Sterling has taken a hit since the vote to leave the EU, adding to nerves on markets, but UK investors need not suffer.
Sterling has been steadily losing value against the dollar since mid-2015, but on 24 June it saw a particularly abrupt dip. While part of that post-referendum drop simply reversed the gains of the few previous days, most of the descent was mining fresh three-decade lows.
Since the appointment of Theresa May as prime minister, the pound appears to have found a temporary level against the dollar – around 15% below where it began the year. It has lost some 12% of its value against the euro over the same period1.
There are some significant advantages in sterling’s fall for the UK economy. Aside from aiding exporters, encouraging inbound tourism, and softening the blow of any growth downturn, the pound’s fall also helps to insulate many stocks. In some cases, it has made them significantly more attractive.
In great part, this is because sterling-denominated stocks are popular with foreign investors. For an investor whose base currency is euros or dollars, sterling-denominated stocks are more than 10% cheaper than they were at the beginning of the year1, irrespective of whether the company’s business outlook has actually changed. Many companies choose to list in London due to its deep and well-regulated capital markets, even if their business is conducted elsewhere. The ‘trading effect’ of the currency change is what investors need to watch.
“For those companies whose operations are mainly overseas, this is the effect on the companies’ profits before they are translated back into sterling,” says Nick Purves of RWC Partners.
“For a consumer staple [company] such as Unilever, whose operations are mainly outside the UK, the trading effect is neutral as Brexit does not alter the amount of product that they sell,” says Purves. “For a cyclical [company], such as BP, the Brexit uncertainty may be bad for oil prices and it could therefore lead to lower dollar profits. The trading effect is therefore negative. For both of these sets of companies, however, the translation of overseas profits back into sterling at a more favourable rate is a positive.”
Little and large
It follows that the companies more vulnerable to a fall in sterling are those that focus their activities in the UK – often companies further down the FTSE 250, rather than those in the higher reaches of the FTSE 100, which are typically more international. Thus, while the FTSE 100 has been reaching new highs since the referendum, the FTSE 250 remains below where it opened 2016. Yet even the poorer performance of the FTSE 250 cannot be solely explained by the news of 24 June.
“The comparative performance of FTSE 100 and FTSE 250 stocks since the vote needs to be set in the context of the huge outperformance by smaller and mid-cap companies since the financial crisis – in other words, they had further to fall,” says Purves. “These companies are typically better geared towards a growth environment, whereas bigger companies provide scope for better protection when economies struggle. Valuations in FTSE 250 stocks are still very high in general terms.”
There is also a great deal of variety in how the Leave vote might affect different sectors or types of companies. The first and obvious defining difference is to what degree a company imports its goods (or parts for its goods) and to what degree it exports goods elsewhere – inevitably, a cheaper pound helps net exporters and that fact has already been partly reflected in share price movements since the vote. UK companies that rely heavily on investment as part of their business model, on the other hand, have fared less well since 24 June.2
“For UK-based cyclicals that often source from overseas, the trading and currency effect is negative,” says Purves. “For example, airlines are likely to see demand fall at the same time as costs like fuel rise in sterling terms – the choice is to take the hit on profits or to put up prices.”
Distance and diversity
Recent events underline the importance of constructing a well-diversified portfolio. Not only does it enable you to pick up on growth across more markets and asset classes, but it also limits the impact of any localised falls. Thus, for a UK investor with a diversified portfolio, recent losses may well be more than offset by the sterling effect of holding stocks in, say, euros and dollars.
If your base currency is sterling, then the mere fact of your dollar-based stocks maintaining their market value translates into a rise in value of more than 10% since the referendum. Attempting to jump in and out of currencies at a fast pace can prove expensive, and ultimately futile, but the simple fact of diversifying across different currencies and geographies means that local market events can only have a limited impact. In short, a slide in sterling need not spook UK investors.
The value of an investment with St. James's Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.
The opinions expressed are those of Nick Purves of RWC Partners and are subject to market or economic changes. This material is not a recommendation, or intended to be relied upon as a forecast, research or advice. The views are not necessarily shared by other investment managers or St. James's Place Wealth Management.
RWC Partners is a fund manager for St. James’s Place.
1Yahoo Finance, accessed 28 July 2016