In the past year, we’ve seen a divergence in performance between internationally focused companies and domestically facing ones, with the former basket coming out on top.
Some prominent investors, like Neil Woodford and Mark Barnett, hold a positive view for the UK economy’s prospects so are favouring areas whose fortunes depend on its good health.
Others still feel it’s prudent to invest in companies that source most of their revenues in dollar terms due to sterling still being lower than its level before the EU referendum despite a more recent re-rating.
But Colin Morton, manager of the Morningstar Silver-rated Franklin UK Equity Income fund, favours a more balanced approach.
Being UK equity income focused, his portfolio is typically large cap in its nature. He aims for at least 70% blue chips, so holds overseas earners like Shell (RDSB), BP (BP) and HSBC (HSBA). That’s worked well for the fund since mid-2016, though, Morton admits, more by luck than judgment.
But currently he says he has “a foot in both camps”. “It’s not a time to be all on either way,” he explains. That’s because there are still potential risks ahead.
With cracks beginning to show in the incumbent Conservative government, there are two possible political outcomes that are rather diametrically opposed. On one hand, Tory government could “fall apart”. That would see a new leader replace Theresa May and, more than likely, lead to yet another general election.
The polls suggest Labour would then become the largest party. “That has severe short-term repercussions for the UK equity market,” Morton says.
With Jeremy Corbyn’s movement increasingly moving towards the left of the political scale, we could see a ramp up in corporation tax and the potential nationalisation of many industries.
That would see the pound “get hit very hard” – more good news for those that earn cash abroad. “Yes, your large-cap international stocks who make 5-10% of their money in the UK would have to pay an increased corporation tax, but it would be on a small part of their business,” Morton explains.
“Whereas if you’re a 100% UK company, instantly your tax bill’s gone up from 19% to 28%. On top of that if the pound drops significantly you’ve got these import issues and we’ve got much higher inflation again.”
At the same time, Morton acknowledges there’s a possibility the Conservatives will “continue to limp on for the next few years and Brexit negotiations could go much better than they think they’re going to go”.
Then, recent rally in the pound we’ve seen would continue, making the environment better for domestic stocks.
“You’ve got to get that balance right between keeping exposure to those really high-quality large-cap names that we like, which gives us a natural hedge if there was something to happen from a political point of view; but also trying to identify those stocks what have been weak in the last year or two because of Brexit and worries about the UK consumer.”
It’s a difficult market for investors currently, he notes, and “it seems like much more of a time to be a bit more sensible” in your allocation decisions.
Morton’s hope is that five to 10 years down the road all of this – Brexit repercussions, etc – won’t matter. While investors will be hoping that’s the case, short-term noise and volatility is likely continue impacting portfolios.
