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How big a part of your portfolio should the UK be right now?

Tom Stevenson

Tom Stevenson - Investment Director

This article first appeared in the Telegraph

Investors have a tendency to pay too much attention to domestic news. At the very least, it can lead to home bias in portfolios. The local headlines can certainly over-influence market sentiment, as we forget that most of the world’s markets are indifferent to our self-inflicted political and constitutional crisis. This week, however, we might be forgiven for our navel-gazing.

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Whatever happens this week, and there remains a bewildering array of possible outcomes, the reporting of it will be a key chapter in the first draft of the history of Brexit. By Friday, the options will be narrower than they are today, and we will have a clearer idea of where we are heading at the end of October.

So, this is a good time to think about our exposure to the UK in our portfolios. In most cases, this will be higher than a neutral analysis of Britain’s place in the global markets would suggest (about 6%). Most investors overweight their own stock market thanks to the familiarity of the local investment opportunities. How things pan out over the next few days may determine whether that is a good or a bad thing.

One thing looks clear to me. The economic impact of No Deal is less controversial than it was. The British economy is not well-prepared for leaving the EU without an agreement. Growth is weak, even adjusting for the distortions to the GDP figures caused by the spring’s two aborted exits. Productivity is low after four years of Brexit-fuelled under-investment by businesses. Even if you think some of the scenario-planning is alarmist, no-one can deny there will be more trade friction after a No Deal exit than before. Mitigating fiscal and monetary measures can be taken (interest rates will fall to near zero, Government spending will ramp up, quick-win tax cuts such as VAT will be implemented) but leaving without a deal will hurt.

Domestically-focused companies have been at the sharp end of Brexit uncertainty for what seems like an interminable four years since the EU referendum was set in stone by David Cameron’s unexpected majority at the 2015 election. This week, a string of companies whose fates are driven almost wholly by their home market will report on their progress. In their different ways, they illustrate the challenges faced by businesses operating in Brexit Britain today.

Take Restaurant Group, owner of the Wagamama, Frankie & Benny’s and Garfunkel’s casual dining chains. Its shares traded at over 500p four years ago. Today they are around 150p, having halved the dividend as consumers tightened their belts and the sector’s over-expansion in recent years proved over-optimistic. Barratt Developments has had an easier ride thanks to the Government’s manipulation of the housing market through Help to Buy and its results will be good. But the stock market is clear what it thinks of the outlook for the sector - a dividend yield of 7% and a share price that’s only a single-digit multiple of forecast earnings is hardly a vote of confidence. Its chief executive recently sold a third of his shares. Go-Ahead, the trains and buses group that you might expect to be the most stable of businesses, is expected to deliver no growth in earnings and dividends over the next three years.

Perhaps fortunately for investors, this kind of domestic company is less and less a feature of the UK stock market. This week we will also learn who is in and who is out when FTSE conducts its latest reshuffle. Almost certainly, Marks & Spencer will fall out of Britain’s blue-chip index for the first time since the FTSE 100 was created in 1984. It will most likely be replaced by Polymetal International, a gold miner operating in Russia and Kazakhstan. Fewer than 30 of the original FTSE 100 constituents remain in an index which has less and less to say about the British economy.

The overseas focus of leading British companies is one reason to relax about this week’s political drama. Whether there is a vote of no-confidence in Boris Johnson’s Government, whatever we think about prorogation, these are neither here nor there to Polymetal’s shareholders and probably not of much interest to those in BP, HSBC or Glaxo either. Perhaps only Jeremy Corbyn outliving a caretaker premiership has the potential to unsettle these investors.

Another reason not to worry unduly about this week’s events is the message from history. There have been plenty of UK-focused political crises in the post-war period. All of them have, with the benefit of hindsight, proved to be good times to stick with the domestic portion of your portfolio. After the devaluation of the pound in November 1967, the FT 30 rose by a quarter in 1968. Following the “who governs Britain” elections of 1974, the market doubled the following year. The ERM crisis was quickly welcomed by investors in 1992.

A key difference between those periods and today, of course, is that the stock market is not at crisis levels. BP is not trading on three times earnings and yielding nearly 13% as it was in January 1975. Valuations in the UK are attractive relative to perceived safer havens, but they are not in the bargain basement. Investors are still calculating that the doomsters have indeed got it wrong.

This week will be fascinating for lots of historical, political and constitutional reasons. But for investors I would be surprised if it warrants more than a footnote. The UK still merits a place in a well-diversified portfolio because sentiment is weak and valuations attractive. The next few months will probably be choppy, but the fundamentals of our internationally-focused market are unlikely to change much. I wouldn’t dive deeper into the UK market in these uncertain times but I’m equally relaxed about the exposure I do have.

Five year performance

(%)
As at 2 Sept
2014-2015 2015-2016 2016-2017 2017-2018 2018-2019
Restaurant Group 5.6 -40.7 -7.1 -8.1 -25.4

Past performance is not a reliable indicator of future returns

Source: Refinitiv, as at 2.9.19, in local currency terms with income reinvested 

Important information The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

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