Unilever, Reckitt Benckiser, Diageo

Another theme that has influenced our strategy is falling real interest rates, something we have been seeing for the last 20 years. That trend has put fixed income securities under pressure – they cannot protect investors the way they used to because their income has evaporated and so has any opportunity for meaningful capital growth. As such, we prefer to get our bonds exposure via the likes of treasury inflation-protected securities (TIPs) and index-linked bonds. Savers may note that I do not foresee positive real (inflation-adjusted) interest rates emerging for some time yet. Elsewhere, we have held some gold for around 15 years as a diversifier. In a world of currency debasement and zero interest rates, it will always have role to play. Since we first bought it in 20042005, the price has outperformed the broad UK stock market by a reasonable margin in sterling terms. Our remaining holdings tend to be in liquid assets so that we are ready to take advantage of volatile markets and any short, sharp falls in equities. That said, we only go after stocks that meet our strict criteria. Since we like firms that pay us to own them, rather than those that need to raise capital at the first sign of trouble, we look for strong cash flow and solid balance sheets.

Victoria Stephens, Fund manager and member of the Economic Advantage team at Liontrust Asset Management

What is your view of the UK stock market post-pandemic?

We are enthusiastic about it but nonetheless operate a very strict investment process. We only select businesses that demonstrate at least one of our three key intangible asset strengths; substantial intellectual property (IP), an edge in distribution, and high levels of recurring income. The technology and healthcare sectors meet our criteria, as do some industrial, engineering and FMCG firms plus a few in the media space. We also like fee-based financial companies, such as wealth managers and those investment platforms that can demonstrate a recurring income. Conversely, we tend to avoid areas of the market where we cannot see much intangible strength, such as retail banking and the materials sector.

As a specific example, the UK is home to some wonderful engineering companies with world-beating IP, such as Renishaw which is a leader in the field of metrology (the science of measuring things). The firm manufactures specialist probes and software for precision measurement so that machines and parts can be calibrated to very high tolerances. Its applications range from neuroscience to manufacturing and the automotive industry. They are also leaders in ‘additive manufacturing’ or ‘3D metal printing’. This high-tech process uses machines to create three-dimensional, complex metal parts, building them up layer by layer from powder. This is an exciting, cutting edge, production technique. More broadly, I am a big fan of UK technology in general because it is underappreciated by other investors. Whilst I concede that exciting, large tech firms may be few and far between in the London market, within the smallcap and AIM arena I could pick out 56 software specialists, a number of which have the potential to become tomorrow’s industry leaders. IMImobile is a case in point. It provides enterprise software solutions which help large firms, such as banks or telecoms companies, to communicate with their own customers. It was recently acquired by the US software giant Cisco, at a considerable premium, as they could clearly also see the potential. At the other end of the size spectrum, we also hold some FMCG giants whose competitive advantage is built on huge international distribution networks that support household brands. Unilever is one, with its vast array of personal care, food, and homecare products. Reckitt Benckiser is another that spans personal health and hygiene. Diageo is a third, with its premium spirits such as Smirnoff and Johnnie Walker. These Londonlisted firms all offer investors access from the UK to increasing global wealth and the world’s developing markets.

Are equity market valuations too high?

I do not think so. For starters, the principal source of uncertainty that has been hanging over shares for four-plus years has gone now that a Brexit deal has been signed. Whilst we expect to see a significant period of adjustment to the new normal, the firms we are speaking to have not tumbled over a cliff edge in the way that some commentators predicted. Most of them are looking beyond Brexit, and COVID-19, with a degree of confidence and an intention to invest capital. Sterling adds to an improving picture. We have seen a decent recent rally, yet in historic terms the pound is still far below its longer-term average level versus other currencies. In that context, the UK market should remain attractive to overseas investors.

A focus on growth does mean that some of our stocks can look expensive when screened using traditional valuation metrics. Nonetheless, our fund remains at the cheaper end of its spectrum overall, relative to its benchmark. Besides, I am satisfied that the businesses in question can grow faster than the average UK company thanks to some of the competitive strengths I flagged earlier. Our preference for smaller firms, with impressive growth potential, makes the search for this type of holding a lot easier. Importantly, many of the businesses we like are exposed to multi-year, structural growth themes which should outlast even the biggest cyclical swings. An obvious example, given our focus on intellectual capital, is digitalisation. We gain our exposure to it via specific technology investments, or by holding firms in sectors where it is enabling them to become more efficient, or to grow their suite of products and services. Whatever investment choices we make, they will always reflect a focus on buying into permanent thematic transitions, rather than short-term fads. ●

At a recent Killik Family Office virtual event, Vicky assessed the impact of the pandemic and Brexit on our economic future.

What is the immediate outlook?

