Deep Dive: China's reopening benefits UK large caps

The end of China’s zero-Covid policy offers a clear boost to the UK large-cap market, as a result of the sector’s higher than typical international exposure.

Daniele Antonucci, chief economist Quintet Private Bank, said 80% of FTSE 100 companies receive the vast majority of their earnings from overseas, with one of the key markets being China and the Asian consumer.

The overexposure of UK large-cap firms to other regions means that global macroeconomic conditions play a key role when assessing any investment in these companies, Antonucci said.

China’s economic growth was stunted by the extended lockdown imposed by Beijing, negatively impacting firms with revenues exposed to the country, which includes several businesses in the FTSE 100.

But with restrictions now lifted, spending in the region is accelerating, Antonucci said. It is also benefiting from the looser fiscal policies being rolled out by the Chinese authorities.

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“While policymakers are raising rates and tightening the fiscal belt in the UK, the opposite is happening in China,” he said.

“This is stimulating the Asian consumer, boosting earnings prospects for the larger UK companies, which are more exposed to China and Asia at large than smaller companies.”

The international earnings of the sector mean currency exposure is a key factor, especially US dollars, which most firms report in.

Although the dollar has weakened recently, Antonucci noted that it tends to act as a safe haven during periods of macroeconomic uncertainty and market stress, which reinforced his view that the greenback would hold out over the long-term.

Guillaume Paillat, multi-asset fund manager at Aviva Investors, agreed, adding the currency factor was an “attraction” of UK large caps thanks to this insulation.

That does not mean that all FTSE 100 firms are created equal though, as Blake Hutchins, manager of UK Equity Income at Troy Asset Management, pointed out. He tends to avoid heavily cyclical, capital-intensive and levered business models, such as banks, oil companies or miners.

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But these comprise a large part of the FTSE 100, Paillat added, making for “very distinctive style characteristics that provide useful diversification benefits when building a multi-asset portfolio”.

“The higher exposure to cyclical and value sectors will help the FTSE to benefit from a more pronounced negative correlation with fixed income, which tends to be beneficial during episode of rising inflation and higher interest rates,” he said. 

“So, after years of underperformance, no surprises the FTSE 100 was the best performing index in 2022.”

While the UK benefited from its cyclical exposure last year amid an oil and energy crisis, this had been acting as a headwind long-term, as Paillat ntoed, and was not expected to benefit the market going ahead.

This factor is unlikely to be that supportive in the future, Antonucci explained: “Things are different now; slower economic growth implies weaker commodity prices.”

The lack of technology stocks and high share of mature, lower-growth companies has meant the size of the UK market as a share of world equities has shrunk over the past 20 years, Paillat said, adding that its role in a multi-asset portfolio “can rightfully be questioned” but can still play a role.

“As the political and fiscal risk premium has faded this year and the UK might avoid a technical recession in the near term, we continue to prefer UK large cap which should remain supported by high dividend yields and exposure to commodities where tight global supply should remain a central theme,” he said.

In general equity funds, Troy’s Hutchins also defended the role of UK large-caps which, in some cases, can provide better options than other markets.

He pointed to the recent volatility in the banking sector, which has driven share prices of UK banks down double digits due to fears of instability after the collapse of Silicon Valley Bank and Credit Suisse.

Hutchins said that, thankfully, the bulls were correct and the “UK banking system is much better capitalised than it was heading into the financial crisis”.

However, he still prefers the consumer staples sector, which sells “affordable, everyday products through trusted brands that consumers love”.

He added: “The fact they do not consume large amounts of capital as they grow means they are extremely cash-generative and are therefore great dividend paying stocks.”

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Hutchins’ Trojan Income fund was highlighted by John Monaghan, research director at Square Mile Investment Consulting and Research, for exposure to UK large caps.

Monaghan called it a “compelling option for investors seeking a lower risk UK equity income strategy with the potential of growing its yield over time”, something he said it had successfully achieved over the long-term.

Troy’s mantra of placing capital preservation at the core means it will lag markets in more aggressive upswings, Monaghan argued, but it is a “strategy providing a reliable and growing income stream”.

His second choice was the Lindsell Train UK Equity fund, which he said is “more focused on providing capital growth over the long-term”.

Monaghan described manager Nick Train as “highly experienced, articulate and thoughtful with a proven track record as a responsible steward of investors’ capital”. He predicted the fund could outperform the FTSE All Share Index by at least 3% annually over a rolling five-year investment horizon.

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