Head of investment management and CIO, Vince Hopkins of BRI Wealth Management pinpoints why the election result brings more uncertainty to the UK.
'It could be argued that for investors in the UK there is an exceptional amount of economic and political risk due to the impending negotiations (this is a ‘B’ word free article). When you add in a hung parliament and a conservative majority propped up by the DUP, it looks even more uncertain.
The UK has been the focal point of our asset allocation committee for the last few months, for a whole host of reasons. Is the market too high (large cap, mid cap, small cap)? Is the economy slowing? Will an evolving political environment deter investors away from the UK? While we have debated these issues for many hours, unfortunately none of us have a crystal ball to predict the future.
It has clearly been a strong 12 months for the UK market, which is up nearly 30% on a total return basis. To a certain extent this is understandable given the marked depreciation of sterling against most major currencies. This makes UK investments far more attractive to overseas buyers but also helps the underlying companies, who on average generate 70% of their revenues from overseas.
Currency tailwinds are generally only translational, in that you can buy more pounds with your dollars and euros, they do not mark any improvement in the underlying business. Faced with expensive valuations on elevated earnings due to currencies leaves us feeling a bit wary about owning too much large cap exposure.
When you look further down the market capitalisation spectrum, things start to get more interesting. The UK is home to some world class companies that just do not have the fortune of being worth billions of pounds (yet). These companies tend to be priced at a reasonable discount to their larger peers and can have more resilient earnings (less dependent on currency fluctuations and potentially in structurally growing markets).
While investing in the smaller end of the market comes with its risk (liquidity, potentially less established business models etc), having a collection of highly experienced fund managers to invest with will tend to do well over the longer term. Miton, Livingbridge and Downing stand out for us.
While we are more bullish on small caps, we are starting to get more wary of certain parts of the UK economy that are starting to slow. The consumer is feeling the pressure, facing negative real wage growth, which is feeding into slower spending and a weaker housing market. With the results of last week, we think this is likely to continue for the foreseeable future and have reduced our exposure to the mid end of the market in housebuilders and retailers.
Our view on the UK market is complemented by a higher than usual exposure to lower risk asset classes funded by an underweight in equities generally, but more heavily in North America. The US economy is doing relatively well but it is the valuation of the wider market that concerns us. On certain valuation metrics, it is the third most expensive it has ever been and we are more than eight years into a bull run.
We would much rather try and protect capital in portfolios now, than aggressively try and grow it. We remain focused on investing in good quality companies and unit trusts and feel our portfolios are well positioned to take advantage of future market growth while also protecting from the inevitable downturn.'
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