Opportunities in UK Pharma, Oils, Tobacco

Speaking at the Morningstar Investment Conference earlier this month, in the interim period between the UK's 2010 general election and the Conservative-Lib Dem coalition agreement, Threadneedle Co-Head of UK Equities Simon Brazier told me he's all doom and gloom on the UK economy. Citing examples from Canada and Sweden, he outlines the decisions available to government in tackling the fiscal deficit. On an investment level, however, he sees plenty of opportunities in the UK, thanks to British companies' strong financial positions and global diversification. The full transcript of this video is available to read below.

To read notes on Simon Brazier's presentation, and other investment luminaries' presentations, read my blog from the Morningstar Investment Conference.

Transcript
Holly Cook: We’re here at the Morningstar Investment Conference and joining me is Simon Brazier who is Co-Head of UK Equities at Threadneedle.

Simon, thanks for joining us. 

You just gave us a presentation that had some pretty scary stuff about the political landscape. Can you summarise that for us?

Simon Brazier: Yes, well here we are in the post-election UK, maybe not with a government in place but one thing that is certain is that whatever government does form needs to address public deficits and financial deficit here in the UK. My premise is that really, the public are not fully aware of just how bad things could be and the government is going to have to take a much stronger line in terms of reducing this deficit than is probably anticipated. Just to put it in context, public debt, total debt is around £750 billion. This rises to £1.4 trillion by 2014--80% of debt to GDP. My concern is that even this is based on some relatively aggressive growth assumptions in the targets and I think that amount of debt could be higher. My major concern is that we need to finance that debt, at the moment £800 billion of gilts need to be sold in the next five years. If the markets had any wobble in terms of wanting to buy those gilts, there could be a serious issue and buyers strike a failed gilt auction.

So what I have said is that I don’t believe the UK can grow its way out of this problem and actually Mervin King is not going to allow us to inflate our way out of this problem, so what we’ll have to do is balance our books, potentially higher taxes and lower public spending. I gave two examples of countries that have done this, without the help of the IMF, which is Sweden and Canada in the early 1990s.

The examples I gave, Canada for example, cut 21% on average across the board through its departments. It cut public sector employment by 19%, these were very serious reforms they undertook. Sweden spent less time looking at cutting expenditure, it also raised taxes and a more balanced approach to cutting spending. But again, cut spending by 11%. Both of those countries in three years managed to turn big fiscal deficits back into positives. Now, I’m not sure if there’s the political will and also the will of the people for us to do this in the UK, but if it doesn’t, it may be done for us and that is my concern.

And just finally I looked at what the reality in the UK might be. I think that, based on what I just said, there is no doubt that we will see taxes go up. I think there’ll be taxed on consumption initially, particularly VAT, they will try to avoid taxing corporates and more income tax because that distorts economics. And in terms of spending cuts I think the obvious spending cut is one that follows on from Sweden and Canada is cutting welfare benefits and getting people back into work as and when the recovery comes.

Cook: So whichever form of government we end up with, we’ve got a pretty rough ride ahead of us by the sounds of it. Obviously you spend most of your time picking UK equities, where abouts do you see particular opportunity?

Brazier: Well you see on the economy I’m all doom and gloom, but it’s a well rehearsed argument and one that I believe in which is that over 75% sales of UK companies are outside the UK and not only that, the UK consumer is very indebted, the UK government is very indebted but actually, since the tech boom, companies have spent their time getting their debt down. And actually UK companies are not that indebted, they don’t have huge refinancing risk like the government and so actually, not only do we have companies that are well financed, they are actually globally diversified and in some sectors that are global in their reach. We have big weightings in the market in the likes of AstraZeneca and Glaxo and pharmaceuticals, the oil stocks, the tobacco stocks which are relatively defensive providing good dividend yields. So actually I think, whilst at the moment you might get half a percent in your bank account, you’ll be able to buy some of these good, defensive, cash-generative stocks like the pharmaceuticals which are offering you 5% plus dividend yields that look very attractive to me and I think provide a lot of down-side protection as well.

Cook: Well thank you very much for ending on a positive note and thanks for your presentation, extremely interesting.

Brazier: No problems.

Cook: For Morningstar, I’m Holly Cook.