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Brexit: asset managers' views

Fund managers consider what markets might do around the EU referendum and what the fallout might be if the UK leaves
Brexit: asset managers' views

As the referendum on whether the UK should leave the European Union (EU) approaches, many financial industry figures are expressing their views on what the consequences might be for financial markets.

These include some of the UK’s most prominent fund managers – Neil Woodford is effectively sitting on the fence with his view that the outcome will not influence the overall course of the UK economy either way, while Richard Buxton is adamant that we won’t leave, so believes there is nothing to worry about. Other managers, meanwhile, argue that the companies they invest in will be good businesses in or out of the EU and even that an exit might provide investment opportunities.

So we have rounded up the views of a number of managers, including some who run *IC Top 100 Funds, to get an idea of what investors need to consider as the vote approaches, and if Britain leaves the EU (Brexit).

 

UK VIEW

Carl Stick, manager of Rathbone Income Fund* (GB00BHCQNL68)

"There could be a great deal of volatility in sterling. But we believe the scope for the exchange rate to fall is more limited than many expect. In terms of markets, the FTSE 100 is a London-based global index, so we expect Brexit would have little impact there. However, FTSE 250 and small-caps are likely to suffer more.

"While the Brexit referendum is front and centre, let's not forget the US elections later this year, the future direction of commodities - especially oil - and the impact on inflation, the health of the Chinese economy, the future of Europe and the migration issue. Markets hate uncertainty, and we have it in spades. It's not as easy as saying a sector or index has been hit by the upcoming Brexit vote alone.

"We are not running the fund based on a Brexit outcome, but continue to focus on the growth and sustainability of dividends. We continue to invest in businesses which can sustain organic earnings growth, and are financed by internally-generated cash flow that translates into dividend growth.

"After 23 June one major uncertainty will be in the rear-view mirror and the market will find its own level."

 

Mike Prentis, portfolio manager of BlackRock Smaller Companies Trust* (BRSC)

"If the vote looks finely balanced, which currently seems to be the case, we expect investors to remain nervous. If the UK votes to leave the EU, we would expect uncertainty to become elevated, largely because trading arrangements with EU countries would be unclear in the years ahead. Immediately post a vote to leave the EU, I would expect sterling to weaken against the US dollar and the euro, and UK equity markets to sell off - markets do not like uncertainty.

"UK investors have been trying to identify the potential winners and losers for some time, and after the vote will be able to implement their plans. Companies with significant international earnings could benefit as the value of their earnings would be greater in sterling terms. Some UK-focused companies would be more exposed, for example those owning significant London property. However, markets have generally already sold off the shares of these companies, so further share price downside may be quite limited. Indeed, a vote to stay in could see a bounce in the shares of UK domestically-orientated companies.

"Medium-sized and smaller companies are often perceived to be more vulnerable in times of uncertainty, and their shares can be sold off more heavily. This could well happen if we vote to leave the EU, but there will be winners and losers. Many UK medium-sized and smaller companies have significant international earnings, especially those operating in sectors such as healthcare, IT and media, and like their larger counterparts could see higher earnings on the back of weaker sterling. Even among the more domestically-focused stocks there will be some companies whose business models are resilient - those that have strong competitive advantages, which should fare well operationally whichever way the vote goes. If we see indiscriminate selling there could be some attractive buying opportunities.

"Earlier in the year, we had identified a number of more domestically-focused portfolio holdings which we felt may cope less well in the uncertainty ahead of the vote and if we vote to leave. We have either sold off these holdings or significantly reduced them. The proceeds were redeployed by adding to some of our more internationally-orientated holdings - especially those exposed to the US and emerging markets.

"We have added to holdings such as 4imprint (FOUR), which derives all of its revenues in the US, and companies such as Next Fifteen (NFC), which makes the majority of its profits in the US.

"But smaller companies are often more adaptable and creative than larger companies, and we expect many to cope well. Many are also very international and will not be negatively impacted if we decide to leave the EU."

 

Gervais Williams, manager of funds including Diverse Income Trust* (DIVI)

"The uncertainty is already affecting markets and certain companies - for example, ITV's (ITV) advertising figures are down and this may be related to the Brexit vote.

"If we do vote to exit the chances are that there will be a slower period of growth, and there may or may not be a recession. If there is a long period of negotiations following this the uncertainty will extend for that period - and this could take years.

"We have already seen the effect of the weak pound: the cost of imports for some retailers has gone up, while international buyers are less willing to buy London property. If there is a vote to leave, international investors are less likely to invest in the UK until the situation becomes more certain.

