DFMs argue investors face bigger risks than Brexit

Cash could be the wrong place to be on no deal

A global economic slowdown and simmering tension between the US and China remain the biggest threats to UK investors despite the ongoing Brexit fiasco ramping up a gear, according to fund selectors.

On Tuesday, prime minister Theresa May’s Brexit deal was trounced in the House of Commons by a record margin of 230 votes, the largest majority in the house since the 1920s. Labour leader Jeremy Corbyn swiftly tabled a motion of no confidence in the UK government leaving May once again fighting for her job.

At the time of writing, the motion was being debated in Parliament and commentators were predicting May would come through the no-confidence vote, expected to take place at 7pm on Wednesday.

Whatever the outcome, the direction of the UK’s future will remain no clearer. No deal could still happen, as could revoking/extending Article 50, a second referendum, a revised ‘plan B’ deal, and cancelling Brexit altogether. Who knows?

All this makes it even more difficult for already confused investors to know how to play markets.

Currency as an indicator

The currency market is regarded as the clearest indication of how investors see Brexit playing out and Merian Global Investors head of UK equities Richard Buxton has long said the pound will be both “judge and jury” when it comes to the UK’s economic prospects.

Sterling sold off in the immediate aftermath of Tuesday’s vote but rebounded sharply soon after. Bank of England governor Mark Carney said on Wednesday that the currency’s bounce back reflected some investors’ belief that Brexit could be delayed beyond the end of March.

Sterling versus the dollar since the referendum

International earners listed on the domestic index have benefitted from sterling weakness since the referendum on 23 June 2016, but UK-focused indices have suffered since the Brexit vote. For example, the FTSE All-Share has returned 19.19% in sterling terms versus the MSCI World’s 40.68% and the S&P 500’s 48.04%.

Indices and sectorsTotal return since referendum (£)
FTSE 10020.05%
FTSE All Share19.19%
IA UK All Companies15.24%
IA UK Equity Income11.14%
IA UK Smaller Companies27.94%
MSCI World40.68%
S&P 50048.04%
Source: FE Analytics

Beaten up UK assets look attractive

Yet fund selectors told Portfolio Adviser they are seeing opportunities in beaten up UK assets.

Psigma Investment Management head of investment strategy Rory McPherson says some UK equities are trading on valuations not seen since 2009 and he believes it will be possible to make good money from these starting points over the next few years. However, his enthusiasm for these assets is tempered on account of the complete absence of political direction.

“We may be approaching a moment of chaos and capitulation that could well signal a good buying opportunity into what is a hugely unloved, under-owned and cheap area of the global market,” he says.

McPherson also likes UK corporate credit markets where there is a very attractive “Brexit premium” baked into the spread.

“By being exposed to high quality, short-dated debt of companies in this market, we believe that returns of 4% to 5% are very much on the table this year, which dwarfs that of international equivalents,” he says.

Whitechurch Securities head of research Jonathan Moyes also says given the extreme pessimism and hysteria surrounding the UK’s political situation, the UK now trades on relatively attractive valuations and dividend yields, particularly domestic facing stocks.

Gore Browne Investment Management founder Simon James says braver clients should “probably start buying back into UK”. He says there is good value in sectors such as house builders, residential rental property and IT, as well as plenty of M&A targets when the dust has settled.

Bigger worries than Brexit

Despite deepening political turmoil and uncertainty, wealth managers say the real issue for their clients is China and US tensions and a slowdown in the global economy, rather than Brexit.

Moyes says his clients hold globally diversified portfolios which means the impact of Brexit tends not to be too substantial. “Far more important are the US/China trade talks and the Federal Reserve’s outlook for rates,” he says. “We have had surprisingly few calls regarding Brexit negotiations.”

However, Moyes adds those clients who have called to discuss Brexit have asked about the merits of “tactically” moving their portfolio into cash in anticipation of a no deal.

“Ironically, this is almost precisely the wrong thing to do for a long-term investor. The greatest risk from a poor Brexit outcome is the risk to the value of sterling. We remain of the belief that a patient contrarian approach within a well-diversified portfolio will serve long-term investors well.”

Ready to respond

Similarly, Brewin Dolphin head of research Guy Foster (pictured) says some clients are particularly concerned about the risk of the UK stock market sharply selling off as a result of Brexit. However, a bigger risk to their portfolios is a slowing global economy.

“In late 2018 many clients found it intuitive to associate the weak markets with Brexit, whereas overwhelmingly they were driven by the slowdown in global growth and particularly China,” he says.

As a result, Foster says Brewin is pretty balanced in its UK exposure. “We’re trying not to focus too much on Brexit angst as a theme and are ready to respond should the negotiations lead to opportunities emerging in either UK or overseas plays depending upon the relative tone of the negotiations.

“We always assumed that the rhetoric would turn pretty negative in the final stages of EU and UK negotiations. The efforts by Parliament to take control of the process are making a more benign outcome more likely.”

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