The Daily Telegraph - Saturday - Money
Will the recent market rally suffer a reversal?
The Prime Minister’s surprise general election announcement this week was met with a six-month high for the pound against the dollar, and a 2.5pc fall for the FTSE 100 index of blue-chip stocks. The strengthening of the pound indicates that markets are expecting the Conservative party to win a large majority, making it easier for Theresa May to push through a Brexit deal. Such a result would remove an element of uncertainty about the Brexit process – one of the main factors that has been depressing sterling’s value.
But what does a stronger pound mean for investors?
Before the EU referendum, the pound was highly volatile, reacting sharply to polling data indicating which way the vote was swinging.
Following the vote it sank dramatically in value, falling from around $1.45 to lows of under $1.20. This slump was one of the main drivers of UK investor returns in 2016, with any company generating earnings from overseas getting a boost when it was converted into sterling. According to investment bank Stifel, if the Conservative party does achieve a stronger majority the pound should strengthen further. pound. Global funds vary enormously in terms of the international exposure that they offer, and UK funds will offer differing exposure to movements in the pound based on the type of company they invest in.
The table below shows the percentage of a selection of large global investment trusts that are invested in the UK.
At just a 4pc weighting to the UK, the £5bn Scottish Mortgage rtgage Investment Trust is s the most internationally exposed osed global investment trust. It t is therefore more exposed to movements ovements in the pound, although it has delivered substantial returns on top of the currency boost.
In pounds its one-year e-year return is 35pc and in dollars rs it is 21pc, according to data service ervice FE.
At the other end of the spectrum Law Debenture trust st has 70pc invested in the UK and Lindsell Train investment stment trust has 74pc in the e UK.
However, it is not as simple as saying that Scottish Mortgage is 70 percentage points more exposed to movements in the pound compared to Lindsell Train. The Lindsell Train fund invests in a number of large international businesses that are listed in the UK, such as Diageo, Relx and Unilever. All of these companies earn the majority of their revenues fromm over overseas. That means that, as ind individual stocks, their e earnings are swayed by the value of th the pound, in turn aff affecting the share pric price and the fund’s per performance. The impactimp of the pound will be the same o on these companies as some overseas-lis overseas-listed stocks that Scottish Mortgage owns. As a re result, Lindsell Train Investme Investment Trust has retu returned 36pc in poun pound-terms over the past year and 22pc in dollars – an identical difference to Scottish Mortgage despite the vastly different UK weighting. One way to mitigate the role of if you were investing in local currency, which is beneficial if the pound is strengthening, but means that you could miss out on gains if it weakens.
However, while the funds attempt to cancel out all currency effects, they cannot always do this entirely.
For most investors however, the answer to the problem of a shifting pound is to ensure they are diversified, incorporating domestically focused UK investments and investments that do not correlate with wider stock markets, alongside broad international exposure.
UK smaller companies have proven a surprising haven since the referendum result, as the UK economy has performed markedly better than pre-vote predictions suggested.
Despite not benefiting as heavily from the weakening of the pound, the average UK smaller companies fund has returned 22pc over the past year.
If sterling continues to strengthen, what are the consequences for your portfolio, asks James Connington