We are closing in on the final month before the UK leaves the EU. And still nobody has the faintest idea how it will unfold.
Many IFAs are opting to stay the course with their current investment strategies, adopting a ‘time in the market, not timing the market’ approach.
But with the prospect of ‘no deal’ still very much on the table, a number of firms are taking steps to reduce exposure here in Blighty.
Mandy Dale, director of Bishop’s Stortford-based Hanbury Wealth, says the firm takes guidance from Distribution Technology (DT) with regards to the initial asset allocation within its model portfolios.
As of October 2018, DT’s portfolios risk-rated four, five and six (out of 10) reduced their allocation to UK equities and UK property assets, shifting to mainland Europe, the US, and emerging market equities, while suggesting greater exposure to global property.
DT cited Brexit as a key influence on some of its changes towards the end of last year, Dale revealed. However, UK equities still play a ‘prominent part’ in Hanbury’s portfolios (see Table 1).
‘As the majority of our clients are medium-to-long-term investors, we haven’t switched to cash. Instead, we increased our exposure to the US, global properties, and on a smaller scale emerging markets and European equities,’ Dale says.
‘Within our portfolios, UK equities still play a prominent part, but we have switched holdings that were previously in more nimble small-to-mid-cap funds over to large-cap funds, which also have exposure to overseas earnings, and typically have less volatility.’
In the UK, Hanbury is fond of the Liontrust UK Growth fund, run by Citywire AA-rated managers Anthony Cross and Julian Fosh since 2009. It ranked 13th out of 212 funds in the Equity - UK (All Companies) sector over five years.
Dale adds: ‘With regards to the funds we are selecting to help with navigating out of Brexit, we have increased exposure to multi-asset funds. We particularly chose those that follow a strict rebalancing process, such as the Vanguard LifeStrategy range. Their performance has benefited from pound-cost averaging in light of the recent volatility within the market.’
National advice firm Mazars has developed an internal probabilistic model, which suggests the chance of a ‘hard’ or ‘no-deal’ Brexit is 33%. The firm has even odds on the final deal being an improvement on prime minister Theresa May’s current offering, or that Brexit will be rescinded, ‘in spirit if not the letter of the law’.
Mazars’ senior economist George Lagarias says: ‘We thus treat a crash Brexit as a tail risk, a position subject to change, of course, in the next few weeks. We have set up processes to take rapid decisions, and we have already compiled the list of investments we think may suffer the most.
‘However, we feel pre-empting the result of the process could be very risky, both on an absolute and a relative return basis.’
Though Mazars has maintained and increased a ‘significant underweight’ position in the UK from the run-up to the referendum to present on the basis uncertainty alone could hurt returns, it has never considered abandoning UK-focused funds entirely.
Lagarias says: ‘This does not reflect home bias, as much as it reflects the realities of UK large caps. Most of these companies are global operations with less than 33% earnings in the UK.
‘The inverse relationship between UK large-cap equity prices and a weaker pound, the latter really reflecting Brexit anxiety, has been well documented. In other words, why should we sell exposure in Royal Dutch Shell or Rio Tinto just because of Brexit?’
While UK large-cap equity managers are not expected to suffer significant pain, Lagarias suggests wider dispersed funds with more underlying exposure to the UK economy could face challenges.
Mazars has identified the fund best positioned for Brexit as the Majedie UK Equity fund, which invests in global behemoths Shell, BP, GlaxoSmithKline and HSBC, along with a selection of defensive names such as Tesco and Morrisons.
Lagarias also warned cash is not as defensive as many believe, especially when considering international portfolios, since GBP exposure can still hurt sterling investors in terms of ‘opportunity costs and loss of real purchasing power’.
Thus, strategically, the firm does not hold large cash positions, but has increased exposure to gold and short-term bond funds, limiting investments in absolute returns. This is reflective of Mazars’ concerns the global economic cycle is mature, rather than Brexit preparations (see Chart 1, below).
Taking a pounding
London-based Holden & Partners has remained neutral on UK equity. Given the impact of the Brexit outcome on other global asset classes and sterling, the firm believes the best way to hedge against both equity and currency volatility is to maintain a diversified portfolio across both sectors and geographies.
Investment manager Amelia Sexton says the most evident effect of current Brexit uncertainty is sterling weakness.
‘This has a positive effect on our global and emerging market equity exposure, where the underlying holdings are typically denominated in a variety of foreign currencies and will therefore increase in value with a devaluation of the pound,’ she says.
The same could be said for listed infrastructure and property assets with overseas exposure. Like Lagarias, Sexton says many UK-listed large companies derive significant revenues from overseas earnings, and thus may benefit from sterling weakness without being reliant on UK growth to generate profit.
While mid and small-sized UK companies may be more vulnerable to a no-deal Brexit, much of this risk is already reflected in current prices and serving to attract foreign investment. This is triggering an increase in merger and acquisition activity, as foreign buyers are drawn to UK assets by cost savings and a weaker currency.
Sexton adds: ‘This suggests a quiet confidence in UK businesses that may be trading at a discount due to Brexit uncertainty. Although it does favour a selective approach whereby a fund manager can actively pick the most attractive stocks.
‘A resolution to the current stalemate would be beneficial for the economy and result in an appreciation of the currency. This would challenge the more globally focused stocks in the index, but provide a more favourable backdrop for domestic companies that have sold-off heavily in the past year.’
As a result, Holden & Partners blends mid and small-cap domestic funds with larger, globally focused stocks within its UK equity allocation, which still comprises a fairly small proportion of overall equity weighting (see Chart 2, below).
Both Sexton and Lagarias prioritise hawkish US monetary policy, the prospect of global economic recession or an economic downturn in China landing as potentially more drastic headwinds than Brexit.
‘Fund managers with a position of conviction in their underlying holdings seem to be coming out better,’ he says. ‘This might be an ethical fund that has “stickier” money or a fund that has decided to back a particular theme.’
Thomas reduced his UK exposure several reviews ago, increasing exposure to the US, Japan, bonds and property, but still partly holds ‘unloved’ UK equities.
‘Follow the story now with investing. Look for conviction. You will not find a greater conviction story than impact investment.’