28th February 2013
The downgrade of the UK’s credit rating by Moody’s may be exercising politicians, but should it be exercising investors asks investment journalist Cherry Reynard.
The headlines have been apocalyptic . There has been talk of sterling reaching parity with the Euro, of rising yields on the UK gilt market inflating the UK’s debt to Grecian levels. There are consequences for investors, but the reality, as ever, is likely to be more prosaic.
First, and perhaps most importantly, it will put pressure on sterling, which has now formally lost its tenuous grip on ‘safe haven’ status. While this may not be good for George Osborne, it is not necessarily bad for investors. Sterling-based investors with foreign assets – be that a holiday home in the Algarve or a US fund – will see a quick-and-easy appreciation of those assets.
For example, Mike Kerley, manager of the Henderson Asian Dividend Income fund says: “Asian currencies have appreciated against the dollar and even more so against sterling. Our sterling-based OEIC is up 12 per cent year to date, but around two-thirds of that has been currency appreciation. It is particularly good for income seekers, who have seen their income grow in proportion to the weakness in the currency. There is an argument to say that if investors want an income, they may be better off getting it outside of sterling.”
It is also good for internationally-facing UK companies. The FTSE 100 rose on the news – with around 75 per cent of underlying corporate earnings generated overseas, investors reasoned that currency depreciation would either be good or neutral for UK plc. The contrast to the day after, when the FTSE 100 dropped 1.3 per cent on worries over the Italian election, showed where investors’ true priorities lay.
Alan Higgins, Chief investment officer at Coutts says: “Data from FTSE100 companies shows 27 per cent of their revenue comes from growth markets, which we define as Asia and emerging markets in general. This proportion has risen from 23 per cent in 2008, and a weaker pound should further boost the bottom line. A weaker currency not only makes UK exports more competitive, but also gives a greater boost to the UK than the euro or US markets, which derive 21 per cent and 12.3 per cent of their revenue from growth markets respectively.
However, he cautions that companies with a domestic focus are likely to suffer from sterling’s drop, particularly those most exposed to UK consumers, as disposable incomes get squeezed by rising costs of essentials like petrol. He adds:”Profit margins for domestically-focused companies have fallen relative to those of exporters since the credit crisis, hurt by sterling’s substantial depreciation versus the dollar”. This is bad news for the smaller and mid-cap indices where a greater proportion of earnings are generated domestically. It is also bad news for those wanting to buy into foreign assets, such as emerging markets, which will get progressively more expensive.
The other key area of impact for investors is on the price of gilts. It is difficult to find anyone willing to invest in UK Government bonds who is not compelled to do so. Certain pension funds, and the Bank of England via quantitative easing need to buy gilts, but the majority of other buyers are already negative on the asset class. The recent downgrade may make them more so, but is unlikely to exert significant downward pressure. The big drivers in the gilt market lie elsewhere. Mike Amey, head of sterling portfolios at PIMCO says, “We have not seen a significant reaction in the Gilt market, where the prospect for further Quantitative Easing is driving market levels.”
It helps that a downgrade had already been well-flagged by the rating agencies and therefore substantially priced into markets. The mood is markets has been overwhelmingly underwhelmed – yields on the 10 year government bond had already moved out to over 2 per cent since the start of the year.
Amey says: “We were not surprised by the downgrade of the UK’s AAA credit rating over the weekend, as it is something we have been expecting. The UK remains stuck in a low growth environment, and will remain so for a number of years as the excesses of the past is worked through.”