Investors should not panic out of investments in UK stocks and bonds because of the election, according to John Wyn-Evans, head of investment strategy at Investec Wealth & Investment, but should consider avoiding certain parts of both asset classes until after the dust settles.
In just under four weeks’ time the votes of 7 May general election should have been counted and the result of the most hotly contested election for decades known, even if after several days of wrangling to form a coalition.
It is widely tipped to be a very narrow run-off between the Conservative and Labour parties with most polls showing each has about a third of the result with the remainder made up of UKIP, the Liberal Democrats, SNP and the Greens.
The 2015 election promises to be the hardest to call in living memory, Wyn-Evans says, with the ‘kingmaker’ potential of the SNP particularly poignant and several large questions for financial markets in the event of an outright win for the main parties.
For those with exposure to both fixed income and equities, risks abound in certain areas he believes, advising bond investors to sell out of some exposure to gilts due to increased uncertainty.
“There will be uncertainty about the composition of the government or about potential referendums, which might invite some increase in the ‘term premium’, raising gilt yields. However, over the last couple of decades UK yields have tended to follow the path of global yields, and there is no reason for that trend to change dramatically,” he said.
“Neither of the leading parties offers policies that are fiscally irresponsible, although under Labour the deficit would reduce more slowly, and the existing debt burden is currently sustainable.”
“Investment grade corporate bonds, especially of those companies with greater overseas exposure, would be more resilient in the event of higher gilt yields. Overall we continue to recommend at least some holdings of sovereign bonds as an insurance policy against a currently unforeseen growth shock.”
According to FE Analytics, both gilts and UK corporate bond markets have rallied over the past five years, gaining just over 50 per cent. However, gilts have accelerated in recent years ahead of corporates.
Performance of indices over 5yrs
Source: FE Analytics
JP Morgan’s head of multi-asset strategy John Bilton says gilts are supported by international demand and uncertainty after the election could further boost domestic demand. But he adds that a weaker austerity policy could spook gilt markets.
“Gilts would be vulnerable to any coalition that took a firmly anti-austerity position. While fiscal slippage is a risk in some coalition combinations, it is unlikely that even a very left-leaning coalition would fully reverse fiscal savings as an opening policy step,” he said.
Stocks in UK-listed companies, meanwhile, could hold up more robustly, he says.
“History suggests UK equities respond poorly to political uncertainty, but at the same time UK stocks offer both attractive yield and defensive qualities.”
“On balance, we believe that political uncertainty is a headwind, but one that will become more acute the longer the formation of a government takes following election day. Hence we maintain a modest underweight in UK stocks, but could become incrementally more negative if post-election negotiations drag on.”
Wyn-Evans also believes UK-listed equities to be well placed to weather the growing uncertainty as the majority of the FTSE 100 constituents’ revenues come from abroad.
“This also provides a natural hedge against any potential weakness of the pound, although, as we saw last year with the resource companies, sectoral influences can overwhelm that effect.”
However, he says on a sector basis there could be a split depending on the outcome and whether there is a hung parliament.
“It is a notably asymmetric picture, with a Labour-led regime being more punitive than a Tory-led government is favourable. Not only has Labour voiced more overt populist policies, but the Conservatives also acknowledge that they must not be seen to be feathering capitalist nests.”
“Banks, utilities and bus and tail companies stand to bear the brunt of Labour’s populist agenda, with outsourcing companies also recently mentioned. Bookmakers stand to lose income from fixed-odds betting terminals.”
“The Tories have not expressed outright support for any of these industries, but will be keener to defend the UK’s position in the financial services industry.”
House builders are the only sector to achieve all-party support, Wyn-Evans says, but their stellar recent profits may not be tolerated any further.
The likes of Persimmon, Barratt, Taylor Wimpey and Berkeley have made huge returns for shareholders over the past few years as shown in the graph below.
Performance stocks and index over 3yrs
Source: FE Analytics
Several managers such as Neil Hermon (pictured), who heads up the Henderson Smaller Companies investment trust, have benefited, with Hermon still backing the bull case for the stocks. 
More broadly Wyn-Evans says it is likely that the election will lead to greater immediate uncertainty in markets as a second election is not out of the question.
“The electorate faces some stark choices as to how it wishes to see the country governed, and also how it views the future of the UK. The Labour and Conservative parties are now as far apart in policy terms as they have been since the 1992 election, when the Tories unexpectedly held onto the reins of power.”
“Labour promises greater redistribution of wealth and less austerity, while the Conservatives remain a more ‘market-friendly’ choice. However, a vote for the Tories is effectively a vote for a referendum on the UK’s membership of the European Union. If Labour needs the help of the SNP to gain a majority, then that will raise the prospect of yet another Scottish referendum.”
While the outlook for investors in core UK equity and bond markets may appear more uncertain, he says long-term investors should not make big portfolio shifts.
The outlook for investors is broadly optimistic despite the uncertainty, according to the latest Barclays Stockbrokers Poll, as general election approaches.
Some 57 per cent of those answering the survey are backing the UK as a good investment opportunity over the longer term regardless of the outcome.
However, just 4 per cent said it offered good short-term investment opportunities. One in three said they were unsure about the UK for investment opportunities and that the outcome of May’s general election will shape their view.