In a globalised world, what exactly is a “UK asset”?

James McManus


4 min read

Brexit is still top of mind for UK citizens and investors, as a new prime minister takes the helm and the Brexit saga enters a new chapter. In this environment, customers often ask us the question, “How much exposure do I have to the UK?”. Although we show a simple geographical breakdown within the portfolio, analysing the underlying exposure reveals a more complicated and interesting picture.

What UK assets do Nutmeg portfolios own?

Nutmeg portfolios were designed and built with UK investors in mind. While we focus on global investment markets, our portfolios will contain exposure to a range of UK investment assets, such as:

  • UK equities. These are shares of companies that are listed on the major UK stock exchanges and included in indices such as the FTSE 100 and FTSE 250. These assets can be further divided into sector and themes.
  • Sterling-denominated corporate bonds. These are bonds issued by companies in pounds. The sterling corporate bond market is smaller than the US dollar and euro corporate bond markets because there is less demand for bonds denominated in sterling. Companies with UK operations are the natural issuers of sterling bonds, however foreign companies may be attracted to issue in this market, for instance because of its traditionally longer maturity.
  • UK government bonds (gilts). These are bonds issued and backed by the UK government and considered relatively safe investments due to the good credit rating of the UK government1. There are several types of gilts available, including index-linked gilts, which offer returns in line with inflation. The term gilts is used because the original paper certificates for these bonds were issued with gilded edges.

How UK-focused are these UK assets?

Investment assets tend to be classified in a number of ways. Equities are typically classified by their domicile – usually where the security is listed on a stock exchange, but occasionally where the company is based. For example, Royal Dutch Shell is a company that is domiciled in the Netherlands but included in UK stock indices because it has its primary listing on the London Stock Exchange (the company has secondary listings in Amsterdam and New York).

Bonds meanwhile tend to be classified by the currency in which they are issued or the domicile of the legal entity through which they are issued. For example, Wells Fargo is an American financial services company that has issued some of its corporate bonds in sterling.

When showing you the geographical breakdown of your assets within your portfolio, we typically use the domicile of issuer for bonds and the location of the stock exchange listing for equities.

Going beyond domicile

Our investment team examine our portfolios in more detailed ways too, in particular to build an understanding of the “economic exposure” of each asset – that is, where the revenue streams for each underlying security come from and whether the firm is more exposed to domestic or international economic factors. This is a significant data exercise, as it requires analysing every underlying security’s revenue stream. A typical medium-risk Nutmeg portfolio contains approximately 9,700 underlying securities!2

When we analyse the three broad categories of UK assets listed above, this is what we find:

UK government bonds, or gilts, are the simplest to analyse. The UK government is solely responsible for ensuring the repayment of these securities, and the government primarily generates income from taxes in the UK, thus we consider gilts to be a domestic UK asset.

Sterling-denominated corporate bonds are a more complex story. As an example, let’s take the iShares Core £ Corp Bond UCITS ETF, an exchange-traded fund (ETF) that tracks the sterling-denominated corporate bond market. Based mainly on the domicile of the issuer, the fund provider calculates that about 42% of the bonds are exposed to the UK3. Yet, when we review the underlying economic exposure, we find that only 17% of issuers’ revenues are generated in the UK, meaning the companies issuing these bonds are considerably less exposed to the UK economy than domicile alone would imply. In fact, the United States accounts for the largest share of underlying revenues at 23%4.

For UK equities, there is another factor that matters: size. We can draw a distinction between the large, multinational companies that make up the FTSE 100 index and the small to mid-sized businesses that make up the FTSE 250. The below chart shows the breakdown of revenues, by geographical region, for the companies in each stock market index. We have also included the FTSE Europe ex UK index, a major European stock market index, for comparison purposes.

Source: FactSet, July 2019

The chart shows that companies in the FTSE 250 derive nearly 45% of their revenues from the UK compared with 23% for FTSE 100 companies. FTSE 250 companies also receive a larger proportion of their revenues from the rest of Europe than their peers in the FTSE 100.

The FTSE 250 is therefore much more dependent on the domestic UK economy and on the European economy than the FTSE 100. In contrast, FTSE 100 companies get a total of more than 75% of their revenues from outside the UK and more than 60% of their revenues from outside Europe.

How does this affect how my portfolio is managed?

Our investment team use this analysis to inform our investment decision making. For example, the analysis allows us to form a view about how exposed different UK assets are to various Brexit scenarios. In a potentially more disruptive scenario for trade (for example an abrupt “no deal” Brexit), we would expect stocks in the FTSE 250 to be more vulnerable than those in the FTSE 100 because they are more exposed to the UK and European economies.

In contrast, a disorderly Brexit might benefit FTSE 100 stocks, assuming there was a fall in the pound. In that scenario, Brexit would increase the sterling value of FTSE 100 companies’ overseas revenues. Of course, the opposite could be true should the UK and EU agree a pragmatic way forward and agree a deal.

In summary, exposure to UK assets is not as simple as just domicile or country of listing. Increasingly complex global supply chains require deeper analysis to uncover the true extent of regional exposures. Our investment process is built around products that offer transparency on their holdings at all times, meaning our investment team can accurately model our portfolios’ exposures, manage risk and better inform decision making.

Sources

  1. At time of writing (July 2019), Standard & Poor’s credit rating for the UK was AA with negative outlook, Moody’s credit rating for the UK was Aa2 with stable outlook, and Fitch’s credit rating for the UK was AA with negative watch outlook, according to information compiled by Trading Economics.
  2. Based on the holdings of a Nutmeg Managed Risk Level 6 portfolio as at 30 June 2019. Figures derived from Nutmeg calculations and FactSet data, June 2019.
  3. Data on the iShares Core £ Corp Bond UCITS ETF correct as of 29 July 2019.
  4. The analysis of underlying exposures of the fund was done using FactSet, July 2019.

Risk warning

As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest.

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James McManus

A self-confessed ETF geek, James is head of ETF research at Nutmeg. He joined in 2015 from Coutts & Co, where he was an associate director in the investment office. James holds a Bsc (Hons) in International Business from Nottingham Business School.


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