x Abu Dhabi, UAESaturday 29 July 2017

Is it time to avoid investing in the UK?

With the economy appearing troubled, investors might consider steering clear of all things British, but opportunities still abound

All is not well with the UK right now. Brexit, political uncertainty, terror attacks and the Grenfell Tower fire have cast dark clouds over the country.

The economy is alsoi troubled. Manufacturing and industrial output are down, wages are stagnating, inflation is rising and GDP growth is slackening.

The once-booming UK housing market is also floundering, with prices in former  No 1 global hotspot prime central London falling over the past year. Who would invest in a country like that?

It is all too easy to be down on the UK at the moment, and many Britons certainly are. Brexit has divided the country and those who voted to remain in the EU, labelled “Remoaners” by their opponents, are leaping on any bad economic news, of which there is plenty right now, to show how much damage the referendum result has inflicted.

Although the instant economic meltdown predicted if Britons voted to leave the EU has not happened, it still could if the UK crashes out of Europe with no trade deal in March 2019.

The benchmark FTSE 100 index of top UK companies tumbled in the immediate aftermath of the referendum but rebounded just as quickly, as investors saw there was also a bright side to Brexit.

The 15 per cent plunge in the value of the pound against the US dollar, euro and other currencies made British exports cheaper and sent the FTSE 100 flying.

Russ Mould, investment director at online trading platform AJ Bell, says multinational companies listed on the index, notably oil majors and mining giants, generate three-quarters of their total earnings overseas. “These foreign revenues were suddenly worth far more once converted back into sterling, vastly improving company profits and driving share prices higher.”

Within a year the index had risen more than 23 per cent to pass 7,500 for the first time ever, although it has retreated in recent weeks.

Laith Khalaf, senior analyst at wealth managers Hargreaves Lansdown, says the FTSE 100 has another key attraction. “Companies listed on the index pay healthy dividends, typically far higher than you will get in the US.”

The FTSE 100 yielded a healthy 3.84 per cent in average in June, against 1.98 per cent on US index the S&P 500.

Some UK companies pay far higher income than that, for example, Royal Mail, HSBC, Marks & Spencer and telecommunications company BT Group yield comfortably above 5 per cent a year, Vodafone and British Gas owner Centrica yield around 6 per cent, and BP and Shell pay income closer to 7 per cent.

Mr Khalaf adds: “These levels of income are highly attractive in today's era of low interest rates, and growth investors can reinvest the money back into the stock to compound their returns.”

By investing in the UK market today, and leaving your money invested for the long term, you may also benefit from any recovery in the pound after today’s political shadows have retreated.

However, while the internationally-focused FTSE 100 has done well since Brexit, small and medium-sized firms with more exposure to the domestic UK economy are struggling. 

Yael Selfin, chief economist at accountancy giants KPMG, says companies earning 70 per cent or more of their revenues overseas are up a remarkable 28 per cent since the referendum, significantly outperforming the world's indexes, while those with 70 per cent or more exposure to the UK are down 5 per cent.

This could reverse if the UK adopts a “soft” as opposed to a “hard” Brexit, Ms Selfin says. “It would lessen the advantage of companies with a heavy element of foreign earnings and provide a boost to UK-focused firms.”

By investing in the UK you are gambling on the outcome of the negotiations, which is of course a massive unknown at the moment.

Sterling’s dive has given dollar-earning UAE expats another reason to consider investing in the UK, because they will pick up more stock at today's favourable exchange rates.

It may also tempt property investors, with the latest Knight Frank global currency report, published, this month, pointing out that property in prime central London was 11.6 per cent cheaper for dollar buyers at the end of March 2017 compared to one year earlier, purely to the pound's relative weakness. The euro had 5.6 per cent more buying power, the Australian dollar 11.7 per cent more, the Indian rupee an added 14.1 per cent, while the Russian rouble was up a mighty 28 per cent. 

Property prices in central London have also dipped, falling 6.4 per cent last year, which may further tempt overseas buyers, although Taimur Khan, senior analyst at Knight Frank, notes that higher taxes on second home buyers are partly responsible for waning demand. Brexit cannot be blamed for everything.

Mr Khan says the weaker pound may present a good opportunity for British expats. “Those who are looking to repatriate their capital could use these depreciations to enhance their returns.”

Weak sterling is not all good news. It has driven up the cost of foreign imports to the UK, pushing up inflation to 2.9 per cent, upping the pressure on consumers as earnings stagnate. Wages including bonuses rose just 1.8 per cent in the three months to May, which means ordinary Britons are getting poorer in real terms, although the employment rate is at a 42-year high.

Mark Nash, head of global bonds at Old Mutual Global Investors, says this is a particular problem for the UK as its economy remains overly dependent on consumer spending. “Wage rises are low, inflation is high, worker bargaining power is rising thanks to record low unemployment and the UK has a weakened government that can no longer say ‘no’ as anti-austerity sentiment sweeps through parliament,” says Mr Nash.

Mr Nash says opinion polls now suggest the majority of the British public favour the UK remaining in the EU, while chancellor Philip Hammond is warning that Brexit might mean higher taxes. “It seems as though Brexit is getting softer by the day. Dare I suggest it might not happen at all?”

Investors should still assume that Brexit is going to happen, given that both the Conservative and Labour parties continue to support it. Failing to implement the referendum result would also trigger a fierce political backlash from thwarted Brexiteers. 

So how should investors respond to all this uncertainty? Jason Hollands, managing director at wealth managers Tilney Bestinvest, says the old investment rules still apply: spread your risk, never limit your exposure to one particular sector or country, and look beyond short-term volatility to focus on the long-term. “You will still make money in the UK by investing in well-managed, financially robust companies with strong free cash flows that have globally diverse sources of earnings and can repeatedly generate inflation-beating returns for shareholders. UK mutual funds that target such companies include FundsSmith Equity, Lindsell Train Global Equity and Evenlode Income.”

Markets hate uncertainty, the old saying goes, and the UK looks astonishingly uncertain right now. So be aware of the threats, but don’t ignore the opportunities either.