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“The only certainty is there is much to be uncertain about”

13 April 2017

Charles Luke, Manager of Murray Income Trust, gives his thoughts on the impact of Brexit on the UK.

With Article 50 now triggered, negotiations, which will undoubtedly be difficult and complex, around the future relationship that the United Kingdom will have with the European Union can begin in earnest. As investment markets question the extent to which economic logic or populist political ideals will win out, it seems the only certainty is that there is much to be uncertain about. 

So far, the domestic economy has performed more strongly than many commentators envisaged post the EU referendum.  From here, our view is however that the bigger picture is likely one of slowing growth as higher inflation negatively impacts real incomes.  In general, companies are in robust financial shape, but many will be waiting for signs of progress around Brexit negotiations before committing to investment.  Net exports should continue to be helped by the weakness of sterling, although fiscal tightening is likely to gently moderate growth.  As such, our economists see GDP growth slowing from just under 2% this year, to marginally over 1% next year.  Whilst this is certainly not a calamitous fall into an economic abyss, it is clearly a more difficult environment for those companies with significant exposure to domestic demand drivers.

Our belief is that a focus on high quality businesses combined with discipline on valuation and a patient, buy and hold approach will over the long-term stand investors in good stead. The companies we seek to invest in are not immune to the environment in which they operate, but they are more likely to be able to prosper in spite of it, because demand for their products or services is not driven solely by the economic cycle.  This focus on good quality companies typically with robust balance sheets and sustainable cash flows leads us to favour companies with well-diversified international revenue streams, an advantage which should shield them from Brexit-induced political uncertainty. We also think of ourselves as owners of these companies, looking carefully at remuneration structures and engaging with management on capital allocation, to ensure that the company is being run in the long-term interests of all shareholders.

Although the equity market has performed strongly, one area in which we are currently finding value is the pharmaceutical sector, including our holdings in GlaxoSmithKline and AstraZeneca.  We believe industry concerns over pricing pressure and generics are outweighed by factors including strong long-term demographic drivers, emerging markets growth, increased R&D efficiency and new breakthrough therapies.  More specifically, GlaxoSmithKline is turning around its respiratory franchise while enjoying strong growth from its consumer healthcare, vaccines and HIV businesses. AstraZeneca’s immuno-oncology division will be reporting late-stage trial results over the next year or so on a number of very exciting opportunities.  Another company that we believe has excellent long-term prospects is Compass, the foodservice business: structural trends towards outsourcing, further margin improvement and a strong competitive position combined with attractive cash flow generation under the stewardship of an excellent management team are some of the factors that explain why we hold the company in high regard.

One corollary of sterling weakness is likely to be greater merger and acquisition activity. The appetite of global corporations for high-quality businesses is likely to continue and unlike other countries, for better or worse, the UK currently has limited takeover protections.

Therefore, although the UK is facing significant uncertainty around the outcome of its negotiations with the EU, the outlook for many UK-listed companies with diversified international exposure is brighter.  We believe that the principal support for investors in an inherently uncertain world is an appreciation of long-term fundamentals and a disciplined and active approach to investing.

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