Five years ago, the UK was waking up to news that just over half the voting population wanted the country to leave the European Union. After half a decade of political wrangling between the UK and Europe, not to mention a global pandemic, how do domestic investors view the situation?
Looking back, Schroders head of UK equities Sue Noffke (pictured) says the shock and surprise at the referendum result led to a general shunning of the domestic market in favour of international opportunities that carried far less political, currency and economic risk.
“What we had was a deeply unpopular UK equity market, we had weakness in sterling against the dollar and against the euro,” she says. “We had lagging returns from stock markets and lagging economic activity.”
Noffke thinks a lot of the poor sentiment stemmed from the political uncertainty in the aftermath of the vote. In 2017 the Conservative party lost its majority under Theresa May before the looming risk of a Jeremy Corbyn-led Labour government. Optimism was revived after Boris Johnson’s overwhelming election majority at the end of 2019 only for Covid to wipe that out just a few months later.
Brexit expected to have bigger long-term effect on economy than Covid
From an economic perspective, Royal London Asset Management (RLAM) head of multi-asset Trevor Greetham notes the Treasury estimated in 2018 that leaving the EU would knock 5% off the size of the economy 15 years from now, assuming migration arrangements don’t become more restrictive. To put this in context, estimates for the long-term damage to the economy from the Covid crisis are currently at around 1.75%, he says.
“In the short term, Covid is dominating because it has caused such a massive swing down in the economy and over the next year or so it should be creating a massive swing up in the economy,” he says. “But when we look back at things in 15 years’ time, Brexit would have been more damaging than Covid to growth by a factor of three or four times.”
Greetham notes Brexit has made it harder for the UK to repay the debt amassed due to Covid because the strength of the economy affects the the ability to generate tax revenue. He also thinks Brexit has introduced a bigger inflation risk.
“We know that some prices have gone up because of the disruption of trade and the fact that you’re having to sourcing domestically items you might have found cheaper in Europe, not just the wages part of that,” he says. “So, we’ve got more inflation because of Brexit and then we are hurting our earnings power to repay the Covid debt.”
Greetham says this debt is to be funded either through tax rises or through inflation. “I think there’s much more temptation to let inflation rise,” he adds.
Lack of tech has added to UK woes
Noffke notes the UK stock market participants have not necessarily felt every bump since the Brexit vote because the constituents are largely international in nature. However, the UK’s lack of technology firms meant it has lagged its US counterpart which has been riding the growth company wave over recent years.
“Over that five-year period, we have seen a massive re-rating of growth companies particularly from the technology area,” she says. “The UK in contrast to, say, the United States does not have much representation within the stock market, so that has also been a feature driving relative returns.”
The vaccine breakthrough in November might have triggered a rotation to value sectors that the UK market has in abundance, but a look at the best-performing open-ended funds since the Brexit vote on 23 March 2016 until 22 June 2021 shows the top five being US or technology focused.
The top performing was Baillie Gifford American which returned 439.5% and has information technology as its biggest sector weighting at 29%, according to FE Fundinfo. In second place was Morgan Stanley US Growth with a 374.7% return (43.7% weighting in IT), followed by Multipartner Sicav Baron Global Advantage Equity with a 340.2% return (30.5% in IT).
It is a similar story with investment trusts with the tech-heavy Baillie Gifford Scottish Mortgage delivering 410.5% since the referendum, followed by JP Morgan China Growth and Income with a 378% return and Allianz Technology Trust at 373.3%.
Fairview Investing founder and consultant Ben Yearsley says tech has been the clear winner since Brexit and is a trend that accelerated due to Covid.
“At the top of the fund universe it’s the tech show, at the top of the trust world it’s the Baillie Gifford show,” he says. “Though arguably that’s a play on tech.”
Sticking to asset allocation
Yearsley says weaker sterling was a positive for the FTSE as overseas earners pushed it close to 8,000, but the vote heralded an overseas disinterest in UK Plc, “not helped by the inept Theresa May negotiations and Magic Grandpa in charge of Labour”. UK shares became the “sick man of the world”, he says.
“However, that is seemingly also behind us now with stable policies, vaccines, and cheap prices added to a roaring economic recovery.”
Yearsley says despite a lot of initial “hand wringing” from DFMs, investors would have fared well by broadly sticking to their asset allocation and not chasing returns.
Mitigating currency risk with equities and property
Greetham also notes the elevated currency risk from Brexit. He says during the negotiation period sterling was “effectively an emerging market currency” but portfolio diversification helped ride out the volatility.
“If you look at the volatility of sterling, it was right up there with the emerging markets and sometimes it was actually higher than some emerging market currencies because of the degree of uncertainty,” he says. “What that period taught us was that diversification in multi-asset is really important.”
He points to holding global equities and commercial property in the RLAM GMAP range as giving more insulation against currency volatility than a typical balanced portfolio. This is because global equities and UK equities go up when the pound goes down because of the translation effect and overseas earnings, respectively.
Property has been effective against a rising pound because prices tend to appreciate due to positive economic or political outcomes. “So, we found having property as well as equities gave us more insulation against what could happen to the pound,” says Greetham.
Noffke says the UK equity funds she manages have less in consumer staples than five years ago but just as much in pharmaceuticals and financials, and currently have more in mining stocks and less in oil.
In addition, she describes Burberry as a portfolio “stalwart” and says the team increased the position during the fallout from the pandemic. She is also more confident in Pearson’s prospects. “We feel they have been busy investing in their technology platform and actually the pandemic has supercharged the appetite for online learning.”
‘Well-run businesses have adapted smoothly’
In small and micro-cap world, LF Gresham House UK Multi Cap Income fund co-manager Ken Wotton says the fund has benefited from Brexit driving UK valuations to a historic 30-year discount, particularly companies more exposed to the domestic economy.
“This proved fertile hunting ground for firms with strong management teams operating in market segments demonstrating structural growth potential – such as digital healthcare or energy use optimisation.”
Wotton adds: “While Brexit has generated a lot of noise over the last five years, the segments of the market most acutely impacted by the vote have had ample time to adjust – and did so long ago.
“Well-run businesses have adapted smoothly, embracing technology and remote working long before these were required by the pandemic.”
