Five years on from the Brexit vote in June 2016, the UK has seen three prime ministers, a global health crisis, a divorce from the EU and unprecedented fiscal and monetary intervention which has impacted all asset classes. The pound, which fell to a three-decade low post the vote, has recovered, but still remains 6% lower than the day of the vote.
The UK equity market has been a clear laggard over the period versus other developed markets led by the US, especially the tech heavy Nasdaq Index. The pandemic has served to exacerbate market volatility resulting in a difficult landscape to navigate for investors, especially those focused on UK markets.
The discount applied to the UK by investors has remained throughout the past five years and has led to a series of takeovers of UK-listed companies, including WS Atkins, Scapa, Horizon Discovery, Aggreko, Arrow Global and St Modwen Properties to name a few.
The recent attempt by private equity to take over Morrisons further supports the thesis that the UK market on its current valuation remains highly attractive to investors, especially private equity.
The successful vaccination programme in the UK has been pivotal for investors looking at the UK with a very different lens, with a focus on the opportunities that are available in a high-quality and well-established market which has been unloved for the past five years.
Challenges and opportunities
This has been challenging for UK fund managers who have had to deal with a bitter divorce with the EU and a pandemic. Both events have led to heightened volatility and large changes in asset prices.
The sectors that have struggled included real estate businesses with meaningful exposure to retail. These have had to weather the challenge from online disrupters, and energy where climate change concerns have come to the forefront. Telecom businesses are facing an environment where they cannot generate enough profits from customers to cover the eye-watering costs for building out 5G infrastructure.
The sectors that have held up relatively well and are positioned favourably to benefit post-Brexit include healthcare, which covers a wide range of industries including pharmaceuticals, animal health and life sciences. The UK retains a leading position in high-end industrial engineering serving customers globally. The materials sector, which covers construction and house building, is also well set to deliver for investors, with the latter well placed to deliver on the long-standing supply shortfall of new homes in the UK.
The high saving ratio which has been built up through the pandemic will unwind, when consumer spending rises once lockdown restrictions are fully lifted and those consumer-facing businesses which have embraced digital will be in pole position to benefit.
The challenge for UK fund managers as we move into a post-Brexit world is how to position a portfolio at a market cap level. The small- and mid-cap firms are in better position to take advantage of economic growth which is forecast to come through in the second half of 2021 and beyond. And it is no surprise that both the small- and mid-cap indices are at a record high, while the FTSE 100 has failed to recover to its pre-pandemic high.
The large-cap index is dominated by more cyclical companies which have been out of favour for an extended period, although could be set for a change if we have a meaningful rise in inflation and a change in monetary policy.
In addition, the volatility in sterling has been a headwind for larger companies, with over 70% of revenues derived from abroad. For those investors who favour an active and quality approach to stock selection, there has never been a better period to build a focused UK portfolio.
The unprecedented recent intervention by the Bank of England and the UK government, coupled with optimism around the re-opening of the economy in the second half of the year and pent up demand from the consumer materialising, augurs well for investors in the UK.
The attractive valuations and higher dividend yields which are now coming through after a very tough 2020, which saw a flurry of cuts, deferrals, suspensions and cancellations of payouts, will help to narrow the Brexit discount.
In addition, the pandemic which has resulted in strong headwinds for the UK economy and markets will hopefully fade in time, allowing for normal activity to resume in 2022 and beyond. These factors paint a positive outlook for a market that has been long out of favour with global investors.