British stocks are due a bounce

Uncertainty over Brexit has prompted consumers and companies to put off investing in British stocks. Once clarity returns, cheap stocks should rebound, says David Stevenson.

I’ve long believed that Brexit has resulted in two major dislocations. The first is that many UK domestic businesses have postponed decisions until there is more clarity. The second is that sterling has been oversold and is now cheap.

Once clarity returns, then, there is a decent chance that British businesses will rebound and consumers will also find themselves in a slightly cheerier place. Many businesses are looking for a chance to take part in the global economic upswing, but they are currently sitting on cash waiting for the fog to lift. It’s a similar story for institutional investors eyeing up UK assets, which, as MoneyWeek has repeatedly pointed out, are now looking cheap.

Exactly how the turmoil of the next few days will end and the fog lift is anybody’s guess; my money is on either an extension (by more than a few months), or, by some miracle, the government’s proposal passing. But the bottom line is that there is a decent chance of a UK Brexit rebound at some point this year – assuming, of course, that said rebound isn’t knee-capped by the emergence of John McDonnell as chancellor.

How to ride the rebound

One way to play the bounce is via UK-listed, sterling- denominated exchange-traded funds (ETFs). In the table below I’ve listed either the biggest by assets under management, or the cheapest (based on the total expense ratio, TER).

Choose your index carefully. The FTSE 100 is, as we all know, a globally diversified index of international blue-chips where most of the earnings are denominated in a foreign currency. So every slump in the sterling-dollar rate (“cable”) ends up giving these firms a boost in foreign profits. A rebound in sterling might therefore actually be bad news for some constituents of the blue-chip index.

This has a knock-on effect on another index, the FTSE All-Share, which, to a large extent, tracks the FTSE 100 index. Because the All-Share index comprises not only the FTSE 100, but also the FTSE 350 and SmallCap indices, in good years it tends to have a bit more upside (those small-and mid-cap stocks increase sharply) than the FTSE 100; in bearish years it tends to fall slightly harder (as riskier small and mid caps slip further than blue chips). But the difference isn’t great.

By contrast, the FTSE 250 mid-cap and FTSE SmallCap Index are deemed more reflective of the UK domestic economy, although the foreign exposure of FTSE 250 stocks has risen in recent years. It is certainly true, however, that the UK small-cap sector is vastly more reflective of the UK domestic economy and might experience a sharp rebound if the Brexit gloom begins to clear. The challenge is that there is no FTSE small-cap ETF. Investors would need to invest in the MSCI UK Small Cap index and the accompanying iShares ETF. This ETF is expensive with a TER of 0.58%, but I think this could be an excellent bet if we have a big Brexit rebound.

Nevertheless, if you are looking for the broadest possible exposure to all UK stocks (small and large cap), the All-Share index is arguably a better bet in a Brexit rebound than the FTSE 100. The challenge is that the few All-Share trackers out there are appreciably more expensive than their FTSE 100 counterparts.

I would also consider a Lyxor UK fund that tracks a FTSE All-Share clone from research firm Morningstar – this looks and feels a lot like the All-Share index, but the accompanying Lyxor ETF charges a cracking 0.04% per annum in fees. I think this is a fantastic deal and performance from the last year has been pretty impressive to boot. Back in the FTSE 250 mid-cap world, I’d highlight the Vanguard fund, which dominates this niche with a TER of just 0.1%.

The choice for income seekers

When it comes to investing for income, there are two options: the FTSE UK Dividend Plus index and the S&P Dow Jones Dividend Aristocrats index. I am no fan of the former. It has a simplistic focus on high yields only, and has underperformed for years. By contrast, the Dividend Aristocrats index is thoughtfully constructed and robust, and has produced some excellent returns.

I don’t really like firms with an aggressive focus on dividends, especially when they ignore growth in favour of payouts. But the stocks in this ETF give investors proper UK exposure with top holdings such as M&S, Greene King, BT, SSE and Tate &Lyle. This UK-focused ETF also includes the odd smattering of global players such as GSK and Imperial Brands – and it is not expensive.

Index Fund Ticker Assets under management
Total expense ratio (%) One-year return (%)
FTSE 100 iShares Core ISF 7,397 0.07 9.67
FTSE 100 Vanguard VUKE 3,087 0.09 9.64
FTSE 250 Vanguard VMID 1,385 0.10 2.74
FTSE All-Share SPDR UK All Share FTAL 557 0.20 8.19
FTSE UK Dividend Plus iShares UK dividend IUKD 763 0.40 0.64
MSCI UK iShares CSUK 134 0.33 9.24
MSCI UK Small Cap iShares MSCI Small Cap CUKS 174 0.58 1.77
Morningstar UK Lyxor Core Morningstar LCUK 24 0.04 9.25
S&P Dividend Aristocrats SPDR UK Dividend Aristocrats UKDV 99 0.30 8.56