It’s almost impossible for UK equity investors to try and guess what the outcome of the Brexit talks is likely to be in the coming six months, according to Franklin Templeton’s Colin Morton, but there are ways they can position themselves.
Morton, lead manager of the Franklin UK Equity Income fund, said that Brexit continues to cause problems for long-term investors such as himself.
This could be seen towards the end of last year when a ‘no deal’ Brexit seemed likely, before the domestic market rallied on hopes that some agreement would be reached.
As the below chart shows, the FTSE All Share index lost 10.25 per cent during the final quarter of the year but rallied during the first half of 2019 to record a flattish 1.4 per cent return by the end of June 2019.
Performance of index Q4 2018 – Q2 2019
Source: FE Analytics
“We’ve got Brexit and, from the UK perspective, that really hit the market at the back-end of 2018 when everyone got really fearful about a ‘no deal Brexit’, ‘it was all going to go pear-shaped, they were just going to walk away’,” he said.
“All the UK domestic stocks, in particular, the housebuilders, the retailers, the leisure stocks, etcetera, they all got hit very hard.
He added: “They’ve all sort of settled down a bit now, they haven’t gone back to the lower levels they were at in the fourth quarter of last year, but they’ve drifted down a little bit with Theresa May resigning and the ongoing change in leadership coming along, which almost certainly is going to be Boris Johnson – unless there’s some absolute shock result.”
Morton said Johnson is talking a ‘harder game’ over Brexit, threatening to walk away without a deal when the next deadline expires on 31 October.
He added: “That makes people a little bit more nervous again in terms of the more domestic-oriented stocks and they have struggled a little bit more recently, as everyone started to worry a little bit about that.”
As such, UK equity investors face multiple political outcomes over the next six months, each of which could have a significant impact on their portfolio. 
Morton’s first outcome is that – should Johnson be successful – a new deal is agreed and passed by Parliament in the few months between his election as leader of the Conservatives and the 31 October deadline.
“If we get Boris and can somehow get a deal through Parliament which allows breathing space for the next phase of the talks to continue over the next year or two, the likelihood is that the pound would rally relatively hard because it has been incredibly weak,” the Franklin UK Equity Income manager said.
“Lots of people globally are very underweight the UK stock market. Almost nobody is investing in the UK because the risks have been too high – that’s their perception – so we will probably get the relatively broad-based rally in the market.
“But those international stocks which make a lot of that money overseas and have been good performers for the last few years because of Brexit – partly because of that safety, but partly because of the currency – they would probably struggle relative to the more domestic-oriented stocks.”
Second, Morton (pictured) said that Johnson could carry out a threat to walk away from negotiations and leave without a deal on Halloween.
“I could be completely wrong, but the likelihood is sterling would be a bit weaker on the back of that and the uncertainty it would cause for a lot of companies,” he continued.
“There might be some short-term dislocation for three, six, nine, 12 months, none of us really know and that’s the problem with ‘no deal’.
“No one, if we’re honest about it, even the politicians, really knows what’s going to happen.”
He added: “The international names which make less of their money in the UK would probably do a bit better in that scenario. And the UK domestic stuff would probably struggle a little bit.”
This would likely lead to some sort of transition period, which may or may not have as big an impact as people fear.
“I think the market will probably overreact to it. But again, I don’t know, that’s just me thinking that and I could be completely wrong,” the manager added.
The third and final outcome, which Morton said “scares the market a lot more than even a ‘no deal’ Brexit” is the potential for a Jeremy Corbyn-led Labour party in government.
“To the equity market, that is probably a lot more scary in some ways than a ‘no deal’ Brexit,” he said. “What we’ve got to acknowledge here is we haven’t had what you would describe as a socialist or left-wing government in the UK for 40 years.”
The Blair/Brown governments of the late 1990s and early 2000s were more centrist than left-wing, he said.
“What’s different this time is this current Labour party is making no secret of the fact that they are going to be a proper socialist government in business. There’s no hiding from that, that’s what they’re saying,” he explained.
“We’ve already heard all the stories about increasing corporation taxes in the UK back towards 30 per cent from its current 17 per cent or 18 per cent. Instantly, if you’re a UK domestic stock making all your money in the UK, you’re going to have to pay a lot more tax.”
In addition, said Morton, talks of renationalising utility companies and other sectors will increase borrowing significantly and would have a significant impact on monetary policy and sterling.
“I’m 53. And I’ve been doing this for years, but I was only 10 years old when the last proper socialist government [was in power],” he added.
“I remember the power cuts and the candles and stuff like that, it was quite good fun when you are 10 when the power went off and you’re playing cards, you know.”
Given the three very different scenarios that could emerge, it is difficult to make longer-term plans, the manager acknowledged.
In terms of positioning, he is trying to address all outcomes, albeit he has been accused of dithering.
“Someone described me a few days ago as ‘sitting on the fence’ at a meeting. And I thought ‘that’s quite a good description’ and to some extent what I am doing,” he said.
Morton added: “When I do get a good opportunity in either an international or domestic stock where they look very cheap, I think to myself, ‘well, regardless of what the outcome of all of these things is, I still think that company is good value at those levels’ and I’m willing to get involved.
“But, generally speaking, I’m sort of sitting there a little bit, trying to wait and see how things develop over the next six-to-12 months.”
The £732.8m Franklin UK Equity Income fund has made a total return of 658.94 per cent since Morton joined in 1995, compared with 470.96 per cent from the average IA UK Equity Income fund and 444.11 per cent from the FTSE All Share index.
Performance of fund vs sector & benchmark under Morton
Source: FE Analytics
It has a yield of 4.47 per cent and an ongoing charges figure (OCF) of 0.52 per cent.