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How to view UK assets now

Q4 UK market newsflow

Q4 2020 for the UK is important in terms of newsflow events:-

  1. End of October furlough programme (31st October 2020); the trajectory of UK unemployment post furlough will be important to UK GDP over 2021.
  2. US Presidential election (3rd November 2020); we expect a Biden victory with global capital markets welcoming a return to more conventional, and predictable US leadership but there is some risk in the November- December handover period if the election result is contested.
  3. Resolution to the Brexit event! As the endgame plays out, hopefully the Conservative government will put the interests of the country first rather than risk the disruption of the UK crashing out post the transition period (31 December 2020).
  4. C-19 developments; the UK has 2 horses in the C-19 vaccine race, wouldn’t it be nice if one of them came in. We await Phase 3 trial results in Q4 2020.

What assumptions are being made given Covid-19?

Global capital markets are bifurcated over 2020 with the good areas expensive and the others cheap. UK equities are in the ‘cheap’ camp. An investment in the UK ‘cheap’ camp, requires the buyer to take on trust that:-

  1. C-19 impact will diminish in 2021.
  2. Brexit disruption is minimized, a UK/EU free trade deal concluded in line with the UK’s needs and desires.
  3. the UK public will travel abroad and its workforce return to the office again.
  4. the impact of climate change on the energy mix will have a lower impact than current expectations.
  5. UK corporate profits and dividends will rebound in 2021.
  6. UK unemployment will return to February 2020 over 2021.

This is a hefty set of cumulative assumptions for 2021!

The issue is the extent to which changes are structural i.e. permanent or semi-permanent and which are cyclical or temporary and will be fixed. This is a difficult question to answer, because the longer an unreal situation lasts, the longer a new reality takes hold. I do not expect everyone to return to the office, or to return to gallivanting around the world, I think many jobs will be lost because the industry that hired them is no longer capable of doing so.

This is similar to the post Brexit market in 2016 – a major disruptive event that created an array of viewpoints but overall a sense that Brexit had to be resolved (the same way that C-19 has to be resolved) for clarity and for ratings on UK assets to rise.

The UK assets that were marked up post Brexit were typically profitable UK multi-nationals i.e. companies for whom Brexit had little relevance or where there was a net positive earnings translation. Brexit dragged on because an argument broke out in the governing party as to which faction should be in charge. I digress a bit here, but it seems a major reason for lengthy 3 year Brexit talks has been the change in the various UK governments approach to the EU negotiations post Brexit. But now Brexit must be resolved……I assume.

Looking at previous periods of change and disruption, I draw a parallel with 1989, the fall of the Berlin Wall / Warsaw Pact. It took time for the ramifications to emerge. It was 2 years from the fall of the Romanian regime on Christmas day 1989 to the fall of the USSR / Gorbachev resignation also on Christmas Day 1991. C-19 is a period of profound change and disruption so far only 9 months old.

Investors place a high value (premium) on certainty and a low value (discount) on uncertainty. Hence low valuations are to be expected given the C-19 context.

I am left with the choice of i) taking the macro view i.e. letting the index decide ii) investing in various sectors iii) stock-picking individual companies. Of these i) is the least risk ii) far higher risk iii) substantially higher risk.

The magnitude and duration of the drop in many individual companies this year is similar to declines last seen in 1974. But unlike 1974 investors cannot park their money in the bank and earn 12%.

Do low base rates help much?

Sub 1% rates have been a reality since 2008 and were essential in the 2008 crisis. But global central banks shied away from significant rate changes as the global economy recovered. This was a departure from previous rate hike cycles which had seen interest rates normalize. By adopting this approach central banks deprived themselves of a means of managing the next problem.

Besides, C-19 is not a problem monetary policy can fix. Only governments can replace lost income and provide tax relief. Only pharma companies can find a C-19 vaccine.

The small downward movements over 2020, i.e. the drop of 0.6% in the base rate will result in only marginal differences to consumer behaviour, given that negligible savings income has been a constant since 2008. Very low base rates have had a similarly low impact on asset markets given the pre-occupation with the profit impact of C-19.

