Executive Summary
British equity funds tend to have less exposure to international equities than would be commensurate with the scale of the global opportunity set. A potential under-allocation to U.S. equities, in particular, means that U.K. investors may be foregoing a potentially useful diversification opportunity. This paper examines the S&P 500 from the perspective of a U.K.-based investor. We examine:
-The concentration and sectoral makeup of the U.K. equity market, as well as the motivations of U.K.-based market participants to diversify internationally;
-The role of the U.K. and the U.S. in the global economy and global equity markets;
-Potentially complementary aspects of an S&P 500-linked investment for a broad-based U.K. equity portfolio denominated in British pound sterling (sterling); and
-The differences between the S&P 500 and other indices or active portfolios tracking U.S. equities.
Although this paper provides a perspective on the S&P 500 through a specific filter of an investor with an expected existing bias toward U.K. equities, many of our observations hold more generally for international investors considering U.S. equities.
Introduction
Most market participants have encountered the S&P 500; it is a widely referenced gauge of U.S. equity performance and a popular benchmark for investments. The S&P 500 contains many of the world’s largest and most recognizable companies, with a global reach of operations, customers and revenue sources. Further, as a consequence of an increasing popularity and scale of S&P 500-related products, including index funds, exchange-traded funds (ETFs) and listed derivatives such as futures and options, the typical cost and barriers to entry for S&P 500-linked investments have fallen over time.
For a market participant predominantly investing in U.K. equities, U.S. stocks arise in several investment contexts. Most importantly, U.S. equities represent a significant proportion of the global opportunity set for diversification, with the S&P 500 making up 50% of the S&P Global BMI float-adjusted market capitalization. However, Exhibit 1 illustrates that investors in U.K. equity funds have not yet taken full advantage of their diversification potential. Specifically, Exhibit 1 shows the estimated aggregate allocations within U.K.-based equity funds to U.S. large,- mid- and small-cap equities, as compared to the relative share of each segment in the S&P Global BMI. As of September 2022, U.K. funds had a cumulative “underweight” of 22%.