The data suggests that we are in a global recovery phase, at least in the short-term, as economies open up and pandemic restrictions are lifted. The backdrop for this has been some unexpectedly strong performances from key global markets. The US economy, for example, only shrank by around three percent over the course of a challenging 2020, whilst China managed to generate growth over the same period. Closer to home, UK manufacturing production has been on an upward trend. Alongside construction, it was able reopen after the first lockdown, through the early part of 2020, and has grown more or less uninterrupted since. This was evidenced by recent data from the CBI Industrial Trends Survey, which was some of the best we have seen in the last few years. Meanwhile, Make UK has doubled its forecast expectation for manufacturing growth for 2021 to 7.8%. As for the services sector, it too is starting to make a significant contribution to growth, having only been able to gradually ease face-toface restrictions.

On the consumer side, retail sales bounced back strongly this spring thanks, in part, to a mini boom in the hospitality sector, triggered by the unleashing of pent-up consumer demand. This is being reflected in staff shortages across businesses ranging from restaurants to bars and theatres, a trend that will doubtless be reflected in wage data going forward. A property market surge, coming on the back of an extended stamp duty holiday, has helped to further bolster consumer confidence.

In summary, then, the short-term outlook is sunny, albeit problems linger across travel, tourism, hospitality, entertainment and sport as reduced social distancing measures nonetheless continue to impinge on their full re-emergence.

Britain’s balancing act

Vicky Pryce

Economist and author

How long will this last?

The key question is to what extent the economic uplift we have seen so far in 2021 can be sustained. Once we look beyond a widely anticipated initial surge, as lockdown savings are released, things are less clear. Whilst we have seen a spectacular recovery in some sectors, others such as airlines, travel firms and entertainment venues, including those catering for the night-time economy, continue to languish. Elsewhere, in the retail sector, we have seen a serious shake-out, with heavy job losses coming on the back of increased automation and consumers substituting online purchases for visits to high street shops. This is at a time when millions of people are still being supported by the State, via measures such as the furlough scheme, albeit on a gradually decreasing basis. Government policy decisions will therefore continue to play a key role in our longer-term fortunes. I hope that firms will start investing again, spurred on by the super-deductions for tax announced recently by the Treasury, even as they absorb corporation tax rises announced in the same Budget. The early signs are positive, in so far as we have seen relatively few complaints from businesses so far. Nonetheless, many firms face other bigger challenges, such as increasing costs and a huge debt overhang accumulated in the low interest rate era that preceded the pandemic. Estimates suggest that up to 800,000 smaller UK firms are in severe financial difficulty, with some at risk of going under, even as their larger peers pay back special loans and furlough money. Consumers with jobs and money to spare, meanwhile, will need to stay confident in the face of tax increases as the impact of the Chancellor’s decision to freeze certain key thresholds starts to bite. A recent FCA report, suggesting that around 3.5m extra people are now under financial duress in 2021, muddies that picture somewhat over the medium term.

Are we a more productive nation post-pandemic?

Up to a point, yes. Firms in some sectors seem to have successfully reduced their overheads by, for example, decreasing their reliance on expensive properties. At the same time, they have adopted new practices, such as teleworking. Where they have been able to boost output per worker as a result, without incurring greater wage costs, they will have enjoyed some productivity gains. However, with labour shortages rife, it remains to be seen how long they can hang onto these, which is why I think it is too early to judge whether we have seen a stepup in overall UK productivity. Further, there is a hidden problem here, and it is one that should concern policy makers. In a bid to cut costs, as things begin to normalise and we see a gradual return to the office, firms may well be tempted to limit the amount of space they provide, and start distinguishing between workers by bringing the workers they need most back to the office (perhaps using a flexible or hybrid model) whilst leaving others at home. The risk, which has already been flagged by the Trades Union Congress (TUC), is that in doing so they create an ‘underclass’ made up of employees who are based remotely, quite likely at home, doing largely commoditised work. Not only are these workers likely to miss out on training, promotions and pay rises, but they may be offered little, or no, compensation for the costs that working at home carries. If these same firms also strip out their more expensive, but also more experienced, middle managers, how will they retain the skills needed to motivate and supervise this sort of complex, hybrid workforce? So, whilst the shift to more remote working during the pandemic may have prompted people to work harder, the extent to which this effort will translate into lasting productivity gains is not obvious yet.

How will Britain balance its books?

