Investors are retreating from bullish bets on Britain as hopes of its new Labour leadership reviving growth and investment are overshadowed by concern about the debt-laden economy and the government hiking taxes in this month's budget.
After sizzling summer rallies, sterling has faltered and UK stocks, which bounced back sharply from depressed valuations this year, are turning lower.
The sentiment shift comes after Prime Minister Keir Starmer and finance minister Rachel Reeves struggled to balance their ambitious growth messages with gloomy assessments of UK finances, and as economic trends have deteriorated.
Premier Miton Global Investors chief investment officer (CIO) Neil Birrell said he had cut a hefty British stock allocation in his multi-asset funds from 45% of global equity holdings to 30% just days ago.
POSITIVITY WANES
"We have been positive on the UK for some time and had very significant exposure," Birrell said.
"But this is risk management. I was worried about the level of UK exposure we had," he added, citing declining trends in UK business and consumer confidence and nerves about potential budget tax hikes weighing on growth.
Investors pulled a net 666 million pounds ($874 million) out of UK stock funds in September, fund tracker Calastone said on Thursday, while adding money to all other geographically focused fund sectors, favouring U.S.-focused vehicles.
Ahead of the Oct. 30 budget, UK business optimism has slumped to nine-month lows, having surged in the summer, and markets are bracing for higher capital-gains tax and bank levies.
Britain's FTSE 100 share index is trading at a 46% valuation discount to Wall Street's S&P 500, almost the widest on record.
The UK-focused FTSE 250 index (.FTMC) gained about 16% from mid January to late July in a strong catch-up trade but is on track for a 2.4% fall this week.
BUDGET CAUTION
Marlborough CIO Sheldon MacDonald said investors in the group's UK equity funds had started taking profits in the last two weeks, which he attributed to pre-budget caution.
"People are watching and waiting to take the measure of Labour and see if they have a feasible and thought-through plan for the next few years," he said.
But he also tipped lowly valued UK stocks and underperforming government bonds to recover if the Bank of England cuts interest rates faster than expected.
Michael Crawford, CIO at Chawton Global Investors, said he was concerned Labour might scrap inheritance tax breaks that incentivise investment in stocks listed on Britain's junior AIM market.
Finance minister Reeves has hinted she may redefine how Britain's public debt is measured or limited, in a move that could unsettle Britain's lenders in international bond markets.
DEBT WOBBLES
UK gilt yields, which move inversely to prices of the government debt and set state borrowing costs, have risen 25 basis points (bps) in two weeks as equivalent German yields fell .
Adding to debt market pressure, traders expect UK interest rates will stand at about 3.5% in a year' time, compared with around 3% in the U.S. and 1.7% in the euro zone, even after dovish hints from BoE governor Andrew Bailey on Thursday.
Sterling remains this year's top-performing major currency against the dollar but is on track for its worst weekly drop since April, which Deutsche Bank analysts said partly reflected traders rethinking long-held bullish positions .
SUBMERGING MARKETS
The recent allure of UK assets, which were long overlooked after 2016's Brexit vote, is fading just as emerging markets that benefit from Chinese stimulus grab investor attention.
Royal London Asset Management multi-asset head Trevor Greetham said he had reduced UK equity holdings to switch money into emerging markets, where stocks are now racing ahead of their British equivalents.
Janus Henderson equity portfolio manager James Henderson said investors may have turned too negative on Britain and planned to raise his UK exposure and cut in the U.S.
"There's opportunities for things to turn out a little better than expected," he said.
