As the prospects of a no-deal Brexit recede, fund managers are flagging up the big gains that could be made by investing in “historically” cheap mid-sized British companies. Brexit has turned UK companies into the pariahs of the international investment community, their revenues and profits deeply uncertain while a cliff-edge no-deal remains on the table. If a deal finally emerges, could they soar in value?
“The UK market is a historic opportunity,” says Scott McKenzie of Saracen, an Edinburgh-based fund firm. “The worst-case Brexit scenarios are quite grim but valuations are already at historic lows and UK shares ought to recover from here.Waiting for the gloom to clear may risk leaving it too late and missing the sunshine. It’s time to stand up.”
At Fidelity, which controls £1.5tn in assets globally, fund manager Alex Wright says the “unrelenting negativity” towards UK equities could turnaround rapidly, with any clarification of Brexit the likely catalyst. If so, the UK “could be among the top performers globally” in 2019.
JP Morgan, another major global investment firm, runs a UK mid-cap investment trust specialising in the shares of companies outside the giant firms in the FTSE 100. Manager Georgina Brittain says: “We are now hopeful that if – and it remains a big if – the government is able to negotiate its way out of the current impasse, we will see sterling rise, inflation fall further and a much-needed boost to consumer confidence. This would be extremely positive for domestically focused FTSE 250 businesses.”
Since Jeremy Corbyn gave more support to a second referendum, and Theresa May moved towards ruling out a no-deal Brexit, sterling has already rebounded significantly, hitting six-months highs against the dollar and the euro.
But a rally in sterling is a double-edged sword. The giants of the London stock market, such as BP, declare their earnings and dividends in US dollars. When sterling plummeted after the referendum result in 2016, shares in the biggest UK companies surged, because of what’s called the ‘translation effect’. The dollars they earn overseas are then worth much more in sterling. But the opposite happens when sterling rises – so a resolution to the Brexit crisis could actually see their share prices slip back.
This is why some fund managers are more excited about “mid-cap” (the “cap” stands for market capitalisation) shares. While Brittain says the FTSE 100 is negatively correlated to a rise in sterling, that’s not the case with mid-caps, which earn far more of their profits in sterling, not dollars. She adds that the UK consumer has already turned the corner, pointing to healthy levels of employment growth, falling inflation and indicators such as the Asda income tracker which show household income powering back.
One problem with mid-sized UK shares is that many of them are struggling high street firms, such as Ted Baker, which issued a profit warning this week, and Superdry, which has lost three-quarters of its value since the beginning of 2018.
Brittain flags up pub companies as winners from a Brexit deal and rising disposable income, and also highlights smaller financial groups such as Charter Court and One Savings Bank.
At Saracen, McKenzie names Lloyds Bank and Aviva as UK-focused companies likely to benefit if the clouds clear on Brexit.
Stockbroker Brewin Dolphin names British Land, Howden Joinery and Legal & General as best placed for a ‘good’ Brexit. If you think the fund managers above have got it all wrong and we’re still headed for a ‘bad’ Brexit, then Brewin Dolphin says Unilever, Diageo and Royal Dutch Shell are a safe harbour in the storm.
At JP Morgan, Brittain wans that a bad Brexit has not been fully priced in to shares, and that if it happens, UK shares could lurch down. “Are mid cap shares cheap? Yes. But if we have a hard Brexit, prices will fall further.”
If you’re prepared to take the risk, how do you go about buying shares and funds? Remember, the Isa rules give you a £20,000 allowance to invest in shares and funds with the capital gains and dividends entirely tax free. But hurry – the deadline for this year’s Isa allowance is 4 April.Trustnet.com is a good place to researchfunds, while index-tracking companies such as Vanguard offer a cheap way to mirror market performance. Or try web platforms such as Hargreaves Lansdown, Fidelity and interactive investor where you can buy funds and shares. Langcatfinancial.co.uk has a useful guide to the platforms and Isa investing.
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