UK investors, with many of the global funds set up in recent years aiming to take advantage of this.
“There’s quite a lot of global income funds that have launched and I think they’ve come about particularly thanks to the lack of opportunity in the UK space,” he said. As a result, many have to have a UK bias to attract more inflows.
As well as UK equities, exposure to sterling has also impacted global funds this year in particular, with the recent Brexit vote having a lasting impact on the value of sterling,
Evan-Cook says sterling exposure in particular is “obviously very relevant at the moment and this year” and has contributed to the underperformance of the average fund in the IA Global sector.
Performance of pound sterling vs US dollar in 2016
Source: FE Analytics
As the above graph shows, the pound has fallen 17.31 per cent against the US dollar so far this year, making currency an important factor for global funds.
“You’ve also got the [fact that the] cash element of your portfolio is likely to be held in sterling and at the moment I think a lot of managers are conservatively positioned given the fact that we are so late in the cycle,” Evan-Cook said.
“So if you have your cash position at 5, 6 or 7 per cent it’s been a terrible year.”
However, he says there may be the opportunity for global funds to outperform in the near future for those investors willing to wait.
US equities, he says, have had everything go their way, from a strengthening US economy to globalisation suiting the largest, most internationally facing (and also highest weighed) companies.
“It’s been a great time to own US equities but we have concerns that US equities are due a run of underperformance – it might well come that even having a slight underweight to US equities turns into a tailwind over the next five years or whenever that changes,” he said.
“What you don’t want is having the very largest thing in your benchmark outperforming because the chances are you haven’t got an overweight to it. What you want is the largest part of your benchmark underperforming.”