1. would this change in the event of Britain leaving
the EU?
FTSE 100 vs small and mid-caps
A good indicator of what could happen might be
to look at UK stocks. Large-cap FTSE 100 names
have been relatively unscathed, simply because
of the global nature of the UK’s biggest businesses.
Although the companies most exposed to the
UK consumer and the domestic economy have
struggled, it is not necessarily because of
Brexit fears.
Edward Smith, asset allocation strategist at
Rathbones, explains:‘If you take the 25 stocks
within the FTSE 100 most exposed to UK revenue
streams, it does look as though they have
underperformed since the start of the year, but
actually half of that underperformance is due to the
fact there are no miners or oil and gas stocks, and
they have had a huge rally this year. So it is not so
much the market penalising UK large caps geared
in to Brexit risk, it is really the fact one global sector
is having a big rally.’
Although small and mid-caps,which are more
exposed to the domestic economy,have been more
affected than large caps,they could offer opportunities,
as a lot of risk has already been priced in.
Uncertainty around the outcome of the EU
referendum has been building since the start of
the year, and there is a clear correlation between
economic uncertainty and the equity risk premium
on small and medium-sized stocks, leading to
lower valuations.
‘Over the past couple of months, there has been a
substantial valuation discount already priced in to
mid and small caps,’ says Smith.‘If you take the P/E
multiple of the FTSE 250 as a ratio relative to FTSE
100, that ratio is the lowest it has been for six years
and is falling precipitously.
‘That suggests there is already a substantial
valuation cushion, and possibly Brexit is being
overpriced relative to the risk, which could present
an opportunity if we vote to stay.’
Domestic vs overseas earners
The performance of sterling could present a risk or
an opportunity to UK investors, depending on what
kind of businesses they hold.
Invesco Perpetual’s head of UK equities Mark
Barnett suggests a weak sterling would benefit a
number of the stocks he holds in his Income and
High Income funds.
WHAT TO EXPECT FROM
THE UK EQUITY MARKET
AS BREXIT VOTE LOOMS
AS THE REFERENDUM ON BRITAIN’S EU
MEMBERSHIP APPROACHES,WE LOOK
ATWHERE UK EQUITY INVESTORS ARE
SEEING THE GREATEST OPPORTUNITIES
AND RISKS
BY HANNAH SMITH
The day is fast approaching on which British voters
will have to decide whether to break away from the
EU.With everybody from Boris Johnson to Keira
Knightley expressing their opinion on Brexit, the
polls show a lot of voters remain undecided.
A poll of polls, run by NatCen Social Research,
averaging the results of six recent polls up to 31
May, revealed 51% of UK voters are in the Remain
camp and 49% want to leave the EU. But, as we
know from previous experience, polls can often
be misleading.
Royal London Asset Management recently
conducted its own poll of 89 wealth managers,
institutional clients and financial advisers, and just
11% said they expect to see the Leave Campaign
triumph on 23 June.
But what do UK equity fund managers expect to
happen, and how are they positioning their
portfolios for this? Where are the risks and
opportunities in the UK market now and how Continued on page 32
UK EQUITIES
SPECIAL FEATURE
www.citywire.co.uk/wm 31

2. A LOT OF
DOMESTICALLY
EXPOSED CONSUMER
STOCKS LOOK CHEAP
NOW AND HAVE
UNDERPERFORMED
SOME OF THE MORE
INTERNATIONAL
STOCKS
MARK BOUCHER
SMITH & WILLIAMSON
remaining at historic lows. However, it would be
under much greater pressure in the event of a vote
to leave.
Hargreaves Lansdown co-founder Peter
Hargreaves recently surprised the City by coming
out in support of Brexit, saying the uncertainty that
would come from leaving the EU could give the
British economy a boost.
But Rathbones’ Smith says the complications that
would arise in terms of EU regulation for financial
firms would be a huge blow.
‘Financial services stocks in the UK would
certainly come under threat, due to the direction of
travel of European regulation, which is making it
harder to do business in Europe from outside its
jurisdiction,’ he says.
‘If we lose our passporting via Ucits and MiFID,
then that could prove something of a regulatory
headache.The sentiment that will be applied to the
sector will mean any financial company will be
affected somewhat.’
