Investors are far more likely to harm their portfolios by holding cash in sterling rather than equities ahead of the impending EU referendum, according to Alex Wright (pictured). 
The FE Alpha Manager, who runs the five crown-rated Fidelity Special Situations fund, has been increasing his exposure to UK domestic-facing stocks due to attractive valuations in the market area while many of his peers have been doing the opposite.
He also believes that holding cash is dangerous, given there is a strong likelihood that equities will fare better than cash regardless of whether we remain in the EU or not.
“You need to untangle the difference between the UK economy and the UK market. While I think a leave vote will undeniably be bad for the economy, I don’t necessarily think it would be bad for the UK market over the short to medium term because of the 66 per cent of the market which is facing non-UK currencies,” he explained.
“If we were to vote to leave, the most hit asset class will be pound sterling which could potentially devalue significantly but also, the third of the market in the UK that is facing pound-based earnings in the economy will be sold off.”
“But, I think that will be counteracted by the other two thirds of the market doing much less badly and therefore actually, even on a vote to leave, you would see the market outperforming sterling cash.”
In the run up to the referendum, many investors have been reducing their exposure to inward-facing UK stocks and instead buying into larger, global-facing franchises in order to minimise Brexit-induced volatility.
This is shown through the difference in performance between the varying UK indices, with the FTSE 100 outperforming the FTSE 250 and FTSE Small Cap indices until this morning.
Performance of indices in 2016
Source: FE Analytics
That being said, there has been a mini sell-off across the board over the last week as people have turned their backs on the UK market altogether.
In an article published last week, FE Alpha Manager David Coombs told FE Trustnet he is holding his highest ever cash weighting at the moment due to Brexit concerns and says that his only UK exposure is in global-facing stocks.
“[My current cash weighting] is all about Brexit. Whenever you’re going into a market event that you know is going to happen, I like to have lots of liquidity,” he said.
This sentiment is shared by AXA Wealth’s Adrian Lowcock, who says that investing ahead of the vote with a set view that we will either remain or leave is a brave decision as it will be binary when it comes to whether the investor has made the right call or not.
“Given this is a very short-term issue cash is a perfectly acceptable defensive asset. It will protect from market volatility and puts investors in a strong position to take advantage of any opportunities following any sell-off that we expect would accompany a Brexit vote,” he said.
However, there are other investment professionals who believe that holding sterling at the moment exposes investors to far more risk than they realise.
In an article published yesterday, FE Alpha Manager Nick Train said that holding cash during rising market conditions is one of the biggest mistakes investors can make.
He says that this is putting their clients at risk over the long term and goes against what they want from a fund manager – for them to invest their cash and make it work harder.
“I start with a pragmatic observation, though many may think it is a cynical observation. The truth is, being bearish about equities is dangerous for your career security. The reason I say that, certainly in our experience, is because the biggest sin in our industry (I’m not talking about illicit sins) is holding too much cash in a rising market,” Train said.
Keith Ashworth-Lord, manager of the Conbrio Sanford Deland UK Buffettology fund, agrees with Train that investors should not hoard cash in a rising market and believes it is a waste of time to focus on Brexit considerations.
In fact, he believes it is crucial never to be unknowingly underinvested in strong companies, which is why he actively manages his fund’s cash position.
“Holding cash can be seen as holding an option on future investment at a more favourable price. Our cash weighting is currently under 10 per cent and will be further reduced following the shake out I anticipate if the Brexit decision is favourable (i.e. Leave) next week,” he said.
“We are seeing positive inflows into the fund so a priority is to ensure these are invested wisely.”
More specifically, Fidelity’s Wright says that it is dangerous to hold sterling at all when we are just two weeks away from the referendum, despite its ‘safe haven’ status.
The manager reasons that if we voted to remain, the market is likely to do well as a whole, which means that markets would strongly outperform cash.
“Being in sterling is a lose-lose scenario because you won’t gain anything if we stay in but you will still lose a lot versus other currencies if we leave, whereas I think the market will do well if we stay and fare less badly than cash if we leave,” he added.
Another mistake that investors could be making, according to the manager, is buying into expensive, high-quality, dividend-paying stocks or ‘bond proxies’.
This area of the market tends to divide opinion – while some investors believe that it is worth paying for safety during a period of such high macroeconomic risk, others say that the high valuations of these stocks poses a valuation risk in itself.
“Expectations for interest rates continue to be very low and over an extended period of time, even to the 10-year gilts that are yielding 1.5 per cent - this means companies are effectively borrowing for free,” Wright explained.
“What that has led to in equity markets is very high valuations in defensive stocks which have bond-like characteristics, so the likes of Unilever.”
“They’re so expensive because of extremely low expectations for interest rates and inflation over what is actually the long term.”
“I’m not trying to make a call on this, but if there is a change in environment then some of those expensive stocks could underperform.”
Instead, while many investors could be afraid to do so, the manager believes that it is prudent to make the most of cheap valuations among domestic-facing UK stocks.
Over recent months, Wright has increased his exposure to the likes of Royal Mail, BT and Lloyds while adding a new domestic-facing holding – Ladbrokes – to the fund.
“I think this part of the market is clearly pricing in some fear around the upcoming referendum as well as other factors and therefore you’re starting to see an increasingly interesting valuation opportunity in some of the more domestic-facing UK stocks, which make up about 33 per cent of the UK market,” he said.
“If you then have a look at how [Fidelity] Special Situations is positioned, you can see that over the last 12 months there was quite a big fall in my overweight to this part of the market.”
“Recently that’s picked back up again and that reflects the fact that I have been adding to some of these names that have domestically-facing UK earnings streams because the valuations look better there.”
Over Wright’s tenure, Fidelity Special Situations has returned 7.18 per cent, outperforming its average peer in the IA UK All Companies sector more than 12 times over.
Performance of fund vs sector and benchmark under Wright
Source: FE Analytics
The £2.7bn fund has a clean ongoing charges figure of 1.16 per cent.
