Though it won’t take place until May 2015, Davies says that the outcome of the election is so important that investors need to start focusing on its impact sooner rather than later. “Over the next 12 months, every fund manager in the UK will have keep as close an eye on the opinion polls as they do with profit and loss data,” Davies (pictured) said.
A recent FE Trustnet poll shows that a massive 80 per cent of our readers would be less bullish on the UK equity market if Labour were to win the election next year. While Davies isn’t necessarily bearish on the impact it would have, he says it is likely to have a stark effect on valuations across the board.
The manager says that the major issue investors will have to deal with is the possible movement in sterling.
Performance of £ relative to $ over 1yr
Source: FE Analytics
The pound’s strength compared to the dollar, euro and other major currencies has already had a substantial impact on areas of the UK equity market.
As FE Trustnet highlighted earlier this year, sectors and companies that derive the majority of their revenue from overseas have already been hit sterling’s strength; not only has it made it harder for them to compete on the global stage, but their earnings have also been hit by the exchange rate.
UK-facing companies – many of which that are listed on the FTSE 250 – have benefitted from the trend, as the large majority of their earnings are priced in sterling.
Davies says a Labour victory, along with a number of other factors, could change that, however.
“There is the broader concern about what may happen to sterling,” Davies explained.
“There are a couple of events on the horizon which could affect the strength of sterling. There is the Scottish referendum in September and my assumption is that if there is a yes vote, it will go down at first.”
“Then you’ve got the potential rise in interest rates and then finally the election itself. At the moment, my portfolio is focused on the UK economy and banks and I will have to revisit that if there is a high likelihood of a change in government.”
“I’m not saying I would sell the lot, because we do take a three to five year view on a stock, not just 12 months. However, I might have to take a different view on the UK’s big international earners as they will look more attractive if sterling were to weaken.”
Charles Hepworth, investment director at GAM, agrees with Davies.
“We would expect some of the big exporters to be major beneficiaries, because you wouldn’t expect sterling to stay as doggedly high as it has done if Labour were to win,” he said.
Some of the UK’s largest international earners include Diageo and Unilever, with both offering decent sizeable exposure to emerging markets.
Two portfolios which could well benefit from a fall in sterling are FE Alpha Manager Nick Train’s CF Lindsell Train UK Equity fund as well as his Finsbury Growth & Income Investment Trust. Unilever and Diageo, combined, make up more than 17 per cent of both portfolios.
Another fund which offers high exposure to overseas earners is the five-crown rated Evenlode Income fund, which is managed by Hugh Yarrow.
The £55.4m portfolio, which has been a top quartile performer in the IMA UK Equity Income sector since its launch in October 2009, counts the likes of Unilever, Diageo, Reckitt Benckiser and Imperial Tobacco as top-10 holdings.
Davies says that while international earners could benefit from a Labour victory, the outlook for other sectors looks more uncertain.
The major reason why experts expect sterling to weaken in the event of a Labour victory is because the market would anticipate a more interventionist form of government from the current Conservative-led coalition.
There are already stark signs that the fears will ring true, with Miliband announcing last year that he would freeze energy prices to combat the “cost of living crisis.”
The statement caused shares in Centrica, one of the UK’s largest energy companies, to plummet. As the graph below shows, they haven’t yet recovered.
Performance of stock vs index over 1yr
Source: FE Analytics
It also caused a huge stir in the financial services industry, with star manager Neil Woodford – a prominent investor in Centrica – describing the policy as “insane.”
Miliband vowed to tackle the UK’s retail banking sector as well, saying that too much power was in the hands of too fewer people. The other industry which could come under fire from a Labour-led government is bookmakers. The Labour leader said he would look enforce laws preventing an increase in fixed odds betting machines.
Jupiter Undervalued Assets, which has been a top quartile performer in the IMA UK All Companies sector since he took over in January 2012, would be at risk if Miliband were to pursue such policies – assuming the stock and sector positions stay the same.
Performance of fund vs sector and index since Jan 2012
Source: FE Analytics
The manager currently holds Lloyds, Barclays and RBS in his top-10, with financials making up 30 per cent of the portfolio.
Other funds with a high weighting to the banks include Fidelity Special Situations and JOHCM UK Growth. Alex Wright’s Fidelity fund holds Lloyds and Barclays, while Mark Costar’s JOHCM fund has Lloyds and RBS.
No UK funds hold a bookmaker in their top-10, however, with tax increases in this year’s Budget likely to have put them off. Smith & Williamson Enterprise and BlackRock European Absolute Alpha are the only IMA funds that count William Hill as a top-10 holding.
While a Labour victory could cause the share prices of banks, energy companies and bookies to fall, Davies says investors should be ready to pounce if those areas of the market were to sell-off dramatically over the next 12 months.
“How we would change the portfolio will be subject to what prices will be,” Davies said.
“However, one would expect that the market will overreact in certain sectors if a Labour-led Ed Miliband were to win the election. We already know there are a number of areas he is targeting, such as banks, utilities and bookies.”
“We have a number of companies and target share prices in mind where we think they could be interesting and where we feel all the bad news will be priced in,” he said.
Indeed, while Miliband has outlined a number of his policies, the likelihood of him getting them all through – or indeed actively pursuing them – is questionable.
