After a victory for ‘Leave’ in the Brexit referendum, UK equities emerged as the most shunned asset classes among international investors. But will they remain outcasts after the Covid-19 crisis?
Sentiment towards UK equities had softened somewhat following December’s snap general election and a majority Conservative government was returned, removing some of the uncertainty over Brexit. However, the spread of coronavirus pandemic and the UK government’s slow response saw a significant sell-off in the UK markets.
Performance of FTSE All Share YTD
Source: FE Analytics
Despite the fall in UK equities, they are unlikely to remain as unloved as they were after the referendum, according to Rathbone’s Alexandra Jackson.
“I’d be amazed if we went through another period like the post referendum years,” she said. “Really, really surprised.”
Jackson, manager of the £35.2m Rathbones UK Opportunities fund, said although the UK had seen a return of some foreign investment ahead of the pandemic – a so-called ‘Boris Bounce’ – the UK still wasn’t in the best shape at the start of 2020, a factor she said has contributed to its poor performance now.
“After Brexit uncertainty lessened in January and February, we [the UK] were still not great but getting much better,” Jackson said. “[At Rathbones] we were actually starting to talk in February about a ‘mid-cap melt-up’ because we were seeing that – in a lot of our holdings – global investors had started to come back to the UK in a more stock-specific way rather than just ETF tracker-type holdings.
“But it doesn’t mean that the UK market was in great health, so I think that it was probably vulnerable to trending down.”
However, whilst UK equities are in a sore place at the moment, the Rathbone UK Opportunities manager said this hasn’t scared off all the foreign investment the UK saw earlier in the year.
“I think that most people if they could’ve fled the scene, they already have,” she said. Fidelity International’s Jonathan Winton said it has been a highly volatile period for the UK, not just since 2016 but for the past decade.
“The UK has been through an incredibly volatile 10 years,” he explained. “It went through the financial crisis and years of austerity leading to Brexit and all the negotiations around that. It’s been very stop-start for the UK economy.”
The manager of the £347m Fidelity UK Smaller Companies fund said that in 2019 he had built up an overweight in more domestically focused companies in the portfolio, an allocation he’s not wavered on since the crisis began. Nor has he changed his long-term outlook on the UK, which remains positive.
“When I look across the global economy I think that [Covid-19] is a very international issue and all countries have been hit,” he said. “All countries have been impacted in a very similar way, so I haven’t thought that the UK is in a worse position than other countries.”
Value manager Winton said that he would be wary of not using the Covid-19 sell-off as a buying opportunity despite the next few months looking “horrendous for a lot of these companies”.
“Where an Armageddon scenario is already being priced into stocks, then I’m comfortable using that as an opportunity to act as on some of those names,” he explained, as his philosophy already involves investing in companies which have an element of uncertainty.
If markets have already priced in the worst for these stocks, then it’s about balancing out the fundamentals and business risk for Winton, as opposed to how much valuation risk he’s taking.
“If a company or a stock is pricing-in incredibly negative scenarios then for me that’s interesting, and I try and look at the company in a sort of more normalised economic environment,” he added”
One area of opportunity that he has been drawn into in this crisis is aerospace and leisure, a highly contrarian investment area given lockdown conditions in the UK and around the world.
Performance of sectors YTD
Source: FE Analytics
Winton said that he is currently adding to these sectors with a long-term, five-year outlook, investing in the aerospace manufacturers rather than airlines themselves as manufacturers “have the balance sheets to navigate through this period”.
For growth manager Jackson, however, there have been no “big changes” to the Rathbones UK Opportunities fund in response to the crisis.
“I was really happy with the positioning of the fund in February,” she said. “We spent quite a lot of time [last] summer really raking through the names and saying we can see this big bounce back that is going to come after Brexit. Or rather after Brexit uncertainty had fallen away a little bit.”
Currently, Rathbones UK Opportunities fund – which invests in a ‘Four Buckets of Growth’ currently has a little over 30 per cent invested in ‘Defensive Growth’ stocks.
Jackson explained: “I would slightly caveat this because what we all thought was defensive six months ago often has not turned out to be defensive at all in this period.
“So I am re-thinking some of the defensive names but the things that I have in that bucket have generally outperformed,” she said including names such as supermarket giant Tesco, and GP service provider Medical Solutions.