Monday, 3 September 2018

UK v US Investment Returns


Whilst reading back my previous post on the amazing bull run in the US equity market, I was struck by the underperformance of the UK market by comparison.

Not so long back, much of my investments were made up of a mixture of individual shares and investment trusts focussed on the UK market. I was looking for natural income from these investments and the FTSE 100 offered a yield of around 4% compared to the yield of only 2% from the likes of the US market in the form of the S&P 500.

Whilst it has been reassuring to collect this income plus a little additional capital growth, I came to the conclusion in 2015 that my focus on natural income may have been a little short-sighted as more globally diverse options were often overlooked as they did not provide my required level of income.

Total Return

In 2015, I reviewed my strategy and decided to wind down my UK-listed individual shares in favour of globally diverse low cost index funds such as Vanguard Lifestrategy. This also included moving away from a reliance on natural income and a shift to taking my 'income' from the total return generated by these global funds.

Luckily this moved has worked out well due to the fact that global funds are priced in USD and the fall in the value of sterling post the Brexit referendum in June 2016 has boosted the returns on my index funds.

Global v UK Returns

Since March 2009, the US market has delivered a total return in excess of 400%. From a closing low of 677 it has risen to (currently) 2,900 and if we factor in dividends this gives an average total return of 17% p.a.
 
Compare L&G Index funds for US and UK
2009 to 2018 (click image to enlarge)

Unfortunately, the UK market has failed to keep pace and over the same period the FTSE 100 has risen just 190% on a total return basis. Yes the UK dividend yield has been much higher at ~4% compared to 2% in the US, but from a low of 3,750 in March 2009, the FTSE has risen to (currently) 7,500 or 100%.

I would surmise the difference is largely due to tech stocks. The US markets are home to the likes of Google, Apple, Amazon and Netflix which have delivered outstanding returns over the past decade. Tech accounts for 25% of the S&P. In contrast our markets are dominated by the struggling financial services (20%) and energy companies (18%) whilst tech companies account for less than 1% of our market.



Income in Retirement

I guess many investors will look to investment trusts or income funds to provide their steady 4% or 5% income. When I started my early retirement journey back in 2008, the bulk of my investments were a mix of UK higher yielding shares and ITs. I thought it made sense to try to preserve what capital I had accumulated and from that, maximise the income I could generate.

Looking back however, this was possibly not the best strategy. Hindsight of course is a wonderful thing but the lure of tempting natural yields should not mean the focus of total return is compromised.

A total return of 10% per annum over a decade providing a natural income of just 1% or 2% will always be far superior to a return of 7% which includes a yield of 4%.

Conclusion

The UK market has not offered the best returns for investors over the past decade. This may change as reversion to mean cannot be discounted over the longer period however, until the full saga of Brexit is played out - I am thinking probably at least 10 more years - we will likely continue to face headwinds.

The UK market makes up around 6% of the global market and the top 10 companies account for ~35% of the FTSE 100 index. A globally diverse index fund gives access to over 2,500 companies spread over 50 countries.

I think it makes sense to maintain my globally diverse portfolio. We do not know which areas of the global market will deliver the performance over the coming decade or two. My expectation is for more modest returns compared to the past 10 years. Maybe the UK will recover, maybe not...will the US tech companies continue to deliver or will the growth be delivered by the fast-growing China? Who knows...

Nobody can know when the US bull run will end so for me it's about managing risk which involves maintaining a sensible asset allocation in line with my desire for optimising gains matched with my need for minimising volatility during the next downturn. 

Accepting that nothing is certain, the probability of higher returns from my globally diverse equity exposure means I can hold a higher proportion of lower volatility bonds to achieve the same outcome.

Feel free to leave a comment below. What proportion of UK exposure do you hold compared to global? Do you think the US market is over-valued now?

19 comments:

  1. I'm glad I went global with my equities although I'm still 50/50 UK/world.

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  2. Thanks for the posting. My portfolio is still very new - less than a year after transferring my DB pension to a SIPP. My UK equities/funds are approx 20%.

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    1. A friend was recently asking for my views on putting his DB pension into a sipp. I have no direct experience but the general advice is to think twice and then think some more. As it needs to be signed off by a financial adviser I suggested he consult one. Wondering if you found the decision easy and then is the transfer process simple?

      20% UK allocation sounds about right...that would be the weighting for the likes of Vanguard Lifestrategy 80.

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  3. Very interesting thank you for sharing DIY Investor. The first chart is rather stark with the big disconnect starting in 2013. I can't profess to have a clue what happened and why. Still, eye-balling the chart, the correlation of returns is still very high.

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  4. I am invested; global equity 20%, capital preservation (eg PAT) 10%, UK 8%, others each 2% (US, China, Emerg, Asian, Europe, Jap) so 50% equities plus 10% NSI IL, 10% cash, 10% property (not residential), 10% bonds (mainly corporate, currently underweight), 5% gold, 5% venture capital/PE.

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    1. That looks like a good mix of assets Pinner and should help you to ride out the bear market whenever it arrives. I am wondering if this allocation has been in place for some time or has it evolved and changed over time?

