City analysts are pondering a once-unthinkable scenario: what if it all goes right for Boris Johnson? David Stevenson picks the funds he thinks will perform the best.
What if we get a Brexit deal – and Boris Johnson also wins the ensuing (or preceding) general election? There are many hurdles still to clear (see page 8). But among the dozens of institutional investors I’ve seen in the last few weeks, I’d estimate that the odds of the “triple-B” scenario – the “Boris Brexit bounce” – have risen from well below 25% to between 25% and 50%. So it’s far from certain – but not beyond the realms of possibility. And if it does happen, the argument goes, then after years of negative sentiment towards UK equities, investors have to be prepared for a rebound.
Preparing for “the triple-B”
What would drive this rally? The obvious catalyst will be that businesses (and investors) who have delayed decision making amid political uncertainty will finally jump off the fence – particularly if an election is won by the Conservatives, removing Labour leader Jeremy Corbyn as a source of concern. At that point, the UK equity market could be a major beneficiary.
The reality is that foreign direct investment into the UK hasn’t been hit that badly in many sectors, especially as sterling has weakened, making UK assets cheap. Foreign investment in property, for instance, has been pronounced as has private-equity merger and acquisition activity. However, liquid public markets – such as our stockmarkets – have been hit much harder, precisely because stocks are so easy to buy and sell. As a result, UK equities have been ignored in favour of US stocks in particular. But if sentiment turns sharply, that liquidity could turn from a hindrance to a help – it’s easy to buy into UK equities, so they would likely be among the first assets to gain.
So, if you want to bet on the “BBB”, what’s the best option in terms of funds? First, focus on the more domestically orientated areas – mid-caps (the FTSE 250) and small caps (the FTSE small cap and Aim). These indices are much more UK-centric than the FTSE 100 (although even the FTSE 250 has plenty of fast-growing international stocks). You might also focus on “value” (cheaper stocks in unloved sectors), where the impact of an economic slump is felt most.
In terms of fund structure, there are some FTSE 250 index trackers, but they aren’t huge, and access to UK small caps via index trackers is next to non-existent. So investment trusts are a much better bet.
The top Brexit-bounce trusts
So which funds might do best? Well, in early October we saw a strong Brexit bounce as investors started to hope for an end to the first phase of Brexit. This bounce showed up most strongly in specific funds. Investment trust analyst Simon Elliott and his team at Winterflood ran the numbers on the trusts that did best in this dry run for a BBB scenario. The FTSE 250 bounced by just under 5%, but a handful of funds strongly outperformed – Mercantile (LSE: MRC), Fidelity Special Values (LSE: FSV), Schroder UK Mid Cap (LSE: SCP), JP Morgan Mid Cap (LSE: JMF) and Temple Bar (LSE: TMPL). That’s not a bad shortlist of trusts likely to do well in a BBB scenario.
Alan Brierley at Canaccord Genuity echoes this observation – he likes Mercantile (trading at a 5.4% discount), as well as Aberforth Smaller Companies (LSE: ASL), which “is currently the cheapest it’s been for several years – at the current price and discount you’re almost getting a double discount”. The fund trades at a 10% discount, while many of the stocks in the portfolio also trade on record-low valuations. Brierley also commends BlackRock Smaller Companies (LSE: BRSC) for investors after more growth-orientated smaller businesses.
Elliott, meanwhile, also highlights funds, including Aurora (LSE: ARR) (full disclosure – I am a non-executive director on this trust), Aberdeen Standard UK Equity Income (LSE: ASEI), and Lowland (LSE: LWI).