Managers Cut Exposure to UK Stocks

Managers Cut Exposure to UK Stocks
They Fear Country Could Fall Behind in Global Recovery

By Jim Jornlin, Portfolio Manager
Russell Investment Group
Global Leader in Multi-Manager Investing
March 12, 2004

Managers of international funds have under-weighted investments in British stocks for several years, most recently in expectation that UK stocks could lag other regions in the global recovery. Instead, they have chosen Pacific markets, which they see as most leveraged to the world economic upturn.

UK stocks form 28% of the Morgan Stanley Capital International EAFE (Europe, Australasia and Far East) Index, against which most international funds measure their performance. The country's share is by far the biggest of any country in the Index. In second place is Japan, which, after a decade-long swoon in the 1990s, makes up 22%.

But managers of some international funds are putting far less than 28% of their investable assets in UK stocks these days.

Missing Industrials
Because it has less industrial exposure, the UK is expected to participate less in the early stages of the global economic recovery. The Pacific markets and, to some degree, the rest of Europe are reflecting the global cyclical recovery much more than is evident in the UK.

The UK economy is dominated by a few large corporations — including British Petroleum, GlaxoSmithKline, Vodafone and HSBC Bank — most of which are in less economically sensitive sectors, such as banking, consumer staples or pharmaceuticals.

In addition to the make-up of the market, managers also see liabilities in the fundamental prospects for UK companies. Foremost among these are a weak manufacturing sector and a potentially overheated consumer sector. In addition, the housing market over the past several years has been an area of rather extreme activity. Many believe a housing bubble has developed.

Much of the economy, therefore, precariously rests on the whims of consumer sentiment and anything that causes it to waver may stifle economic recovery and put downward pressure on stock prices.

In this respect, the British economy bears some similarity to that in the United States, where the recovery also has been riding on consumer sentiment and low interest rates have led to what some see as too much riding on inflated housing prices.

Differences Across the Ocean
But the economies differ on interest rates. In the U.S., the Federal Reserve has emphasized that it has no intention of raising rates for some time. In contrast, the Bank of England, in an effort to curb inflation and at the same time ease pressures in the housing market, has raised rates twice in the past few months. The quarter-point increases have been relatively small as the bank attempts to prevent the housing bubble from bursting while also not causing harm to the nascent recovery in other aspects of the economy.

Some analysts still fear that the rate increases could derail the recovery, which would likely have severe consequences for UK stocks. Others are concerned that the higher rates will hit consumers who already are struggling to manage debts as they take on bigger mortgages and spend more servicing credit built up as they took advantage of the lower rates. Any resultant downturn in consumer spending, they believe, could also hurt the economy's recovery and stock prices.

In addition, the rate increases probably have contributed to a gain in the British pound, which could hurt exports and put another source of pressure on the British manufacturing sector.

These factors have led managers to believe that, although the UK economy probably will not collapse, the global economic recovery is likely to continue and that the UK may lag other regions in that recovery.

Copyright© Russell Investment Group 2004. All rights reserved. See Important Legal Information. Date of first use: 03/12/2004.

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