Investors should expect several potentially damaging trends to hit markets as investors become increasingly jittery of a UK exit ahead of the EU referendum, according to FE Alpha Manager Mark Martin, head of UK equities at Neptune Asset Management.
While the details of the ‘deal’ currently being hammered out in Brussels to try and tempt voters to vote against aren’t explicit, what is growing increasingly obvious is that market interest in the event is rising.
Martin says Brexit remains a clear possibility and investors in the UK stock market need to be watchful. As a result, he has been making adjustments to his fund’s positioning to help hedge against the potential volatility that could arise in the coming months.
“Concerns have reignited in the market over the impact of Brexit on the UK. This has been most visible in the weakness of sterling, which I believe is likely to continue if momentum behind the Brexit campaign increases.”
Performance of sterling versus dollar over 6months
Source: FE Analytics
“The UK is running an extremely large current account deficit – relative to GDP, the second biggest in the world only to the US – which makes any reduction in trade and capital investment particularly harmful.”
“Foreign investment has gone a long way in plugging the deficit, but if we leave the EU there is no doubt it will be less appealing to do business with the UK. New trade agreements will have to be drawn up, which could take many months, if not years. In the meantime, the currency would have to weaken significantly to help our exporters fill the void.”
“I am therefore wary of areas that have the highest exposure to sterling weakness, such as the London property market.”
Mark Tinker, head of AXA IM Framlington Equities Asia, says the potential of Brexit is increasing in the eyes of investors and, as a consequence, is sending larger and larger ripples through markets.
“Given the issues with opinion polls both for the Scottish referendum and the general election itself, people are taking the jump in the apparent vote for those wanting to exit with some suspicion, but it is undoubtedly a factor playing on sterling and the euro – albeit both outweighed by the dollar unwind last week,” Tinker said.
“This one looks like running for a while however as the fear of leaving is starting to be counter-balanced by increasing concerns, indeed fears, about staying in.”
Martin, who is also manager of the Neptune UK Mid Cap fund, says one area that could be negatively effect is housebuilders, an area that was hit hard in 2016 following a stellar run.
Performance of stocks in 2016
Source: FE Analytics
Martin said: “I profited from being overweight housebuilders between 2009 and 2013, but I believe the potential for sterling weakness could put a strain on valuations, which are currently at elevated levels. The only direct exposure I have to London property is via brewery company Fuller Smith & Turner, but I have been reducing my weighting of late.”
The manager adds weaker sterling could also have a knock-on effect for consumer and economic confidence, and expects greater pressure on retail and consumer facing companies. Therefore, he is avoiding consumer discretionary stocks.
“We have also gone some way in hedging the risks of weaker sterling and indeed a weaker UK economy with our overweight US dollar and euro exposure – particularly through our healthcare names. These companies have fundamental drivers, but their international exposure is an added bonus. “
“While investors must be mindful of the political uncertainty and of concerns over broader macroeconomic factors, there are reasons to be optimistic. We have a lot of faith in the UK domestic recovery, which stands to benefit mid cap companies.”
Martin says he is finding a lot more value currently compared to six months ago, as investors have become increasingly nervous of the chance of Brexit as well as fears over the health of global economy.
“It could well be that there will be an even bigger buying opportunity in the coming months, but in my experience market timing is extremely difficult. I have been topping up exposure to the companies I have the most conviction in of late, including Paypoint.”
The Neptune UK Mid Cap Fund has returned 280.95 per cent since it was launched in December 2008, compared to 222.05 per cent from the FTSE 250 ex ITs Index and 106.154 per cent from the IA UK All Companies sector average.
Performance of fund, sector and index since launch
Source: FE Analytics
It is a top quartile performer in the sector over one, three and five year periods, and since launch and he fund has consistently beaten the sector average for volatility has the lowest maximum drawdown of any fund in the IA UK All Companies sector since its launch.
