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Article 50: How Mark Whitehead of Securities Trust of Scotland is positioning his portfolio

hard Brexit
  • Securities Trust of Scotland’s exposure to UK equities remains unchanged
  • However, it’s naïve to expect a business-as-usual scenario, and periods of volatility are expected as markets assess the impact of Article 50 on individual businesses
  • Mark will continue to focus on companies that can generate sustainable growth and returns on capital, and will be looking to exploit any valuation anomalies

Mark Whitehead, Portfolio Manager, Securities Trust of Scotland, commented:

“The triggering of Article 50 today formally signals the UK’s intention to seek a divorce from the EU and allows exit negotiations to begin in earnest. As global income investors based in the UK, we are keeping a close eye on what this means for British companies and the risks and opportunities that may arise from ‘Brexit’.”

What do we know so far?

“Sterling has predictably been a key barometer since the referendum, with its weakness starting to feed through to inflation and lifting concerns about the impact on real wages. Retail sales have held up relatively well, but we cannot really extrapolate from such a short period.

Source: Bloomberg, 12 months to 28 March 2017.

“In the stock market, sectors such as consumer discretionary, real estate (house builders) and utilities have been particularly sensitive, and are likely to remain so. The first two are particularly vulnerable to any further squeeze to real incomes, while utilities’ margins have been hurt by the rising sterling bill of energy imports. Fears of a mass-exodus of company HQs may be overblown, but equally it is naïve to expect a business-as-usual scenario. Recent warnings from EU top brass that UK-based airlines will have to relocate their HQs if they want to maintain their routes within continental Europe is a case in point.

“On the other side, exporters have seen a boost thanks to the weaker sterling, but this could prove fleeting if the negotiations result in a more acrimonious separation (including a return of tariffs) – ironically, the scenario that the currency market appears to be discounting.”

What can we expect?

“The probability of a ‘hard’ outcome – leaving the European single market and customs union – appears to have risen, with the rhetoric suggesting that politicians may be preparing the public for such a scenario.

“The exact monetary cost of the separation to the UK government is also unclear – even if numbers have been bandied about in the news – and there is a risk that this point will consume a lot of the energy early on, at the expense of the critical and more complex discussions such as a possible trade pact.

“In terms of the policy agenda, there is little doubt that Brexit negotiations will divert attention from domestic issues over the two-year negotiation period. This includes Prime Minister Theresa May’s ambitious industrial strategy, one of the central pillars of which is ramped-up infrastructure investment in areas such as transport, broadband and energy.”

How we are positioning our portfolio?

“Given the many unknowns, it is difficult (and unwise) to try to predict who the ultimate beneficiaries will be. We had pretty small direct exposure to UK stocks pre-referendum and this has not changed in any material way. In many ways it is more important to know what to steer clear of, than to try to isolate potential winners. For us this means more intense stress-testing at a company level to ensure that cash flows – and therefore the ability to pay dividends – won’t ebb if the economy takes a harder knock.

“In terms of the portfolio, home-improvement company Kingfisher is susceptible to a deterioration in conditions for UK consumers, but the impact will be cushioned by its diversified portfolio (which spans Europe and Asia) of businesses. Other holdings such as soft drinks name Britvic could naturally be impacted too, but we believe that the fundamentals (and valuation) here continue to support the investment case.

“In short, Article 50 marks the beginning of what is likely to be an eventful bargaining process and we expect to see recurring periods of volatility as markets assess the impact on individual businesses. As bottom-up stock pickers we focus on identifying high-quality companies that can generate sustainable growth and returns on capital, and will be looking to exploit valuation anomalies that may arise throughout this process.”