28th March 2018 by Darius McDermott
The 29 March marks one year since Prime Minister Theresa May formally invoked Article 50 – the clause in the Lisbon Treaty which enables countries to leave the European Union.
Over these past 12 months, there have been endless debates about whether the UK will undergo a ‘hard’ Brexit – which would cease our full access to the single market and to the customs union – or a ‘soft’ Brexit’ – which would likely mean we can access the single market trade without tariffs, but would have no seat on the European council.
Of course, both of these scenarios could have very different impacts on market behaviour, the value of sterling and the broader economy – all of which are interlinked. When sterling plummeted immediately after the referendum, FTSE 100 companies – which generate most of their revenues from overseas – outperformed domestic-facing smaller companies*.
Since Article 50 was triggered, however, the dollar has weakened versus sterling and UK small and mid-caps have outperformed* their larger company peers.
As we continue to take steps towards leaving the European Union, can domestic-facing UK companies keep outperforming? What has the referendum meant for UK equity investors over the last year? Here, we’ve gathered the thoughts of four FundCalibre Elite Rated managers.
Mark Martin, manager of Neptune UK Mid Cap
Neptune’s Mark Martin said the strong relative and absolute performance of UK small and mid-caps in 2017 reflected relatively low valuations for the market area and bearish sentiment at the start of the year.
“It is also important to remember that the constituents of the mid-cap index in aggregate generate approximately half their revenues from outside the UK,” he reasoned. “Encouragingly, smaller companies within the UK market also benefited from increased merger & acquisition volumes.”
That said, Mark warned that the Conservative party will face further challenges throughout 2018, so it would be dangerous to assume domestic politics will become less complicated this year.
He added: “The prospect of a general election in 2018 should not be ruled out and any further improvements in the chances of Jeremy Corbyn as the next Prime Minister would likely cause ructions in domestic stock markets.”
Siddarth Chand Lall, manager of Marlborough Multi Cap Income
Sid Lall, who runs the Marlborough Multi Cap Income fund, said the fluctuations in sterling since the EU referendum have been significant.
“If you take currency movements as a barometer, to me they say the market has already priced in a soft Brexit since the referendum,” he explained. “So, it might be that we do get some form of customs union and perhaps we could get a trade agreement, but we may have to go through the admin to get it and there may be a cost associated with that.”
Similarly, Sid believes a reasonable trade agreement is likely to be reached because it will be in the best interests of both European and British importers and exporters.
“Take the example of Germany, who want to sell their cars here,” he continued. “While there will be moments when any economic change is felt more acutely, we are focusing on companies’ stock-specific stories and how company management can improve margins regardless of Brexit uncertainty – I think that is somewhat independent of whether the UK is in our out of the EU.”
Sue Round, manager of EdenTree Amity UK
EdenTree’s Sue Round said: “Our EdenTree Amity UK fund primarily focuses on the mid and small-cap areas of the market, where we continue to identify many unique companies displaying strong fundamentals.
“Many of these innovative companies, such as hazard detection company Halma and filtration technology firm Porvair, have market leading products and geographic spread and are more likely to exhibit resilience through the uncertainty of Brexit negotiations due to their reliable income streams.”
Nick Osborne, co-manager of BlackRock UK Absolute Alpha
BlackRock’s Nick said that, within the UK market, many investors have underestimated how difficult it has been for banks over the past few years. As such, the challenging conditions have separated the wheat from the chaff and left a handful of domestic-facing banks – including Lloyds and some challenger banks – in strong positions.
On the other side of the coin, he warns that pubs and leisure companies have been late to feel the pain – especially those with large employee bases. This is because wage inflation in the UK is essentially mandated in the form of the new National Living Wage – a higher minimum wage for over 25s – which will be rolled out next month. This means that the companies’ outgoings will increase considerably.
One direct impact of a hard Brexit across several sectors, according to Nick, would be the return of many European workers to their countries of origin. Companies would then have to pay more money to hire British employees.
Winners and losers
During such uncertain times, there are always going to be winners and losers. Cheap, contrarian investments can often be value traps as opposed to the bargains they may first appear to be.
As more and more central banks turn to quantitative tightening – which essentially means taking money out of the economy after years of printing money and keeping interest rates low – we are certainly seeing a greater dispersion between the performance of stocks, and this will likely be exacerbated by which companies fly or fall during the aftermath of Brexit.
Now more so than ever, we would say the UK’s current backdrop calls for true bottom-up, stock-picking managers.
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius’s views are his own and do not constitute financial advice.
*Source: FE Analytics. Total return in sterling terms. Correct as of 20 March 2018.
Darius McDermott is managing director of Fund Calibre.