The British surprised financial markets on that infamous 23 June 2016 with their choice to leave the European Union. Since then, uncertainty for the UK has increased considerably, with problems and controversies accumulating on both the political and economic fronts.
Lingering negotiations on the terms of Brexit eventually led to an exit on 31 January 2020, but despite the conclusion of a trade deal with the EU, the UK economy is reaping the bitter fruits of the departure decision. The hastily created car parks for waiting trucks at customs posts are symbolic of the practical problems associated with Brexit. Meanwhile, international trade suffers from a growing paperwork burden and it takes more and more effort for industries dependent on foreign seasonal workers to attract them.
These are just a few examples of the consequences of Brexit causing substantial damage to the economy. For instance, fruit growers are seeing their crops rot due to staff shortages, while McDonald’s was forced to take milkshakes off its menu last year due to a shortage of truck drivers.
Long-term impact of Brexit
According to the Office for Budget Responsibility, the long-term impact of Brexit could outweigh the negative effects of the corona pandemic. Brexit is also a primary reason why the UK missed much of the recovery in global trade after the corona pandemic, according to the institute, and also the main reason for lagging economic growth compared to other G7 countries. The economic malaise is causing growing discontent among the population, making the kingdom clearly less united now than in the past.
The UK also lacked stable and competent leadership to refloat the economy. Since Prime Minister David Cameron’s departure in 2016, the positions of his successors Theresa May, Boris Johnson and Liz Truss proved untenable for various reasons. The latter spent just 44 days in office after her controversial ‘mini-budget’ - the biggest tax cut in 50 years that would be funded mainly by debt - had a mega impact on sterling’s exchange rate, hit UK government bonds midstream, saddled pension funds with hefty losses and confronted homeowners with variable mortgage rates - some 20 per cent of outstanding mortgages - with sharply higher monthly fees. Financial markets lost confidence and panicked, after which the IMF was also critical of the plans and the impact on inflation, prompting the Bank of England to intervene by buying up bonds.
The sacrifice of finance minister Kwasi Kwarteng ultimately proved insufficient to restore order, making Truss’ premiership the shortest and at the same time one of the most high-profile in British history. Led by Kwarteng’s successor Jeremy Hunt, almost all of Truss’ plans were undone, and Rishi Sunak was appointed the new prime minister on 25 October.
Lower returns than Europe
The difficulties facing the UK translate into lower returns for the MSCI United Kingdom index versus the MSCI Europe Ex UK index. Over the period following Brexit referendum up to the end of October 2022, the gauge comprising UK companies has realised a total return of 29.6 per cent measured in euro, compared to 46.8 per cent for the European index excluding the UK. It should be noted, however, that this does not give a complete picture, as the UK index includes many multinationals that rely little on the local market for their sales. After all, how British are Unilever, Shell and Rio Tinto?
Despite political chaos and economic weakness, the UK index performs extremely well in 2022. It is a result of the composition of the index, in which many commodity-related companies such as Shell, BP, Glencore and Anglo American are dominant, all of which benefited from the impact of the war in Ukraine. The same goes for defence multinational BAE Systems, while tobacco manufacturers Imperial Brands and British American Tobacco also had a strong year. That puts the MSCI United Kingdom just 0.76 per cent in the red, while the MSCI Europe Ex UK index is down more than 15 per cent.
Record outflow
Fund investors also seem to have little faith in UK companies. There has been a net outflow from funds investing in UK equities over the past three years, with the €21 billion of outflows over the first three quarters of 2022 already setting a record. UK dividend stocks are being relatively spared by investors, but small-cap stocks, often more focused on the local economy, are being sold off in particular.
The Top 5 best-performing mutual funds in the Morningstar UK large-cap equity category, measured over performance in the current year to the end of October, is led by Invesco UK Equity, which managed to keep its loss limited to 22 basis points. Manager Martin Walker, who has been at the helm since October 2018, takes a valuation-driven bottom-up approach leading to a top-heavy portfolio of around 40 positions. The energy sector accounts for 17 per cent of the portfolio as of the end of September, with BP and Shell both having a 7.8 per cent weighting. Financials are another pillar of the fund, with a 16.3 per cent weighting. Here, Hiscox and Prudential are named among the 10 largest positions in the portfolio. For sustainability reasons, the fund excludes tobacco companies, which did not work out well in 2022.
Jeffrey Schumacher is director manager research at Morningstar. Morningstar analyses and evaluates investment funds based on quantitative and qualitative research. Morningstar is one of Investment Officer’s knowledge partners and ranks five mutual funds or providers every week.