The first thing to note is that an increase in state debt, no matter how large, is not expected to be paid back in any conventional sense. Indeed, if anything, the stock of debt tends to increase over time, unless the public sector starts to run annual balanced budgets (or even surpluses), as it is rare that revenues in any given year exceed spending. During the period since 1970, Britain’s budget deficits have averaged 3.6% of gross domestic product (GDP) and the last time we ran a surplus was in the financial year 2000-2001. While a persistently high gap between revenues and expenditure would worry markets, large budget deficits themselves tend not to last for long. The “automatic stabilisers” spring into action as the economy starts to recover, and tax revenues and other receipts subsequently pick up. Additionally, the planned corporation tax rises in 2023, plus the freezing of income tax thresholds from next year, which were amongst other measures announced by the Chancellor in March, will help. So too will tightening the purse strings for a number of non-central government departments, about which we will hear more in the in the autumn spending review. Cutting expenditure back more sharply, by imposing austerity measures, like the ones we saw during the decade after the financial crisis, is another way of bringing deficits down and possibly even reducing the stock of debt. However, the cost to the economy can be significant and persistent. Besides, given the long-term impact of both the pandemic and Brexit, the government will still need to borrow to cover the economy’s needs for years to come and certainly throughout the course of the current parliament. So, whilst a certain amount of tightening may be needed, the best way to get the debt to GDP ratio down from its current level of nearly 100% of GDP is via faster economic growth. Little has been said explicitly so far by the Treasury about areas such as capital gains tax and inheritance tax, where many people expected to see changes. So, it appears that the plan is indeed to rely heavily on growth, coupled with some inflation, to get the UK back to a more stable fiscal footing. The obvious short-term risk to this scenario is a sharp rise in inflation. So far, although the year-on-year consumer price index (CPI) has gone up here, at the time of writing it is still only just above the Bank of England’s 2% target. This uptick has been caused by a demand spike colliding with supply constraints, a problem reflected in commodity price jumps for everything from oil to copper and in input costs to manufacturing, for example across semiconductors and construction materials. It is also spilling through to wages, despite a relatively high rate of unemployment. What is more, inflation is becoming a global phenomenon – in the EU it has risen to 2% and in the US to 5%.

Central Banks will no doubt keep a watchful eye on prices going forward, albeit they mostly have little choice but to let the inflationary cat out of the bag to some degree. If they raise interest rates too far or too fast in response, or slow down or reverse their quantitative easing operations too soon, they risk damaging any recovery. They also need to prevent unemployment surging as that could trigger a host of wider societal problems.

As state support, such as the furlough scheme here, is phased out, a big challenge will remain for all advanced economies when it comes to dealing with the many unskilled, and mainly young, people who have lost out during this crisis.

What impact has Brexit had so far?

In the short-term, it has created an extra set of headaches for policymakers and businesses. The immediate priority for the government should be negotiating the changes needed to the original Brexit deal to ensure that goods can flow as freely as possible between the UK and Europe. The extra costs now involved for anyone who exports to the EU, or imports from it, are substantial, which is a problem given that we sell 45% of our goods and services there. The non-tariff barriers that have been imposed on the UK across everything from airlines to road hauliers, as well as the extra health and other checks needed at the border, are restricting the movement of goods, increasing costs and dragging down profit margins. Small and medium-sized enterprises (SMEs) in particular, are voicing their concerns about the difficulties created by this new environment, now that the UK is a third-party country as far as the EU is concerned. Meanwhile, there has been no agreement with the EU on services, including the all-important financial sector, or around qualifications. The resulting restrictions on the freedom of movement are already creating shortages in many areas of the economy, including construction, hospitality and agriculture. Admittedly, some of this downside had already been anticipated and on the positive side, a certain amount of uncertainty has now disappeared. However, I do worry about the longer-term impact. From a structural perspective losing free access to what was practically a domestic market of 500m people, where economies of scale could be enjoyed, can only be bad news for many businesses even if other trade deals materialise.

That is because the “economic gravity model” suggests it is usually easiest, cheapest and most synergistic to trade with your nearest neighbours. Free trade deals with the Anglophone countries, including the US and the BRICs, alongside closer links with the Commonwealth or Pacific and South East Asian nations, are unlikely to fully substitute for what are likely to be weaker ties with the EU. Meanwhile, the attraction of the UK as a gateway to Europe for foreign direct investment has been inevitably reduced. The benefits of being outside the EU also confer little extra advantage in terms of policy flexibility. After all, we were always able to initiate state aid programmes as an EU member, for example, and yet we spent less on state aid whilst we were within it than, say, Germany and France. Meanwhile, the concept of “Freeports”, eight of which were announced to great fanfare by the Chancellor recently, could always exist, though in a slightly more limited way, within the EU structure. We had in fact abolished them ourselves in 2012!

Whilst we were a member state, we also had a powerful impact on the standards and regulations adopted by Europe as a whole and, by extension, internationally. We pushed for the eastward expansion of the EU bloc and opened our doors early to people from some of the later succession countries. For me, therefore, the fact we are the first major country to leave is ironic and adds a layer of economic uncertainty to Britain’s future path.

Vicky Pryce is a board member of the Centre for Economics and Business Research (CEBR), a former Joint Head of the UK’s Government Economic Service and author of ‘Women vs Capitalism’. ●

For a copy of Vicky’s latest book, please go to hurstpublishers.com/ book/women-vs-capitalism/ and apply the code WVC1411 to obtain a 25% discount as a Killik client. A short article, featuring some of the key themes from it, will appear in the next issue of Confidant in the Autumn.