Opportunities in UK assets

Wei Li
Wei Li, CFA
iShares EMEA Head of Investment Strategy

Keep it brief

  • UK assets have been unloved, under-owned and relatively cheap compared to other developed markets since the Brexit referendum in 2016.
  • Political uncertainty has receded following the decisive UK election outcome, translating into a better outlook for the UK economy in 2020.
  • Challenges may re-emerge, even amid relative stability, as the UK and EU negotiate a post-Brexit trade deal.

Capital at Risk: The value of investments and the income from them can fall as well as rise and are not guaranteed. You may not get back the amount originally invested.

The UK Conservative Party secured a decisive 80-seat majority in December’s parliamentary election, clearing the way for Prime Minister Boris Johnson to advance his legislative agenda and bring the UK out of the European Union on 31 January. While challenges remain – particularly in negotiations over the future UK-EU trade relationship, which must be concluded by the end of 2020 – domestic UK politics now appears more stable than at any point since the 2016 referendum. This relative stability should prove supportive for UK assets, particularly sterling and domestically-focused UK equities, in both the near and longer term.

Back in Vogue

UK assets have been unloved, undervalued and under-owned since 2016, with political and economic uncertainty triggered by the Brexit referendum turning investors away. This trend began to shift in late November 2019 as electoral polls – notably the closely-watched YouGov MRP model – pointed to a large Conservative majority in December’s general election, prompting global investors to double down on domestically-focused UK mid caps (see chart below).

Cumulative global flows (USD) into UK mid cap exchange-traded products (ETPs), Oct-Dec 2019

Cumulative global flows

All figures in USD.
Source: BlackRock and Markit, as at 31 December 2019. Past flows into globally-listed ETPs are not a guide to current or future flows and should not be the sole factor of consideration when selecting a product.

New year, new opportunities

Any opinions and/or forecasts represent an assessment of the market environment at a specific time and are not intended to be a forecast of future events or a guarantee of future results. There is no guarantee that any forecasts made will come to pass.

We expect allocations to UK equities to rise in 2020, as the perceived clarity and stability presented by a strong majority government continues to draw investors back to the UK. Global growth is also likely to rebound this year, although we do not anticipate a return to pre-referendum growth levels in the UK. Relative stability also means the Bank of England is likely to hold rates steady in 2020, although a cut is not off the cards.

Sterling received a considerable lift in the run up to the election and its immediate aftermath, and it remains the most reactive asset to Brexit headlines – a feature that has made the currency more volatile than a basket of emerging market (EM) currencies (see chart below). As post-Brexit trade negotiations develop, we expect sterling to remain volatile and advocate a currency-hedged approach for UK-domiciled investors accessing international exposures.

30-day volatility of GBP/USD vs. a basket of EM currencies

30 day volatility

Source: BlackRock and Bloomberg, as at 31 December 2019.

UK equities

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. You may not get back the amount originally invested.

We prefer UK mid and small cap equities, and dividend payers, for their domestic focus over internationally-focused large caps. Domestic exposures are well-positioned to benefit from a pick-up in the UK economy and have a positive correlation with sterling. On the other hand, UK large caps garner the majority of their revenue from outside the UK, and could be used as a tool to diversify internationally given their negative correlation to sterling.

UK fixed income

We prefer UK risk assets, as we see some upward pressure on gilt yields due to shifts in expectations on monetary and fiscal policy, amid an improved growth outlook. However, short-duration gilts and UK corporates could offer some ballast against anticipated market volatility during the post-Brexit transition period due to their low correlation to UK equities. A pickup in UK fiscal stimulus would stand in contrast to global trends, as the outlook for fiscal spending appears limited in the US and eurozone. Index-linked gilts are well-positioned in the event of a pickup in inflation as business investment recovers.

UK alternative strategies

UK real estate has been yet another unloved sector since the Brexit referendum, and offers a ‘bricks and mortar’ defensive option with limited correlation to traditional assets.

& Exchange-traded fund

& Index mutual fund

& Active fund

See for full UK product range.

& Exchange-traded fund

& Index mutual fund

& Active fund

See for full UK product range.