Not only is political instability likely to drive volatility in markets, there are also worrying signs of a growing appetite for government interference in the actions of nominally independent central banks, just as the unconventional monetary policy experiments extend further into the unknown. Uncertainty around how the UK actually leaves the EU and on what terms, will remain for the foreseeable future, but is likely to fade into more of a background process. There is no doubt that these are unnerving times and we are now in for a prolonged period of political and economic uncertainty, with periods of market volatility likely.
It is time for investors to keep a cool head, focus on the long term and retain a bias towards funds that concentrate on liquid, high-quality companies with strong and visible cash flow generation and international earnings. While some sectors such as financials and property are going to be impacted by ongoing uncertainty as the UK’s future relationship with the EU is fleshed out, more than 70 per cent of FTSE 100 earnings are made outside the UK, providing some cushion to any near-term weakness in UK growth.
With the FTSE 100 yielding 4.2 per cent at a time when 10-year gilt yields have fallen below 1 per cent as expectations of further monetary stimulus have gathered pace, this yield gap should also underpin UK large-cap equities. These companies typically earn the majority of their revenues outside the UK, so the weakness in the pound should be supportive to them as they translate dollar earnings into sterling profits and dividends.
We therefore think it is sensible to focus more on this end of the market, through well-managed funds focused on large, liquid, high-quality stocks such as Evenlode Income and JO Hambro UK Opportunities. There will of course be selective opportunities in mid-sized and smaller companies that have been indiscriminately sold off, but we remain cautious on domestic cyclicals. A fund that provides exposure to large, mid-sized and smaller growth companies with resilient business models is Liontrust Special Situations, which has historically performed well in down markets.
Of course, there is more to investing than just equities, and for those looking to add a bit more caution, or who simply want to avoid investing in particularly volatile equity markets, there are now a number of absolute return funds that have come of age. Both Invesco Perpetual Global Targeted Returns and JPM Global Macro Opportunities funds have proven themselves more than capable of providing cost-effective returns with low correlation to equity markets.
