How is this going to impact UK equities?
In the short term it will lead to heightened uncertainty as the implications for underlying companies are worked out. The impact will be different company by company – some international companies (such as AstraZeneca) will, we think, see little impact other than the effects of currency moves while others will see their environment change more markedly. It is worth bearing in mind that approximately 70% of FTSE 100 sales are derived outside of the UK, so the UK is a very international market and companies with a competitive product positioning and strong balance sheet should remain well positioned over the long term.
What are the main risks?
· Currency – given the fall in sterling this will mean higher input costs for those that import goods internationally, such as food retailers and clothing retailers. The question then is whether they can pass these higher input costs onto consumers via price rises. In a highly competitive environment such as food retail passing on higher input costs may be difficult and therefore earnings growth forecasts will need to be lowered. On the other hand lower sterling will benefit those companies that generate a substantial portion of earnings in other currencies (such as US Dollars) – for our funds this will benefit companies such as Scapa and Elementis.
· Interest rates – due to the expected slowdown in UK economic growth, we expect interest rates to either remain on hold or to decrease. This has implications for bank earnings, where margins have already been under pressure for a number of years given the low interest rate environment. We have historically held a low weight in Banks and those that we do hold (such as Standard Chartered) are quite international in their exposure.
· Rising unemployment – in the face of uncertainty some companies may put hiring decisions on hold, and some companies will chose to relocate jobs to mainland Europe. Rising unemployment would impact retail sales, particularly of discretionary items such as apparel, and would likely cause an increase in bad debt for consumer lending companies that we hold (such as Virgin Money and Provident Financial).
Does it present opportunities?
At a fund specific level the lower currency will benefit our dividend payments, as a substantial portion of our dividends from companies are paid in US Dollars (such as HSBC). At a broader level yes there will be opportunities, but we need to be cautious of the negatives of Brexit presenting themselves before the positives. For example the lower currency should ultimately make Britain a more competitive area to manufacture, but ahead of new trade deals being negotiated international companies may well be cautious of investing in the UK.
There may also be higher government spending in the event of a new leadership team in the autumn, which could benefit some of our companies exposed to infrastructure spending (such as Hill and Smith) or defence spending (such as Babcock).
What does it mean for you at a portfolio level?
What we have always tried to select within UK Equity Income & Growth are companies that produce specialist products (or services) that can compete on an international scale. Ultimately that should not change following the vote, but in the short term it will mean changes in earnings forecasts and this is something we will need to review company by company. It is worth bearing in mind that some companies we hold (such as University spin-outs, approximately 5% of the total Fund) will not be materially impacted as what matters for them is whether their technology works and is commercially viable, not moves in the wider economy such as this. It is events like this that remind us of the need for a diverse portfolio.
We will be looking over the next few weeks and months to try to spot opportunities where we think the market is either being complacent over the negative impacts (such as the negative impact on consumer confidence), or underappreciating the positives (such as sterling depreciation).