Permanently low interest rates have been priced into fixed income markets with a gilt yield offering a negative real yield. The 50 year gilt offers a yield to maturity of 0.61% a negative real yield when factoring in CPI inflation of 1.2% over 2020.

If a negative base rate happens, it could lead to more equity market investments but only in areas where dividend yields can be relied on. This again leads me back to i) taking a macro view and hence an index tracking type equity investment.

Taking a long-term view and a global perspective

There is much to be said for market index tracking investments and investment trusts, especially in these changeable times. Given the decline in UK GDP over 2020 (-10.3%) according to KPMG and ongoing sterling volatility, the merits of a global tracker and international investments are relevant for UK investors.

One possible approach to tracker funds would employ a split of ‘macro’ exchange traded funds that would add global exposure via a mix of UK listed sterling denominated ETF (exchange traded fund) investment vehicles.

A portfolio could be segregated into ETFs that closely tracked the MSCI World Index alongside specialist investment funds that took a more regional approach.

The iShares MSCI World ETF (LSE: IWRD) is LSE listed iShares exchange traded fund that can form the basis of a proxy for a balanced ETF focused approach that aimed to capture a recovery in global GDP over 2021. The ETF has a published yield of 1.33% and distributes its dividends.

The iShares UK 100 (LSE:ISF) and iShares UK 250 (LSE:MIDD) are designed to track their respective indices providing investors with an return similar to that of the index less a tracking error (a difference that accounts for fees, trading costs, and portfolio administration). The iShares UK 100 ETF offers a yield of approximately 3.8% payable quarterly whilst the iShares UK 250 ETF offers 1.76% payable quarterly.

JP Morgan European Growth (LSE:JETG) is an investment trust run by JP Morgan fund managers. The investment trust is midcap in size and offers exposure to multinational EU and Swiss companies including Roche, Nestle, Novartis, Allianz. The dividend yield is c. 1.93%.

Fidelity China Special Situations (LSE:FCSS) is a UK listed investment trust run by Fidelity and focused on mainly blue chip Chinese IT companies. The trust objective is to gain exposure to China growth opportunities and has had a strong track record. The trust has grown its annual dividend to 4.25p in 2020 equating to 1.17%.

HSBC MSCI USA ETF (LSE:HMUS) is a UK listed exchange traded fund run by HSBC whose objective is to replicate as closely as possible the MSCI USA index. The fund has significant exposure (c.26% portfolio) to the largest 30 US companies and offers a yield of 1.6%

The Fundsmith Emerging Equities Trust (LSE:FEET) is a diversified fund run by Fundsmith specialists with blue chip equity holdings in many emerging markets including India, Indonesia, Mexico, Brazil, Vietnam, Turkey. The trust recently reduced its charges to 1.3% on an annual ongoing basis but the dividend yield is low at 0.27%.

This is a diversified equity portfolio offering an average dividend yield approximating 1.6% a significantly higher income return than gilt yields, however also bearing the risk of capital loss.

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Key to Material Interests:

Please be aware that the following disclosures of Material Interests are relevant to this research note:

Company NameRelevant disclosures: (2)

iShares UK 100 ETF                                                      Relevant disclosures:   <1,2>

iShares UK 250 ETF                                                      Relevant disclosures:   <2>

iShares MSCI World ETF                                             Relevant disclosures:  <2>

JP Morgan European Growth                                      Relevant disclosures:  <2>

Fidelity China Special Situations                                 Relevant disclosures:  <2>

HSBC MSCI USA ETF                                                 Relevant disclosures:  <N/A>                                                         

Fundsmith Emerging Equities                                     Relevant disclosures: <2>

  1. The analyst has a personal holding in the securities issued by the company or of derivatives linked to the price of the company’s securities.
  2. Collins Sarri Statham Investments Ltd has clients who hold either shares or CFD positions in this security.

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