Analysis: Trustees may be tempted to act upon the past few weeks’ eurozone headlines, which have detailed sweeping geopolitical change across Italy and Spain and frightened investors in the process.
Embattled for years, the eurozone now also faces slowing growth. Support for its very existence is being eroded by opposition fuelled by the rise of electoral populism, as recently demonstrated in Italian and Hungarian elections.
Italian bond prices suffered a short-lived rout last week, driven by fears of fresh elections. With the successful formation of a populist government, yields have recovered for now.
Meanwhile, the average UK scheme has opted for greater exposure to overseas stocks than domestic equities since 2007, according to UBS Asset Management, as experts have heralded the diversification that can be earned through overseas investment.
Geopolitical developments can often present tactical entry points that a nimble investment approach can take advantage of
Adam Walker, P-Solve
Political turmoil in Italy and Spain has registered in news bulletins, yet instability is not new to these regions and arguably forms part of a longer-term trend.
At what point should schemes attribute short-term events to a longer trend in Europe, and how should geopolitical risks be reflected in portfolio construction?
Trustees must respond to different rates of growth
Looking backwards, it would seem that beating a retreat from overseas equities to the UK would be unwise, given the former’s recent outperformance of domestic stocks.
In the first quarter of 2016, UK equities returned an average of 16.8 per cent. Data from UBS Asset Management indicates that their overseas counterparts delivered average annual returns of 30.4 per cent.
Dinesh Visavadia, director at Independent Trustee Services, observed that Europe remained an attractive region for investment by UK schemes, while trustees are nervous about the UK’s growth prospects.
Trustees are tasked with responding to differing rates of economic growth across regions around the globe, he said.
“How do we take advantage of this difference in the economic pace of the regions, and what looks more favourable?” he asked.
“Certainly, trustees have been moving away from UK equities into a global space, which offers them better diversification and offers [a] better route into getting some definitely good returns,” he added.
Do not be intimidated by short-term volatility
Not all investors currently share in Visavadia's bullish outlook on Europe. An indicator of euro area investor confidence compiled by research body Sentix, fell to a score of 9.3 this month, down from 19.2 in May.
The organisation’s measure for economic expectations in the area collapsed to -13.3 from -2 over the same period, describing these expectations as “downright tilting”.
Adam Walker, director and head of research at consultancy P-Solve, warned against reading too much into short-term geopolitical events, and said that “rarely are they the fundamental driver[s] or justification for sustained outperformance”.
“We believe it remains more important to have a strong understanding of the fundamental, longer-term drivers behind markets,” he said, such as "growth, productivity and state of labour markets, fiscal and monetary policy, valuations and credit conditions.”
“That said, geopolitical developments can often present tactical entry points that a nimble investment approach can take advantage of,” he added.
Trustee fears on the rise over Brexit investment implications
Brexit has grown among defined benefit scheme trustees as a perceived investment risk, according to professional trustee company PTL's latest DB survey, as schemes are advised against making wholesale investment changes over the next few months.
Schemes focusing on the fundamentals highlighted by Walker might be encouraged by recent productivity figures from the eurozone.
In March, the Financial Times reported that UK productivity growth was due to fall behind that of the eurozone. Eurozone labour productivity growth was predicted to reach 1.1 per cent this year, up from its rate of 1 per cent in 2017.
By contrast, the UK's forecast productivity growth rate for 2018 stands at 0.8 per cent, up from 0.6 per cent last year.
Schemes may look abroad for fixed income
In the fixed income world at least, the UK's shift away from domestic securities may not reflect a particular view on Europe or other foreign markets, but rather a focus on diversification and concerns about the UK's own political and economic health.
Scott Edmunds, investment consultant at Quantum Advisory, recognised a trend of schemes seeking to "migrate away from UK equity-biased portfolios toward more globally diversified portfolios," and noted that some schemes are also tilting their fixed income portfolios away from the UK.
Loose monetary policy and the Bank of England's quantitative easing measures have depressed yields on fixed income, he said. "As a result, pension schemes have found themselves participating in a hunt for yields, which has often resulted in them migrating toward foreign fixed income markets, where perceived value may be better."
"However, one needs to be cognisant of the added risks and complexities of investing in foreign assets," he added.
