Increased uncertainty in the UK and the subsidence of potential political headwinds in Europe have influenced some of Old Mutual Wealth model portfolio manager Stuart Clark’s recent portfolio changes. 
Political uncertainty and weaker economic data have held back the two indices in recent years, with the Brexit vote the most recent significant political event to shock both markets.
UK and Europe indices have underperformed over the past three years compared with other international equity markets, as the below graph shows, languishing at the bottom.
Performance of indices over 3yrs
Source: FE Analytics
“They are different variations on the same theme which is basically the uncertainty and political risk,” said Clark.
Having outlined his process earlier today, FE Trustnet takes a closer look at some of the underweight positions he has taken, with Europe and the UK trending in opposite directions within his portfolios.
“We did our last rebalance in March and took that opportunity to go less underweight – but still underweight – European equity,” the portfolio manager said.
“We did that in the January rebalance. So at the start of the year we went less underweight Europe and have done so again.
“Meanwhile, post-referendum – June 2016 – we took the decision to go slightly underweight UK equities.
“On the one hand that was the wrong thing to do as large caps rallied and the FTSE hit all-time highs but at the same time it reflected the view that we felt the balance of risk favoured international equity rather than UK equity.”
Since the referendum UK stocks have performed well, with the FTSE 100 pushing on to new highs and returning 21.29 per cent to investors. But Clark maintains it is the right decision to underweight the domestic market, although it remains the largest geographic exposure in this portfolio.
“UK equities have continued to do very well in the face of increasing uncertainty I would say,” the manager said.
“Not the least the recent announcement of the snap general election and the quite robust pushback from the European Union on how they are going to negotiate around Brexit.
Performance of index since EU referendum
Source: FE Analytics
“So I struggle to see a situation where UK risk per se is going to be the most beneficial position for clients.”
He added: “Now, obviously, there are opportunities and again by adding the right active managers I think we can add value over and above the UK market but I see better opportunities overseas particularly in the value-driven spaces.”
One such area is Europe which, despite having been underweight almost since inception, the manger now sees the potential to be neutral or overweight at the next rebalance.
“Europe conversely we were underweight more aggressively through the whole of 2015 and 2016 which worked out very nicely for clients as there were ongoing concerns on the sustainability of the EU, Greece bubbling away, the Italian banks and then we had Deutsche Bank – everything was being hurled at European equities,” he explained.
Indeed, over these two years Europe struggled relative to the MSCI AC World, which returned 32.89 per cent in the two years while Europe gained 24.68 per cent.
Performance of indices from start 2015 to end 2016
Source: FE Analytics
“Deutsche Bank marked the low point for European equities,” he said. This took place in September 2016 when the heavyweight German banking firm was it with a £10.5bn charge for mis-selling mortgage securities in the US.
“At that point we were seeing some positive macroeconomic numbers though we still had the political risk and you had a situation where US growth was still being delivered,” the manager said.
“So you would expect six months later that the rest of the world would be dragged up by this US growth and so you had a relatively cheap asset which seemed to be bottoming from the point of macroeconomic growth though there is a lot of concerns about the political risks.
“We took the view that the structure of the European elections made it less likely that you would see such a swing to populism as you had seen in the Brexit referendum and in the vote for [Donald] Trump.
“So although it felt a bit contrarian at the time in January we increased the risk and said if as we get past all of these political milestones we get more comfort that Europe is not lurching sharply to the left or right then we’ll carry on chipping away at the underweight to European equity.
“That’s why post-Dutch election – even though we were in the midst of the French election – we took the opportunity to allocate slightly more to European equity,” he explained.
“He said that with the French elections completed he maintains the option to go to a neutral or indeed slightly overweight position should he choose to do so.
“Europe is so far behind the US equity market that I think we might miss a couple of per cent in relative performance but in the long run clients will still benefit from that more risk aware style of investing rather than trying to throw everything in in one go.”