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Kevin O’ Nolan: Why now is the time to take profits from UK equities

12 July 2016

The multi-asset manager at Fidelity explains why he has moved to a “more aggressive” underweight position in UK equities following the FTSE 100’s recent rally.

By Lauren Mason,

Reporter, FE Trustnet

Uncertainty caused by unfolding political instability, a slow global growth picture and the FTSE 100’s recent rally has led Fidelity’s Kevin O’ Nolan (pictured) to adopt a “more aggressive” underweight to UK equities since the announcement of a Brexit majority vote last month.

The manager, who co-runs a number of multi-asset portfolios for Fidelity, is also underweight bonds which have performed strongly as UK investors have flocked to safety.

The strong performance of the FTSE 100 index has left many investors bemused, given that the result of the EU referendum, has led the country into unchartered territory.

Not only has the blue-chip index returned to levels last seen before the referendum, it is at its highest peak since the start of the year and officially entered into bull market territory yesterday.

Performance of index in 2016

    

Source: FE Analytics

Indices can be used as a gauge of investor sentiment. While some will have breathed a sigh of relief that we haven’t slipped into a bear market, a number of investment professionals remain sceptical as to how UK equities will perform over the medium-to-long term.

In an article published days after the referendum, a number of investors argued that the FTSE’s strong performance is due to its disproportionate number of global-facing stocks, which have benefitted from the weaker sterling rather than the strengthening of the UK economy.

O’ Nolan, who has been at Fidelity since 2008, agrees that there are potential headwinds that UK investors could encounter as we head through this year and through 2017, which is why he has significantly reduced his position in equities in the region.

“Coming into the referendum I moved to a small underweight in equities and that was driven by a lacklustre global growth picture,” he explained.

“In the aftermath of the referendum we’ve actually seen a relatively strong bounce back with equities to the same levels they were at coming into the referendum.”

“I’ve used that rally to sell into and move to a more aggressive underweight position. I do think this is going to play out over a prolonged period of time and I think ultimately it will impact financial channels.”


The multi-asset team at Fidelity began highlighting to investors that uncertainty was weighing on UK growth before the referendum results.

During the first quarter of this year, O’ Nolan points out that UK GDP growth fell from in excess of 3 per cent to 2 per cent and growth softened further during the second quarter.

“The vote to leave is not only going to increase that uncertainty but prolong it and it means that investment in the UK in particular is likely to be cut,” he warned.

“It will also weigh on UK business confidence and I think there’s a good chance that, over the course of this year and as we move into next year, the UK may dip into a technical recession.”

“Ultimately we have seen some response already from Mark Carney suggesting he’s likely to ease monetary policy going forward, but at the end of the day this is a political crisis and it’s going to play out over the course of a number of years.”

Nick Peters, fellow multi-asset manager at Fidelity, says that the political instability will create uncertainty among investors, which is another reason to remain cautious on UK equities.

While he says that the appointment of a new prime minister won’t necessarily be a major cause of uncertainty, he points out that the impact of the impending Brexit is unknown – not only this, nobody knows when it is going to be put into practice.

“With political risk in itself, I don’t think it’s a big deal. The Spanish have gone without a formal government for six months and the market has barely blinked, but the issue we have within the UK is that we’re waiting on a decision on if or when we invoke Article 50, which is basically the divorce agreement between ourselves and Europe,” he said.

“While that timing is uncertain, I just can’t see why any corporate management will decide to invest in the UK unless it’s for urgent measures.”

“I think that’s going to be an issue. Then thinking more broadly in terms of risk, we have the US elections in November, we have a constitutional referendum in Italy in October and, next year general elections in Germany, France and the Netherlands. So political risk is very much going to remain on the agenda for a while to come.”


While O’ Nolan is underweight equities, he remains overweight commodities due to  falling supply in levels and the rising price of oil.

Performance of index in 2016

 

Source: FE Analytics

Elsewhere, he is underweight bonds which he admits has hurt in the aftermath of the referendum. Nevertheless, the manager has still outperformed his peer group composite by 3.02 percentage points since the results were announced, returning 8.82 per cent.

“Ultimately the [bond] picture is likely to change with central banks being looser than they were previously. But, at the moment, the asset class is quite overbought and we’re not rushing to trade there,” O’ Nolan explained.

“Finally, with the currency we’ve been negative on sterling up until the referendum. We closed that position as it became largely fully-priced.”

“We were fortunate enough to be able to re-establish that position pretty much at the same levels we closed at and we continue to hold that. You have a large current account deficit in the UK and I think that’s going to be the place where the pressure is felt the most.”

 

Since O’ Nolan became the lead portfolio manager on all five of Fidelity’s risk profiled Multi Asset Allocator funds in January 2015, he has outperformed his peer group composite by 3.2 percentage points with a total return of 9.45 per cent.

Performance of manager vs composite over tenure

 

Source: FE Analytics

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.