Talking Point  

UK equities are not defensive despite withdrawal agreement

UK equities are not defensive despite withdrawal agreement

Including UK stocks in a multi-asset strategy may not necessarily be counted towards a defensive approach, despite the UK reaching a step closer towards securing a Brexit agreement, warned several in the industry. 

On Thursday, UK prime minister Boris Johnson announced that he reached a withdrawal agreement with the EU. 

The deal needs to get the approval of the DUP, whom the government relies heavily for key votes, and of the parliament. 

Defensive assets are usually a key part of a multi-asset strategy. This is mainly as they tend to have lower correlation to other assets, and typically boost the risk-reward profile of multi-asset portfolios. 

But the industry said the potential agreement is unlikely to improve the outlook of UK equities, which have been considered “cheap” compared to other global stocks. 

Alasdair McKinnon, lead fund manager of the Scottish Investment Trust, said: “It improves the odds in your favour as ‘cheapness’ already implies a degree of pessimism. However cheap, in itself, is not defensive. Ideally, you’d want undervalued stocks with an ability to recover.”

Several others in the industry voiced similar concerns. 

Paul O’Connor, head of the UK multi-asset team at Janus Henderson, said: “While global investor scepticism about UK assets means that the rebound in sterling, gilt yields and UK stocks probably has further to run, we would be wary of extrapolating these moves too far.”

“Does that make UK stocks defensive? Not as a whole, but markets value certainty - a feature that has been sadly lacking,” Mr McKinnon added. 

Nathan Harris, chartered financial planner at The Lothbury Group, says: “Cheap is not always the best, the last value stocks rally we had was in 2016.”

He added: “Cheap [UK] stocks are more of a contrarian assets. Value assets have been out of favour and the gap between value and growth assets keeps on increasing.”

Kay Ingram, director of policy at LEBC Group said while including cheap stocks could be counted as a defensive multi-asset strategy, in practice “it is not so simple”. 

She explained that a stock is only cheap if it is undervalued due to mispricing by the market.

“For an investor the difficulty is understanding whether the valuation fairly represents the fortunes of the company or is over pessimistic.”

Ms Ingram added: “So just because a stock is trading well below its historic P/E does not indicate it is cheap, investing in a company in these circumstances could be catching a fallen knife.”  

To determine whether a stock is good value requires a much deeper analysis of its future business plan and prospects, said Ms Ingram. 

Mr Harris said defensive assets should primarily include cash, and other safe haven assets, such as gold. 

But he added that people are starting to move assets into the UK also  because people are worried that they are holding too much of their money outside sterling in overseas assets, meaning if sterling rallies they may miss out and get a negative return.