"We have not made any changes to our funds with a view to coming out of the EU, because we might have to change them back. We do not have great exposure to the London property markets and, in fact, have been buying on the weakness into a few housebuilding companies operating around the UK.

"A good example is the purchase of Persimmon (PSN). This is a FTSE 100 stock with a price/earnings ratio (PE) of 10.8 times to December 2016, and a prospective dividend yield of 5.4 per cent that has grown at 10 per cent a year over the past three years. It has reported that housing sales are continuing to grow well in the current year in spite of the concerns over the Brexit vote.

"An example of a recent purchase outside the housebuilding sector is the recent Motorpoint (MOTR) initial public offering. This is a retailer of new and used cars up to 18 months old. Naturally, this is very much a British business, and therefore its prospects are closely related to the willingness of UK consumers to buy whatever way the Brexit vote goes. We were particularly impressed with the very high level of customer service. The shares came to market at 200p, with a PE ratio of 12 times to March 2017 and 9.6 times to March 2018, and a dividend yield in the coming year of 3.3 per cent.

"If we exit there will be some winners and losers. But these could change due to other factors, for example a China setback or a major oil price recovery."

 

Mark Martin, head of UK equities at Neptune

"We've seen the electorate in recent months and years being conservative with a small 'c' and pretty risk-averse, so we don't think Brexit will happen. But we're still looking for areas that could be affected if Brexit does happen.

"One such area could be London property, so we've reduced some of our exposure to Fuller Smith & Turner (FSTA). We think it is a very high-quality company with excellent management, but are a bit concerned about London property valuations - quite apart from the Brexit risk.

"But equally we think that some of the dynamics in the market at the moment are really positive for the UK. We expect ongoing weakness in sterling, partly because of the Brexit issue and partly because of the size of the current account deficit in the UK, but that will create opportunities - particularly for exporting companies - to benefit from the weakness of sterling. We've seen a lot of companies in recent years complaining about the strength of sterling, but we now expect some of those dynamics to change, which will be really positive.

"We also expect an increase in mergers and acquisitions (M&A) as a result of weakening sterling, and we think there is real potential for excitement around this.

"We are seeing opportunities across the board in large companies, and also in small- and mid-cap companies. When people anticipate periods of volatility they expect large-cap companies to be safer, for example some of the household names that everyone is familiar with. But what we've seen in recent years has been that a lot of the large-cap companies that are household names, for example Tesco (TSCO), actually turn out to be not nearly as safe as people expect. And a lot of relatively unknown mid- and small-cap companies that people haven't heard of, and maybe think are a bit more risky, turn out to be a lot safer than people expect because of valuations and better earnings growth.

"The mid- and small-cap indices tend to have more of a UK domestic focus. So if you look at companies within the FTSE 250, more than 50 per cent of their revenues are from the UK. This means we have to be more selective when looking at stocks, so specifically seeking out for those that have more exposure to global themes and which will be beneficiaries from the sterling weakness that we expect in the run-up to the referendum.

"Three new stock holdings within our funds are: Victrex (VCT), the plastics producer, Spectris (SXS), the manufacturer of instrumentation, and Jardine Lloyd Thompson (JLT), an insurance broker. All of these have good exposure to a diverse range of international clients."

 

Jamie Clark, co-manager, Liontrust Macro Equity Income Fund (GB00B888YP40)

"We are comfortable with the outlook for equities, and confident that our investments can continue to deliver both capital appreciation and dividend progression. At the same time, we are mindful that this does not apply to the market in general and anticipate that the year-to-date commodities momentum trade will probably unwind as unattractive fundamentals reassert themselves. We are alive to the risk of Brexit volatility, but see little merit in forecasting uncertain outcomes, preferring instead to focus on the intrinsic investment merits of our portfolio holdings.

"We expect UK equities to experience increasing volatility as the referendum approaches, and this is likely to affect all areas of the market. Once the outcome becomes clear, we think that the initial impact on equities could be fairly indiscriminate.

"We also believe that any significant moves are likely to be shortlived. If a remain vote is returned, sterling may spike in the short term, but we would then expect it to weaken as investors refocus on our twin deficit problem and a lack of unity within the government that may see prime minister David Cameron's leadership challenged before the year is out.

"Equally, a vote to leave may see both sterling and UK equities adjust lower, but we think they would then recover as it became apparent that prospects for the UK remain robust.

"We haven't made any specific changes to our investments based solely on the prospect of a Brexit. However, given sterling's current weakness, we maintain our longstanding preference for overseas earners in our portfolios and are taking full advantage of our ability (in line with the sector rules for UK Equity Income funds) to hold 20 per cent in non-sterling investments. We're doing this primarily via US dollar exposure to pharmaceutical and telecom stocks such as AT&T (T:NYQ) and Verizon (VZ:NYQ).

