A torrid combination of Brexit uncertainty, heightened risk of central bank policy error and the impending autumn statement are the biggest risks for UK-based investors, according to FE Alpha Manager David Coombs (pictured). 
Coombs, who heads up Rathbones’ multi-asset portfolios in the IA Volatility Managed sector, said the unfavourable backdrop for the UK is what is keeping himself and the team awake at night and is what he deems to be a significant headwind for investors.
Amid ongoing Brexit negotiations in particular, he warned that a second referendum is becoming increasingly likely, which would in turn cause significant swings in the value of sterling.
“Since the general election in June, it’s been one of the issues that we have been very nervous about because of the impact on currency,” Coombs explained. “There are two things we don’t know: firstly, whether there will be a second referendum; and, secondly, what the result would be if there was one.
“Since the election and the changing of the make-up of parliament, we felt it became more ‘remain’ than ever and it increased the possibility that, if negotiations continued to head nowhere, politicians might find a way of saying, ‘it is much worse than we thought, Project Fear is becoming a reality, we really ought to have a second referendum and check that people are absolutely certain this is what they want’.”
While the manager is not predicting that this will happen, he said politicians seem to be discussing the possibility of a second referendum more as each week passes. As such, he said the likelihood of a referendum in his mind has increased from 10 per cent before the general election to 40 per cent now.
“We’re very underweight the UK and UK earnings. If the probability continues to rise, we may have to change the strategies and start to bring back some of our domestic UK exposure,” he reasoned.
“It’s a bit early for that at the moment, but that’s the kind of thing that, on a daily basis, we’re really looking at.
“This is why it keeps us awake. If Brexit goes particularly badly, or we hit a recession, or direct capex [capital expenditure] falls away and we start seeing public sector strikes because pay demands aren’t being met, confidence will fall.
Performance of sterling versus US dollar after EU referendum
Source: FE Analytics
“You could paint quite a bleak picture and that could be very negative for sterling. For us, sterling is so potentially volatile in either direction and we’re partially hedged. But, if something were to rally strongly, that would not help our performance, so that is the risk which could have the biggest impact on our strategy.”
In terms of his five FE Crown-rated Rathbone Strategic Growth Portfolio, for instance, Coombs has a 14 per cent weighting to UK equities but a 60 per cent equity weighting overall. Within his 14 per cent UK weighting, less than 1 per cent is held in domestic-facing stocks.
“The trouble is, we’re in the UK and therefore we’re surrounded by Brexit,” he reasoned. “That remains the biggest impact because we have such a lack of clarity or transparency in terms of where we are in the negotiations.
“There are no tools or risk systems that can model Brexit risk so we’re all in the dark trying to feel our way through on a daily basis.
“Unfortunately, it is the biggest game in town. If you’re based in the UK and your clients are in sterling-based currency, it is by far the biggest risk factor.”
Another potential headwind for the UK, according to the manager, is the impending autumn statement which will take place November.
Following the cabinet’s decision to scrap the 1 per cent cap on public sector pay rises across some sectors, Coombs is concerned that the “genie is out of the bottle” and that there could be heightened dissatisfaction among many workers.
“You’re going to have claims from every part of the public sector over the next two-to-three months, so I suspect that you will see quite a lot of unrest and strikes,” he warned.
“That is a big worry for me in terms of overseas investors’ perception of the UK economy and of productivity, especially given margins and inflation.”
The manager also said the Bank of England is “behind the curve” when it comes to hiking interest rates, given that he believes the housing market is now finally rolling over.
“The time to increase interest rates was over a year ago and I just think they have left it far too long,” he continued. “This could be the wrong time to raise rates and that really worries me about the UK economy as well.
“Forget the government saying CPI [consumer price index] is 2.9 per cent, RPI [retail prices index] is 3.9 per cent and a lot of people feel that.
“People in the UK have had no wage growth and rising inflation over two-to-three years. So, they have seen a significant decline in real earnings already and that’s before interest rates start rising. I just find policy error to be a huge risk at this stage.”
Since its launch in 2009, the £326m Rathbone Strategic Growth portfolio has outperformed its UK CPI plus 5 per cent benchmark by 16.95 percentage points with a total return of 96.65 per cent.
It has done so with an annualised volatility of 6.95 per cent and a maximum drawdown - which measures the most money lost if bought and sold at the worst possible times – of 8.08 per cent.
Performance of fund vs benchmark since launch
Source: FE Analytics
Rathbone Strategic Growth portfolio has a clean ongoing charges figure of 0.8 per cent and yields 1.42 per cent.