Manager joy over Brexit could evaporate quickly

Money managers say they are investing in the U.K. stock market again following Prime Minister Boris Johnson's resounding victory in U.K. snap general election Dec. 12.

But even as Mr. Johnson managed to recover a parliamentary majority for the Conservative Party, which roughly a week later backed his Brexit plan to formally leave the European Union by Jan. 31, the post-election euphoria could turn out to be short-lived.

The U.K. is set to negotiate a new trading agreement with the EU with a deadline at the end of 2020.

And, if no trade deal can be struck on time by Dec. 31, 2020, the U.K. will trade with the EU under the World Trade Organization's General Agreement on Tariffs and Trade come Jan. 1, 2021. Mr. Johnson could in theory request a two-year extension to the negotiation period in July 2020 — if the current schedule is too tight — but his EU Withdrawal Agreement Bill approved by MPs on Dec. 20 is preventing such an extension.

Once the U.K. leaves the EU, the country will need to negotiate independent trade deals with Europe and all its other trading partners.

Industry sources said the U.K. is more likely to reach a basic trade deal rather than a sophisticated one by the end of 2020. But despite trade concerns, the election outcome in the short term has boosted the U.K. stock market, particularly the FTSE 250, which was up 13.3% on Dec. 20 from March 31, when Brexit negotiations started to stagnate.

"The U.K. is investible again," Sue Noffke, head of U.K. equity at Schroders PLC in London, said in a conference call, adding that U.K. midcap equities, which are 75% exposed to the U.K. economy, have been boosted by the outcome of the general election.

The pound sterling was flat against the dollar at $1.30 on Dec. 20 vs. $1.30 on March 31, while the FTSE All-Share index rose 5% in the same period.

"In the short term, the election outcome is positive for markets but there is still huge uncertainty of the form of what the future relationship will be," with the EU, added Shamik Dhar, chief economist at BNY Mellon Investment Management in London, in a telephone interview.

"Negotiation will be difficult. I expect a lot of volatility as negotiations get underway," he said.

"We (could) end up with a harder end of the exit or a clean exit that also will weigh on the sterling," Mr. Dhar added.

For European investors, however, the risk of a no-deal Brexit hasn't vanished.

Mark Mansley, chief investment officer of the £30 billion ($39.4 billion) Brunel Pension Partnership, Bristol, England, a pool of local authority pension funds, said in an emailed comment: "Considerable concerns remain over the outcome of the whole Brexit process."

Charles Kalshoven, Amsterdam-based senior strategist at APG Asset Management, the manager of the €459 billion ($511.9 billion) Stichting Pensioenfonds ABP, Heerlen, Netherlands, said the "risk of hard Brexit is still there" if a deal is not struck by the end of 2020, as expected under the current timetable.

Mr. Kalshoven said sterling could face more Brexit-related turbulence in 2020 if Mr. Johnson does not ask EU leaders for a deadline extension.

Ever since Ireland's head of government Leo Varadkar and Mr. Jonhson reached a thread of understanding on Oct. 10 over the question of the Irish backstop — an effort to avoid a border between Ireland and Northern Ireland — sterling has appreciated 7.3% vs. the dollar.

Still, not all investors are convinced that sterling-driven investments such as U.K. equities should be injected into portfolios just yet. "Given the political nature of the drivers affecting sterling, we do not have a strong view of its likely direction and note that although sterling looks slightly undervalued at present, there is insufficient certainty to make sterling particularly attractive on medium-term view," Brunel's Mr. Mansley said.

Peter Kinsella, managing director and global head of foreign-exchange strategy at Union Bancaire Privee based in London, noted that the U.K. currency-denominated assets were underinvested by institutional investors for three years. "Consequently, the removal of political uncertainty will be the catalyst for reinvestments toward the U.K. and further pound appreciation," he said.

However, BNY Mellon's Mr. Dhar thinks Brexit's overall impact on the U.K. economy is less likely to extend to the next five to 10 years and is confident the U.K. will be able to replace the 6% loss of trade with the EU — estimated by the U.K. House of Commons in a briefing paper Dec. 16 — resulting from the withdrawal with other trading partners, including the U.S.

Sources at other U.K.-based money managers welcomed the Conservative Party victory, which, they say, has restored political clarity to the Brexit process.

John Roe, head of multiasset funds at Legal & General Investment Management in London, who said the team at the firm adopted a long U.K. equity position against other developed markets just before the election, is less worried about volatility and the threat of another cliff-edge Brexit.

But he acknowledged the risk of volatility in 2020. "We are less worried about the deadline (of Dec. 31, 2020). We see some volatility, which we can afford to take on," he said in a telephone interview.

The Dec. 12 election breakthrough is also reversing the impact of the withdrawal-deal negotiation limbo, which had caused companies to halt reinvestments, staffing, and mergers and acquisitions among U.K. companies. "It's a relief for Allianz," said Marcus Morris-Eyton, director and portfolio manager responsible for European equities at Allianz Global Investors in London, in a telephone interview.

Mr. Morris-Eyton also expects that putting Brexit back on schedule will be supportive of European equities that are exposed to the U.K. domestic economy. For the eurozone, a breakthrough means less outflows, he said.

Some 12% of assets under management have left European equity strategies since January 2018 as global and domestic European investors have reduced their exposure to Europe in favor of global stocks, according to Morgan Stanley data.

"From 2020, we expect to see a reversal of recent outflows from the region," Mr. Morris-Eyton said.

Silvia Dall'Angelo, senior economist at Hermes Investment Management in London, said in the long term the Brexit process hasn't changed much as a new trading agreement with the EU will require further negotiation and compromises on both sides.

"Brexit will linger in the next three, four years — time (is) needed to negotiate a new trade agreement of this size," she said.