"We would expect sterling to bear the brunt of investor uncertainty prior to the vote, but believe any slump in the currency, should we opt to leave the EU, would be relatively shortlived. Regardless of the Brexit vote's outcome, London will remain Europe's premier financial centre. Its size and skilled labour pool, together with English being the global business language, should ensure its continuation as the leading European market. The German approach/bid for the LSE reinforces this view."

 

VIEWS FROM BEYOND THE UK

Sam Morse, manager of Fidelity European Values* (FEV)

"Although direct exposure to the UK economy is relatively small for continental European companies in aggregate - it only represents about 6 per cent of the revenues of the underlying companies in our portfolio - the indirect consequences of a Brexit are likely to be more significant.

"If the UK electorate votes to leave the EU on 23 June, uncertainty will rise and investors may question, again, the sustainability of the EU. Markets do not like uncertainty, so share prices may fall in the event of a leave vote.

"Having said that, if the UK were to leave the EU, it is also likely that UK sterling would depreciate further, which would make overseas earnings and dividends more valuable to UK-based investors.

"But the likely outcome of the vote is unclear, so it is hard to say to what extent a Brexit is already discounted in currencies and share prices."

 

Peter Westaway, chief economist and head of investment strategy group, Europe, Vanguard

"After 23 June it seems likely that the UK economy will take one of two paths. A vote to stay in the EU is likely to remove that uncertainty and could lead to a growth recovery, and possibly even an increase in interest rates by the end of the year as the economy recovers.

"Conversely, the Bank of England monetary policy committee has already noted that a vote to leave, and the subsequent uncertainty about the UK's relationship with the EU, could lead to a prolonged slowdown and perhaps a fall in sterling, leading to a rise in headline inflation.

"This prospect is potentially confusing for investors. Should they abandon sterling assets to avoid potential further losses? Or invest in the UK on speculation of a market rebound? Rather we would recommend that investors focus on the long term rather than trying to make active bets on the direction of markets.

"This current dilemma clearly demonstrates the benefits of holding a globally-diversified portfolio. Of course, Brexit might have an impact on market performance in other regions, too, not least in Europe itself. But, compared with holding a portfolio solely focused on UK assets, investors can mitigate these Brexit-related risks by holding a broad portfolio of assets from different regions of the world."

 

BREXIT AND BONDS

Mark Holman, chief executive officer, TwentyFour Asset Management

"Mark Carney says "Brexit is the biggest domestic risk to UK financial stability," and he could be right.

"Political posturing and grandstanding will ensure that the market experience in the immediate aftermath of a Brexit will result in market turmoil. Therefore we must be prepared and suitably positioned to defend the downside in the immediate aftermath, and to change positioning for the new environment that would follow.

"If there was a Brexit there would be a huge risk-off day for markets globally. The biggest impact would be felt in the UK, with the FTSE 100 index off as much as10 per cent. Sterling would drop against all major peers, especially versus the dollar.

"Risk-free assets would be likely to rally, for example gold and certain government bonds.

"The Bank of England would probably reduce interest rates in July, and the yield on 10-year gilts would fall below 1 per cent.

"There would be spread widening in credit products, with UK, sterling-denominated, high-yielding names affected the most.

"If the UK votes to stay in the EU there would be a relief rally, predominantly in sterling versus major currency pairs. Risky assets should generally perform well, and certain sectors such as UK financials should outperform.

"While the UK's second-quarter data is likely to be impacted by the vote, the third quarter could see a bounceback effect as delayed transactions and investments close. But gilts would underperform.

"Ways to hedge against a Brexit include holding cash, US treasuries and buying spread-widening protection.

"It is a one-day, one-event situation, so market moves will be amplified if there is a result against consensus. However, while we believe the vote will be closer than markets are predicting, we also don't think that a Brexit will occur."

 

Andrew Wickham, head of UK and global fixed income, Insight Investment

"As the UK referendum on EU membership approaches, Brexit-related concerns have had an increasing influence on sterling assets. Markets currently believe that the monetary policy committee could cut official interest rates under a leave vote, and perhaps deploy a further quantitative easing programme. However, our base case remains that the UK will remain in the EU and so the recent rally in the gilts leaves the market looking overvalued, particularly with reference to other global markets such as Australia, where a loosening of policy is becoming increasingly likely.

"Gilts performed strongly through the first quarter of 2016, generally following the course of other government bond markets. Given volatility in risk assets during the first six weeks of the year, demand for safe haven assets increased. During the second half of the quarter, the sector benefited from dovish central bank rhetoric and action outside the UK."

IC Top 100 Fund