Market Views: Is now a good time to invest in UK assets?
The long-running soap opera that is Brexit appears to be reaching some sort of climax and the probability of a messy and damaging divorce between UK and the European Union remains high – so much so, that the pound is trading near historic lows.
The uncertainty is also taking its toll on the UK economy, with weak services sector data on Thursday adding to the growing impression that the country might now be in recession.
Still, it's often said that it is darkest before the dawn, so is now an ideal time for foreign investors to take advantage of their improved purchasing power to snap up UK assets on the cheap?
Some asset owners are optimistic, including Malaysia’s Employees Provident Fund. Others less so, given the scope for heightened price volatility and the reduced projected growth trajectory of the British economy.
Outward appearances can also be misleading as there is still much to play for politically in the UK and the EU, which means the Brexit saga could yet drag on rather than end soon.
UK Prime Minister Boris Johnson has said he is adamant that the UK will leave on October 31, with or without a deal. In a speech to his ruling party's annual conference on Wednesday, he said that even though the government is not seeking a no-deal outcome “it is an outcome for which we are ready.”
But he also knows that he is obliged by law to ask the EU for another extension to January 31 if no deal is agreed by the end of this month because the British parliament has passed a bill – one he provocatively dubs the "Surrender Act" – stipulating such an action.
Undermining the rule of law by refusing to make that request would set a very dangerous precedent and is something even Johnson is unlikely to attempt as it could land him in jail. So he is scrambling around for alternative ways to break the impasse and improve his hand.
However, in each case he is reliant on the goodwill of others – whether that's agreeing to a new deal with the EU and getting it passed by a parliament or persuading an individual EU member to veto an extension were he to request it.
His plans to call a general election have also been thwarted by the opposition, who are refusing to play ball unless he first takes 'no deal' off the table. And there's still a slight possibility that he could yet be ousted via a non-confidence vote and replaced by a 'government of national unity' if only the opposition parties can agree on someone to lead it.
It's both a compelling and tedious political drama that continues to bubble away. So should Asian investors be out there bargain-hunting for UK assets? Or would they be better off shunning the place, or at least exercising extra caution when looking at it?
We asked several investment experts for their views.
The following extracts have been edited for brevity and clarity.
Mark Tinker, founder
With the prospect of the UK actually leaving at the end of this month or perhaps by the end of January next year, it is now coming into an investable time horizon. Sterling does not seem to be breaking below the immediate 'Leave' shock level of $1.20 and, interestingly, the UK housing market is showing some signs of life suggesting some European investors are coming back.
First, we need to understand that ‘leaving without a deal’ does not mean there will never be a trade deal with the EU. The UK government has [also] made it clear that for a 12-month period, 87% of UK imports would have no tariff applied … There will undoubtedly be some bumps along the way, but trade happens without trade deals regardless.
Until we know more granular levels of detail on policies it is difficult to pick out winners and losers. But a good starting point would be to look for those still shouting loudest as identifying they have something to lose, while others have spent the last three years adjusting. This applies to European as well as UK companies, of course.
Meanwhile, a basket of high-quality dividend-paying UK corporates can be bought for an average yield well in excess of 5%, which is literally 10 times the return being offered by 10-year UK gilts. That looks a good place to start.
Dwyfor Evans, head of APAC macro strategy
State Street Global Markets
Sterling is cheap across many metrics but could be a classic ‘value trap’ pending clarity over Brexit. The vulnerability to UK assets from a still-uncertain outcome over Brexit, and its implications, makes it difficult to pursue a strategy and investors remain largely on the sidelines.
As for preferred asset markets, equities look attractive due to yields and we would recommend a preference for equities over UK government bonds or gilts.
The proposed Brexit outcome sits firmly with the UK at this juncture, with signs of a continued pushback from the EU. This does not bode well for a deal by October 31 and limited negotiation time before the October 17 meeting. The likely delay of Brexit also helps our underweight gilts view, reducing as it does the safe-haven premium assigned when the probability of a 'no deal' crash-out of the EU was rising.
Quentin Fitzsimmons, fixed income portfolio manager
T. Rowe Price
We can see implied volatility has picked up in sterling covering the immediate Brexit deadline and further out to cover the risk of an extension. The implied volatility makes sense because a weak government is committing itself to leave the EU on October 31, “come what may,” in Boris Johnson’s words.
The investment case therefore rests on timing. The opportunity to invest may well be outstanding in the next few months, but for now, volatility is gaining the upper hand. While there are lots of unknows, we do know that sterling is objectively cheap (our fair value model suggests the upside could be as high as $1.45 compared with under $1.23 currently).
We also know that the UK stock market has underperformed and that gilts are expecting the Bank of England to cut interest rates.
Three potential outcomes are realistically possible: the UK leaves without a deal on October 31, there is a further extension to Article 50, or Parliament approves a modified version of the Withdrawal Agreement.
The looming prospect of Brexit, and growing sense that the Bank of England will cut interest rates by the end of 2019 have sent investors piling into safe-haven assets, leading to an extended rally in UK sovereign bonds. The rally is likely to continue ... ahead of the deadline.
Richard Buxton, head of UK equities
Merian Global Investors
UK equities are clearly cheaper than other markets and the currency is cheap. Even on a hard Brexit [scenario], my sense is that any further fall in the pound would be relatively limited as it is not going to be the shock that the referendum outcome was to markets.
We note with interest that Li Ka Shing bought UK pub chain Greene King recently ahead of Brexit clarity, suggesting he views UK assets and sterling as attractive.
Despite the unhelpful political backdrop, there are still reasons to be optimistic about the UK. The labour market is strong, wages are rising and there is a solid entrepreneurial dynamic in the country. Corporate earnings for the most part have held up and there are plenty of companies with excellent prospects and attractive valuations. All political parties are promising to boost government spending after an election, irrespective of the Brexit outcome.
In my view, it is impossible to be precise about Brexit yet – either on timing or deal/no deal. But I do believe that the UK is undervalued and, if the Brexit handbrake is removed, the economy and UK equity market could surprise to the upside.
I am a long-term investor and believe that eventually the investment fundamentals will win out; however, in the short term, I may look to exploit the opportunity by topping up holdings in businesses that look too cheap.
James Illsley, portfolio manager, International Equities Group
J.P. Morgan Asset Management
Despite Brexit we are positive on UK equities. Firstly, current valuations are extremely attractive. If we were to compare the dividend yield that investors receive from UK equities versus the yield they are paid to hold UK gilts, the difference has not been wider since the First World War! That means investors are being much better compensated for holding UK equities than they are for UK bonds.
Another measure is comparing the UK equity market with other developed markets. The UK is currently trading at over a 30% discount to other equity markets around the world, further underscoring the value that’s been created by the Brexit uncertainty.
Interestingly, the investment opportunities are not in just a few select sectors. Sectors ranging from retail to media to utilities are looking attractively priced. Whilst institutional investors are typically underweight to UK equities, corporate buyers are seizing this once in a generation opportunity. M&A activity is strong and the UK is by far the most active M&A market in Europe since the UK referendum.
Whilst Brexit does cause uncertainty, we believe it is actually providing an opportunity to get access to high quality companies which are operating internationally.