An ongoing lack of clarity over how the UK will leave the EU is making it more difficult for UK equity managers to position for a post-Brexit environment, according to Franklin Templeton Investments’ Ben Russon. 
Markets have struggled during the final quarter of the year as concerns over the end of the economic cycle, further interest-rate hikes and a flattening yield curve have stoked investor fears.
The MSCI AC World index is down by 4.25 per cent in sterling terms over the past three months.
However, the FTSE All Share – which captures 98 per cent of UK market capitalisation – has fallen by 6.03 per cent, as the below chart shows.
Performance of indices over 3mths
Source: FE Analytics
FE Alpha Manager Russon (pictured), lead manager of the £348.3m Franklin UK Managers’ Focus fund, said that the ongoing uncertainty over Brexit has piled on further challenges for domestic stocks.
He added: “It’s obviously been a difficult autumn for equity markets globally, but the UK has its own issues as well. It’s been a bit tough.”
With prime minister Theresa May failing to find much support for her interim deal, the 29 March deadline approaches with little detail on how the UK will exit the bloc and what its future relationship will look like.
As such, Russon said it remains difficult to prepare portfolios for the post-Brexit environment.
“Our view remains the same: you can point to quite reasonable value in the UK as it stands today,” he added.
“But people are reluctant to get involved in the UK because of all this political noise, the Brexit process and fears of a disorderly Brexit or a collapse in the currency or a change in government.
“It is a very real threat that people are concerned about so if we’re to move through this lack of clarity that will allow people to be more positive about UK equities in the broader sense.”
Russon said it is “quite conceivable” that the Brexit process is delayed or extended and continues to dog markets well into the new year.
“The stock markets like certainty and as long as they know what’s happening, they can price it accordingly,” he continued.
“At the moment there is such a broad range of outcomes that equity markets are trying to price in a hard Brexit, a soft Brexit, no Brexit, and a Labour government.”
Any clarity, said Russon, would allow markets to price more accurately and allow them to move forward rather than remaining in limbo.
“Hopefully that would allow people to be more positively disposed towards UK equities,” he added.
Since the referendum on EU membership in June 2016, investors would have found higher total returns outside of the UK.
As the below chart shows, while the FTSE All Share index has delivered a total return of 18.13 per cent, the MSCI AC World ex UK index is up by 45.35 per cent.
Performance of indices since EU referendum
Source: FE Analytics
With little insight into what a final deal will look like, the Franklin Templeton UK equities team has continued to position for all outcomes by taking a neutral approach.
“We’ve been saying for some time we try to position the funds to be Brexit-neutral,” said Russon.
“Given that it’s so hard to have a clear view on how this will eventually play out, we don’t think it’s appropriate to position fully international [earners] or equally fully domestic ones.”
As it stands, investors could be missing out on a compelling income story if they are cutting back their exposure to domestic stocks.
“Looking at it from a yield perspective, the market is yielding 4.5 per cent and there are quite a lot of shares out there with yields of 5 per cent or more that are a lot cheaper than they were 12 to 18 months ago,” he said.
“Our income strategy [Franklin UK Equity Income] is yielding over 5 per cent which doesn’t really happen that often. You have to go back to the financial crisis for the last time our income fund was yielding over 5 per cent.”
He added: “Obviously bond yields in the UK [on 10-year gilts] are going down to the 1.2 to 1.3 per cent level so the differential between the UK 10-year and equity yields is very wide indeed.
“On those kinds of metrics there is value to be had in equites.”
However, Brexit is not the only headwind facing markets and Russon said it would be helpful to have greater clarity on several other issues that are currently clouding the outlook.
The FE Alpha Manager said it would be useful to have some sort of resolution of the ongoing trade dispute between China and the US, which has contributed to the recent re-rating in markets along with concerns over the pace of rate-hiking by the Federal Reserve.
While these issues remain, Russon said the sharp bouts of volatility that have been seen this year could become a regular feature of markets.
“The lack of volatility we saw in 2017 was probably the anomaly,” he concluded. “We are at a turning point: people are unclear and need to see what the Fed is doing with rates and work out what stage they are at in the interest rate cycle.”
The Franklin UK Managers’ Focus fund is a best ideas fund drawing from the asset manager’s UK equity offering and an equal weighting to the four main strategies: Franklin UK Opportunities, Franklin UK Equity Income, Franklin UK Mid Cap Fund and Franklin UK Smaller Companies.
It aims to deliver a total return in excess of that of the FTSE All Share index over a three- to five-year period.
The fund has delivered a 69.25 per cent total return since Russon joined in April 2013, compared with a 39.91 per cent gain from its average IA UK All Companies peer and a 38.68 per cent return from the benchmark FTSE All Share index.
Performance of fund vs sector & benchmark under Russon
Source: FE Analytics
The fund has an ongoing charges figure (OCF) of 0.83 per cent and yields 2.31 per cent.