Investment Week - Overseas earnings key to equities success
11 March 2010
Most traditional approaches to investing will tell you that the performance of an equities market is underpinned by the growth of the economy. Consequently, you would expect the recent fiscal deficit concerns, political uncertainty and worries about a sovereign credit downgrade to ensure that the UK stock market was suffering in line with the prospects of the UK economy.
However, despite the economic uncertainty, the UK stock market has fared well in recent weeks. Indeed, the FTSE 100 Index is up 9.6%* over the last month and has risen 58.2%* in the last 12 months. The FTSE All-Share is equally spritely, rising 9.3%** over the last month and 59.9%** since March 2009. Clearly conventional wisdom fails to explain the rise, so what is driving the UK stock markets and the UK economy in different directions?
One of the key drivers of the dislocation of stock markets and the economy is the massive overseas exposure of many UK-listed companies. Indeed, more than two-thirds of FTSE 100 listed firms’ earnings are derived from overseas economies, meaning that most firms are not tied to the UK in order to grow their top line. These firms are turning to their foreign businesses for growth in an attempt to avoid domestic pressures.
A closer look at the UK indices also reveals that, as well as firms with overseas exposure, many large companies listed in the UK are not in fact British. These firms have almost no exposure to the UK market and are included in UK stock indices simply because of the benefits of a London listing. This decision is more related to the standing of the City as a major financial centre, where it is easier to raise capital, rather than a particular bias to the domestic markets. This exceptional level of overseas exposure helps explain why the recent deterioration of the UK economy has had mixed consequences for UK-listed firms.
Of course, the market is not completely isolated from the troubles of the domestic economy. There are concerns that some UK-listed companies, particularly in the financial sector, will be negatively affected by the potential impact on borrowing costs of a ballooning deficit and a sovereign downgrade. However, other recent developments such as a slide in sterling on the back of concerns regarding a hung parliament have proved less alarming. Again, this is because a weaker sterling has the potential to benefit those firms with large overseas operations, as they start to repatriate earnings denominated in foreign currencies.
Despite the dislocation between the UK economy and its stock markets this transformation did not happen overnight. Standard Life Investments’ UK Equity team has been quick to recognise the opportunity and our Focus on Change investment philosophy has allowed us to be well placed to benefit from the strong performance of UK firms that generate a large portion of their revenues from overseas.
Standard Life Equity Income Trust, managed by Karen Robertson, has adopted overweight positions in firms such as Vodafone Group and British American Tobacco, which both benefit from substantial overseas operations. Karen has also been able to boost income by gaining exposure to the large portion of FTSE 100 firms that pay dividends that are remitted in US dollars, including HSBC Rio Tinto and BP.
Standard Life UK Smaller Companies Trust has also positioned itself to benefit from the overseas exposure of its portfolio, with firms such as online fashion retailer ASOS adding significant value on the back of the performance of its international business. The Trust has also increased its direct exposure to overseas stocks, adding to its positions in firms such as P Z Cussons and ITE. These acquisitions mean that emerging markets stocks now account for 14% of the portfolio including firms from Russia, India and South East Asia. Overall, over 50% of portfolio earnings are derived from overseas.
The commodities super cycle
Of course, the impact of the bullish outlook for overseas revenues will differ from industry to industry. However, one sector that looks set to be a key beneficiary of the global growth story is the commodities sector. Resources and mining firms have been boosted by a flood of money into commodity markets as investors look to diversify portfolios. However, it is also part of a wider commodities super-cycle that is expected to support earnings among the world’s largest mining and metals firms.
Underlying this market trend has been China’s incessant desire to fulfil its infrastructure and industrial development plans. The country has implemented a $500bn plus stimulus package that is designed to bolster an economy already in high-growth mode. The scale of China’s demand has surprised even those firms used to pandering to the country’s vast resources needs, with industry cuts in capacity earlier this year pushing prices higher.
Exposure to the resources sector is a key theme within the Standard Life Equity Income Trust’s portfolio. We retain a large overweight exposure to leading firms in the mining sector, including Xstrata, Rio Tinto and Vedanta Resources. We’ve also been buying Tullow Oil, where we see further significant upside in terms of asset value.
The Smaller Companies Trust has also boosted its exposure to resources stocks with recent acquisitions in Salamander Energy and First Quantum. We believe that these stocks will allow us to increase our exposure to a key element of the global growth story.
Gordon Humphries, Head of Investment Trusts, Standard Life Investments
*Source: Thomson Reuters Datastream FTSE 100 Index (09/02/2010 – 08/03/2010) and (09/03/2009 – 08/03/2010)
**Source: Thomson Reuters Datastream: FTSE All Share Index (09/02/2010 – 08/03/2010) and (09/03/2009 – 08/03/2010)
This article was first published in Investment Week on Monday 22nd March 2010.
