How have fund managers positioned portfolios for Brexit?

It is currency markets that reacted to the event first, with the value of sterling falling starkly against the dollar and the euro.

The large proportion of the earnings of FTSE 100 companies that come from overseas meant the market eagerly repriced those equities in anticipation that the sterling value of those earnings will be higher, justifying a higher share price for the companies concerned.

But the optimism of the FTSE 100 has not been borne out by investors into UK assets, with £10bn withdrawn from UK equity funds since the Brexit vote.

But while there has been a wave of capital directed towards companies with overseas earners, it has not been the unanimous position of all fund managers that the best place to deploy capital while the political risks are high is in the overseas earners.

Fund managers Neil Woodford, head of investment at Woodford Investment Management, and Mark Barnett, head of UK equities at Invesco Perpetual, have chosen to invest a greater than the market average proportion of their capital into UK domestic earners, on the basis that the outlook for the UK economy is better than the market expects, and that when this becomes apparent, the share prices of the domestic earnings companies will rise.

We are taking advantage of some low valuations of domestically-focused companies, but also buying strong global businesses.Simon Gergel

Mr Barnett says the valuations at which many of these equities trade implies that a recession in the UK is imminent, but that he feels such a recession to be “unlikely”.

This stance has hindered the performance of the funds managed by Mr Barnett and Mr Woodford.

Mr Barnett's Invesco High Income fund has returned 10 per cent over the past three years, compared with 30 per cent for the average fund in the IA UK All Companies sector in the same time period.

Mr Woodford’s funds have performed even less well, returning 2 per cent in three years, against the sector average.

Taking advantage

Simon Gergel, who runs the £693m Merchants Investment Trust at Allianz Global Investors, notes: “Overall we are not negative on the UK market due to Brexit.  

"The UK stock market is lowly rated in comparison with the major international stock markets. The majority of UK listed companies’ sales and profits comes from overseas, mostly outside of the EU.

"This provides investors with a considerable level of protection from the worst case Brexit scenarios, especially as any weakness of sterling would result in an appreciation of the value of these overseas earnings." 

He continues: "We are maintaining a diversified portfolio, exposed to different industries and geographies. We are taking advantage of some low valuations of domestically-focused companies, but also buying strong global businesses.” 

He adds that while Brexit is holding back the performance of many parts of the UK economy, he doesn’t believe that a Brexit outcome that is regarded as “soft” would lead to a substantial improvement in the outlook for the UK economy. 

Mr Gergel says the rate of unemployment is presently so low that the economy is already operating at as close to its long-term capacity as it can. 

Large cap opportunities?

Alex Wright, who runs the Fidelity Special Situations fund, explains he has been buying large-cap companies because many investors have turned to small and mid-cap shares, meaning larger companies are where the value lies.

Mr Wright says small and mid-cap shares have actually outperformed the FTSE 100 since the Brexit vote, despite the popular narrative being that large caps have performed better because they earn a greater proportion of revenues from overseas and were less impacted by the slower growth rate of the UK economy.

As a result, Mr Wright says he sees large caps as an opportunity and has been investing more capital into three areas in particular: banks, oil companies and defensive shares, such as tobacco companies.

James Thomson, who runs the £1.4bn Rathbone Global Opportunities fund, confirms he is maintaining a minimal exposure to UK equities because, while he cannot know what the outcome of the various bouts of political uncertainty will be, he feels that as a global fund manager he doesn't need to take the risk of investing in the UK.

John Goodall, WHIreland’s head of private client research, says he is very cautious on UK assets for a variety of reasons.

“We remain cautious on the UK with underweight recommendations across all our mandates," he explains. 

"This is more a reflection of weak underlying growth prospects in the economy rather than anything specific in relation to Brexit. Brexit uncertainty is holding back investment.

"Potentially a positive outcome would lead to a short-term pick-up in growth. However, this is unlikely to be sustained."

But he points out: "With the economy close to full employment and precious little in the way of productivity growth, alongside an aging population weighed down by a heavy debt burden, it is hard to see how the long-term growth trajectory can be improved."

david.thorpe@ft.com