With the its separation from the EU now completed, the UK now has greater freedom to pursue trade deals on its own and build out some industries without falling foul of the bloc’ state aid rules. As such, the UK economy is likely to become increasingly decoupled from the EU.
This poses the question of whether asset allocators and fund strategists should now treat the UK as a separate asset class, rather than as part of a pan-European allocation.
Indeed, this is something that Lazard Asset Management’s head of UK equities Alan Custis has already begun to ponder.
Custis told Trustnet that while many years ago investors would make separate allocations to European and UK equities, this has “morphed” into a pan-European allocation more recently.
Since the 2016 referendum, UK equities have seemingly been treated as a separate asset class by international investors and remains the most underweighted area in the closely watched Bank of America Global Fund Managers Survey.
But is this something that could become common practice for investors?
According to Nick Peters, multi asset-portfolio manager at Fidelity International, it depends on whether you are a UK or international investor.
Peters said there is no right answer on whether to treat the UK as a separate asset class.
He said: “In our experience, investors’ preferences generally tend to depend on their location.
“In the UK, many investors already consider the UK as separate from the European market. On the other hand, many overseas investors will consider them together.
“We don’t believe this is likely to change significantly following Brexit, as many overseas clients already tend to think regionally, already accounting for the fact that politics and economies will be different for countries across Europe.”
But going forward Peters does believe that there will now be a greater demand for standalone UK funds on a “tactical” basis for two reasons.
He explained: “Firstly, Brexit caused four years of uncertainty with regards to the UK’s future relationship with the EU, which led to UK shares materially underperforming in recent years leading to a potential undervaluation in asset prices.
“Secondly, the UK equity market – due to its composition – has a bias towards financials and energy sectors which are likely to perform well in a post-pandemic environment where economic growth gains momentum.
“While investors may not change the way they think about the UK versus Europe in structural terms when building a long-term portfolio, there may be increasing appetite to express tactical positions over the coming months and years.”
Other multi-asset managers fell on either side of the fence on the UK becoming a separate asset class.
Managers of the £5.6bn BNY Mellon Real Return fund said that it would be “unlikely”, for investors to start treating the UK as a separate asset class post-Brexit.
They said: “As investors observe how the UK emerges post the Brexit-deal, confidence should start to rebuild, assuming the economy regains its poise. We are already seeing evidence of this, with the FTSE 100 being one of the best performing markets so far in 2021.
“The UK is unlikely to be treated by investors as an entirely separate allocation to Europe and remains a constituent within broader pan-European indices.
“Furthermore, with many UK-listed companies, notably at the large cap end of the spectrum, being global in nature, their businesses are not materially impacted by any Brexit repercussions.”
Performance of FTSE 100 in 2021
Source: FE Analytics
However, Trevor Greetham, head of multi-asset at Royal London Asset Management, said he already treats UK equities as a separate asset class when constructing multi-asset portfolios for UK savers.
“We treat UK equities as a separate asset class when building multi asset funds for UK savers,” he explained. “A purely global [benchmark] approach would mean less than 5 per cent of equity exposure in the UK but we find a weighting of 35-40 per cent reduces risk and results in a more diversified sector mix.”
Greetham added: “The UK underperformed sharply in 2020 because it has a heavy weighting in leisure, resources and financial stocks hit hardest by Covid but almost no exposure to technology, a sector that benefitted from increased revenue and an upward valuation shift as bond yields fell.
“The UK outperformed sharply on vaccine news in November, however, and we are overweight tactically for the first time in years.”
He finished: “Lockdowns continue but there is light at the end of the tunnel and the UK is likely to do better in a post-Covid recovery as commodity prices and bond yields rise.”