As an aside, Smith notes Brexit would also create
problems for Swiss financial firms, many of whom
do business in Europe using a regulatory passport,
granted by their London subsidiaries.
So, if we voted to leave, Swiss financial services
could also wake up with something of a headache
the next morning, he adds.
Threat to GDP
Brexit would pose a potential threat to every
business in the UK simply because of the impact it
would have on GDP growth.
As Smith points out,the uncertainty alone is
enough to delay corporate spending and investment.
Rathbones predicts the UK economy would‘almost
certainly’lose 0.5% to 1% of annual GDP growth in
the first two years after an exit from the EU.
‘Whether you think Brexit over the long run is a
good or a bad thing for the UK economy, in the first
couple of years it is very difficult to envision a
scenario where GDP won’t fall,’ says Smith.
‘Investors may want to consider tilting their
exposure to sectors that have a low correlation to
UK GDP growth, such as chemicals and oil and gas,
and away from those with a high correlation, such
as construction firms, housebuilders, some
domestically focused banks and insurers,
household product companies.’
Rathbones’ fund managers are continuing to
focus on overseas earners, as they have done for
the past 18 months, with particular emphasis on
firms deriving a large part of their revenues from
the US.
No escape from volatility
For now, many investors are holding their breath
and awaiting the result of the vote before making
any big moves.
‘Volumes in the market are low, which is a sign
people are sitting on their hands and not wanting
to do too much because of the uncertainty,’
explains Boucher.
‘Our portfolio is set up in a way that we believe
there will be a Remain vote. In the next few weeks,
there could be volatility, depending on news events
in the run-up to the voting day. It is a matter of
holding our nerve and seeing which way the vote
goes in the end.’
Smith adds:‘If there’s one thing certain about
Brexit, it’s that it will generate uncertainty, and mid
and small caps will suffer somewhat.’
Whatever the country decides, volatility in the
markets seems unavoidable, so UK equity investors
will simply have to grit their teeth. l
‘The weakness of sterling should have a positive
impact on the profits of the companies in the
portfolios I manage, which have overseas earnings,’
he says.
‘[Our] holdings in the tobacco, oil and
pharmaceutical sectors are all likely beneficiaries,
in my view. For example, British American Tobacco
recently noted that sterling weakness was
beneficial to the translation of its overseas
earnings.’
On the flip side, Barnett says firms such as
budget airline EasyJet would find life much harder
if Britain voted with its feet.
‘Businesses such as EasyJet would not be best
served by the UK leaving the EU, but they will be
evaluating and developing strategies to take this
into account,’ he adds.
Invesco Perpetual’s team has also flagged
Booker,Thomas Cook and Tesco as stocks which
could struggle to weather a Brexit.
Meanwhile, Barnett says companies exposed to
the central London property market, including
Derwent London, have already seen some share
price pressure.
Smith & Williamson’s head of UK equities Mark
Boucher echoes this view. Boucher runs the Smith &
Williamson UK Equity Growth fund and co-manages
the group’s Enterprise fund.
‘The list of stocks most affected by this are
housebuilders, retailers, travel and leisure stocks –
as you would expect,’ he adds.
He notes London-focused property stocks,
including housebuilders, have risen too much and
are now likely to underperform as their costs rise.
Boucher bought a number of property stocks
when prices fell on the Monday after Boris
Johnson announced he was backing the Leave
Campaign, but has since been selling them,
following a bounce.
‘A lot of domestically exposed consumer stocks
look cheap now and have certainly
underperformed some of the more international
stocks. A lot of people are waiting to see which way
the vote goes before they start buying these types
of stocks again,’ Boucher adds.
He points to broadcaster ITV, which began the
year at around £2.80 a share, but has since lost
significant ground to trade around the £2 mark.
Another example is electronics retailer Dixons,
which has moved from £5 to around £4 year-to-date,
showing consumer stocks have fallen in absolute
terms as well as in relative terms.
Financial services
The financial sector has also been struggling,
although this is partly a result of interest rates
Continued from page 31
Citywire Wealth Manager • 9 June 2016
SPECIAL FEATURE
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UK EQUITIES