Money managers are easing U.K. allocations

Executives at global money managers and pension funds are adjusting their exposure to U.K. assets and to sterling, as election fever and the uncertainty it brings begin to take hold.

On May 7, U.K. voters will decide — at least to some extent — which political party or parties will run the country for the next five years.

While every election carries an element of uncertainty, this time that uncertainty is more pronounced, with seven parties vying for power. As Pensions & Investments went to press, the Labour Party had edged ahead of U.K. Prime Minister David Cameron and his Conservative Party.

However, money managers and pension fund officials said the outcome of this election is too close to call, beyond the consensus that a hung Parliament is likely, with no single political party expected to gain the majority of seats required to form a government. Forming a coalition government can be a long and messy process.

That uncertainty means some investors have been trimming their exposures to U.K. equities and U.K. currency.

“We are more concerned about the uncertainty the election brings than the election per se,” said Peter Wallach, head of the £5.8 billion ($8.7 billion) Merseyside Pension Fund, Liverpool, England. “We have unwound some of our currency hedging positions — simply because things are even less predictable than ever. Quite a few commentators say that elections are irrelevant to markets and I would agree that in the long term they are. However, there is more uncertainty about outcome this time — hence our caution.”

The £10 billion Santander (U.K.) Common Investment Fund, Manchester, recently dropped its public equity allocation to 20%, said Antony Barker, director of pensions at Santander U.K. PLC. At year-end 2014, the fund had a 22% allocation to equities, according to the firm's annual report. “With elections (on) both sides of the Atlantic and continuing European issues, we just see better value elsewhere in private markets and bilateral deals,” Mr. Barker said.

A number of money managers also have decided to adjust exposure.

“History suggests U.K. equities respond poorly to political uncertainty, but at the same time U.K. stocks offer both attractive yield and defensive qualities,” said John Bilton, London-based global head of multiasset strategy at J.P. Morgan Asset Management, in a note to clients, dated April 13. JPMAM has $1.8 trillion in assets under management. “On balance, we believe that political uncertainty is a headwind, but one that will become more acute the longer the formation of a government takes following election day. Hence we maintain a modest underweight in U.K. stocks, but could become incrementally more negative if post-election negotiations drag on,” he said. The money manager also is underweight sterling.

BNP Paribas Investment Partners' Colin Harte, London-based portfolio manager and strategist within the multiasset solutions team, said election uncertainty often exerts pressure on currency. “Within equities exposures, we have eliminated (U.K. exposure) or are at half weight (depending on the strategy), and we certainly don't have sterling in the portfolio. That is purely on uncertainty.” The manager has e514 billion ($563.67 billion) under management and advice.

The election is “the straw that breaks the camel's back” when it comes to U.K. equities exposure, said Wouter Sturkenboom, senior investment strategist at Russell Investments in London, with $275.1 billion under management. He said the firm is 2% to 5% underweight U.K. equities across portfolios, depending on the strategy, in a decision “more driven by the weak earnings cycle and other factors than the elections. And the U.K. equity market isn't cheap either. If you have all (these factors), an uncertain period around the election makes the decision to go underweight just a bit easier,” he said.

The U.K. government traditionally was dominated by two parties, with elections based around a Conservative or Labour win. That all changed in 2010, when the Conservative Party failed to gain a majority win, and chose to form a coalition government with the Liberal Democrats.

However, the 2015 race features four more challengers: the United Kingdom Independent Party, the Scottish National Party, the Green Party and Plaid Cymru, the national party of Wales.

“It is now much more fractured,” said Eric Lascelles, chief economist at RBC Global Asset Management Inc. in Toronto. “There is an international element to this in that it mirrors a similar fracturing and populist tilt globally. In the U.K., UKIP, the SNP and others represent fairly narrow sets of interests, much as is happening in Greece and Spain. It is an interesting shift.”

Mr. Bilton of J.P. Morgan said: “One of the attractions of U.K. assets to international investors has traditionally been their perceived safe-haven status — in large part reinforced by robust property rights and a predictable parliamentary system.” The shift to a multiparty system is functional, but “as this transition plays out, it has the potential to introduce some volatility into U.K. assets and, for a time, at least, to increase U.K. risk premia,” he added.

Markets will react to that uncertainty. “Political uncertainty itself is likely to be high,” said David Page, London-based senior economist at AXA Investment Managers. “Markets don't like that. U.K. assets as a whole are likely to suffer short term.”

Scenarios vary from a Conservative or Labour tie-up with the Liberal Democrats to a Labour coalition with the SNP, with an outside chance of a Conservative coalition with the UKIP. “Should a coalition include parties that have never been in power before, this could upset market confidence,” warned Mr. Lascelles. “How stable a coalition would be in this context is unknown.”

Depending on whether the Conservative Party or Labour Party is involved in the next government, money managers have different concerns.

“If Labour win, there are more long-term concerns about taxation and regulation,” said Russell's Mr. Sturkenboom. “Will they be business-unfriendly? The other concern, which is slightly more important, is if the Conservatives win, they have promised a referendum (on the U.K.'s continued participation in the European Union). If they do press ahead with a referendum, that is quite a big risk to the business environment. There is uncertainty around every corner.”

An EU referendum is a concern for other managers. “(Sterling) would suffer most under an EU referendum scenario,” said Mr. Page. “That would threaten foreign investment and domestic investment. Weaker GDP would lead to a more prolonged period of monetary policy accommodation from the central bank, which would be concerning for sterling.”

What would alleviate concerns is a calming influence on the right- and left-leaning parties, via a coalition with a middle-ground party. “If you want an outcome that is more stable for markets, something with the Liberal Democrats in a coalition (would do that,)” said BNP Paribas' Mr. Harte. “The Lib Dems are seen as a moderating force for the interventions in the equities market from the left-leaning parties, and also a dampener for some of the anti-EU euphoria that the Conservatives or UKIP might go for.”