      I did hold the Personal Assets trust in the past but it did not work for me and I replaced it with Capital Gearing.

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    2. I have been a keen private investor since 1994 when I received a tax refund for when I worked in Spain for a year in 1990. That went into my first pep and I haven't looked back since. I have a masters and several prof. quals, each time taking investment/corp finance electives. Have worked in corporate banking and DB pensions mgt consult. (covenant assessment) So, yes, it has evolved over time but been stable for the past few years. I also hold CG and try not to tinker with the asset allocation too often. Enjoy your blog.

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    3. Thanks for expanding on your investing journey.

      By coincidence, I opened my first single company PEP in '95. After much deliberation I settled on Sage Group via Charles Schwab. I seem to recall selling it in '99 when the price had doubled but missed out big time as the share price has increased 20 fold over the past 20 yrs!

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  5. the underperformance of the UK market has been a bug bear of mine for sometime now. It's like we've backed the wrong horse and although the dividends are better in the UK (as you say), that's an example of letting the dividend tail wag the investment dog.

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    1. Tail wagging the dog is a good metaphor GFF, must remember it. Of course there are more than just the two horses to back so maybe an each way bet on all or as weenie's strategy seems to work, go with matched betting...you can't lose!

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  6. Hi diy investor -

    On the income side, I've truly never really understood why people bought income generating assets rather than growth assets, especially as capital gains are taxed more leniently in the UK once you use up your personal allowance.

    And yes, the underperformance of the UK does trouble me a bit - I'm down to ~16% UK allocation and intend to run it down further. Especially with all the Brexit turmoil, it's a good hedge against the pound tanking.

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    1. For many years I chose income generating investments as I needed to maximise income to live off as I had no other income and the interest rates on cash savings have been dire for the past decade.

      I have never been at the point where capital gains was an issue but in any event all of the investments are in either ISA or SIPP.

      If I had been a little more savvy in the early years, I could have considered a more globally diverse mix with the lower natural yield and taken 'income' from growth of the fund as required. I think the mistake has been too much reliance on UK investments combined with a gap in my education. I guess we all live and hopefully learn as we go along.

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    2. Hi Ms ZiYou
      I’m not sure how long you have been investing, but we are now nearly 10 years into uninterupted global growth cycle.
      Global growth = growth stocks do well.
      When the cycle turns, and we see a global recession (which is 100% certain) these growth stocks will likely decline disportionately. At that point you may want to own more dull income stocks. They have a place in your portfolio.

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  7. I have been also been thinking about the UK vs US performance lately. I think I am way over-invested in the UK - probably around 50% (thanks to a limited choice in my workplace pension). My fear in switching more to the US within my SIPP has been that I might be buying high; everything I read says that market is over-priced. Maybe a global tracker is the way to go.

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    1. I think it is good to be aware of the allocation/holdings in ISA, SIPP and works pension. If you have limited options in one pot, you can make some adjustments in others.

      As to over-priced market, I have thought the US was over valued and due for a correction for at least the past two years but it just seems to keep rolling. We cannot really know when the turn will happen so, as you say, maybe a global tracker is the solution.

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  8. I'm a Brit living and earning in the Eurozone but some ties (and legacy assets) in the UK. I use a very simple asset allocation model, mostly aimed at reducing fees and currency transactions, which is: UK Equity 20%, Eurozone Equity 20%, and US Equity 20%, Emerging Market Equity 20% GBP denominated bonds 20%. I'm not very experienced so I'm probably doing something wrong.

    I'm wondering if there is any real logic to having any home country bias. For me this is both the Eurozone and UK. Would I be better simply buying an all world tracker?

    Also, if I hold UK equity because I want some home country bias would it make more sense to buy the FTSE 250 as it more accurately reflects the UK economy rather than the FTSE 100 (which I currently invest in)?

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    1. I think the 20% split should work OK. The only point to remember is to rebalance from time to time to maintain the allocation percentages.

      This is on aspect of the Vanguard Lifestrategy I appreciate as it offers auto rebalance so my VLS 60 is always maintained at 60% equities/40% bonds.

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  9. Nice to hear your thoughts on this John. It's a similar story over the pond here in Aus. Our market has only just returned to the pre-GFC level and similarly returns around 4% yield. Definitely something to be said for the giants of the US tech industry - and even large Chinese techs like Alibaba and Tencent.

    I think part of the reason Australian stocks have had such subdued capital growth is that Aussie companies typically have higher payout ratios than in the US, so fewer earnings are available for reinvestment in the company and growing profits. Maybe it's similar in the UK? (We also have a large proportion of financial services companies in the top 100 stocks).

    I don't know what the best mix will be long term but I am expanding my international holdings with a greater allocation to the UK, Asia and US.

    best as always,
    WF30

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  10. Thanks Wf30 and good to compare notes. I see the ASX 200 is currently 6,150 and a decade back it was just below 6,000 so very similar to the UK market with a similar yield. I also see you have quite a lot of miners such as Rio and BHP and they have had a tough decade which will have depressed the markets there.

    Good to see you are expanding your portfolio to the global market place, I am sure it will be a good move long term.

    Following your monthly updates on progress with interest.

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