The stakes are high as the 2015 UK general election draws near. Labour's interventionist approach and the prospect of a referendum on EU membership are both causing concern, but which 7 May outcome would be best for investors?
Campaigns are now in full swing for one of the most unpredictable general elections in recent memory.
The polls are still anything but clear: exactly who will be standing on the steps of 10 Downing Street as prime minister next month is as uncertain as ever.
As Investment Week went to press last week, the Tories had moved into a three-point lead ahead of Labour in the most recent Opinium/Observer poll, following a positive reaction to Chancellor George Osborne's ‘Comeback Britain' Budget earlier this month.
James Dowey, chief economist at Neptune Investment Management, commented Osborne's expectations the UK's government debt-to-GDP ratio would fall in the next tax year had significantly raised the chances of a Conservative win at the polls.
"[It] means the Conservatives are now able to claim they are basically going back down the tunnel at half time, having put in a solid performance in the first half. That was much trickier to do before [the Budget] and so at the margin raises the chances of a Conservative-led win in the election," he said.
However, rising support for the smaller parties means almost any number of coalitions is possible, and the potential of no party winning an outright majority is growing. There is a 10% to 20% likelihood of there being more than one election in 2015.
"There will not be an overall majority winner or a coalition formed in May," said Julian Chillingworth, CIO of Rathbone Unit Trust Management. "I think it will be either a Labour or a Conservative minority government, and, therefore, they will be trading votes on a bill-by-bill basis, which is similar to what occurred in the 1970s. Back then, it caused a lot of uncertainty and there were several elections within a short space of time."
Many industries have already been hit by a pre-election ‘stalemate'. The Council of Mortgage Lenders announced lending fell by almost 10% in February, as buyers postponed decisions until after the election, while bookmakers, such as Ladbrokes and William Hill, have spent much of the past 18 months under a cloud of uncertainty, with Labour suggesting they might restrict the use of profitable betting machines.
This has led some managers to steadily move their portfolio allocations away from the UK over the past year or out of certain sectors.
Slater Investments' Mark Slater told Investment Week he had sold out of utility company Centrica and bookmaker William Hill in his Slater Income fund this year ahead of May's general election as he wanted to "avoid any areas that could become a political football".
"Utility and gambling companies are very likely targets, so we have sold our exposure there," he explained.
Meanwhile, Rathbones' head of multi-asset investments, David Coombs, admitted he too reduced his UK equity allocation in favour of better placed alternatives 18 months ago, while Neptune has also cut back its exposure to the UK in both its Global Equity and Global Alpha funds.
There are fears a Labour win, in particular, will be especially bad for business and investment. Over the past year, Ed Miliband has proposed the introduction of stricter regulations on a number of sectors, plus a potential break up of high street banks.
Meanwhile, the party's pledges for higher taxes, including raising the highest band of income tax to 50%, a mansion tax and changes to capital gains tax, could deter investment - particularly from overseas investors.
Bad for business
Colin Morton, lead manager of the Franklin UK Equity Income fund, said the prospect of a Labour majority was a concern for many in the City.
"Recent attacks on utilities, bankers and the bonus system and controversial proposals around a mansion tax have drawn criticism that the party is staunchly anti-growth and business. Whether misplaced or not, the markets are less likely to embrace a Labour win and we could see the markets impacted, albeit only slightly," he said.
Simon Gergel, CIO, UK equities at Allianz Global Investors, agreed.
"A clear Labour majority would probably be poorly received by the markets," he said. "The energy companies, in particular Centrica, have been hit hard by Miliband's claims - unfair in my view - that they have been profiteering at the expense of the consumer."
Last year, Centrica and SSE shares fell by 3% on the back of Labour's announcement it intended to freeze energy prices if elected. Shares in housebuilders were also negatively impacted following news of the proposed mansion tax.
Prices have since rebounded and equities powered even higher this month as the FTSE 100 jumped through the 7,000 barrier.
However, the fact equity markets are far more buoyant than normal at this point in the election cycle, could be attributed to the impact of various QE programmes on UK equities. As a result, this may be disguising many investors' real fears about how sectors will be impacted, said Chillingworth.
Indeed, Gergel is already concerned about new targets the Labour party might have if it gains power in May.
"Any sector that is high-profile and consumer facing - like tobacco, the water companies, mobile or fixed line telecommunications firms, - could be at risk," he said.
By contrast, a Conservative majority is seen as the most stock-friendly outcome, with Morton believing it would be the best result for the markets, which react well to stability. However, even with a Conservative win there are caveats to consider.
The party has already announced it will push ahead with a vote on the UK's membership of the European Union, which will almost certainly cause uncertainty for businesses and markets trading across Europe. Square Mile Investment Consulting & Research's head of investment, Jason Broomer, believes the noise caused by the Scottish referendum in September 2014 would appear "like a walk in the park in comparison".
Further elections
The most likely scenario is a hung parliament. Markets would be on high alert as a coalition government would take days, if not weeks, to arrange. The identity of those parties will be of most interest to the business world, according to Morton. If a second or even third election occurs it may also lead to companies delaying investment decisions, prompting a slowdown in business which would negatively impact consumer sentiment and hurt retail stocks in particular, according to managers.
This situation is particularly pertinent as smaller players, such as the Scottish National Party (SNP) and UKIP, continue to eat into the larger parties' electoral share.
Last week, a poll suggested the election would see Labour lose most of its seats in Scotland, and Alex Salmond admitted a minority Labour government tie-up with the SNP was the most likely outcome. Morton said there are fears demands from the SNP will cause even more instability for economic policy.
Meanwhile, UKIP, which won its second seat in Westminster after winning the Rochester and Strood by-election in November, runs the risk of damaging the two key parties' chances at the polls too.
"The rhetoric and pledges from the SNP's Nicola Sturgeon, such as putting an extra £180bn into public spending, are enough in themselves to cause short-term disruption to the markets," said Morton.
"However, recent confirmation that Labour won't partner in coalition with the party should allay fears. At the same time, while the media might have us believe UKIP will wield the deciding votes, from a markets perspective their power to disrupt over the longer term is minimal."
Keeping the status quo
While fears over a minority government grow, Allianz's Gergel said this likely scenario could surprise financial markets on the upside.
"Ironically, a coalition or minority government situation might actually produce the best medium-term result for the stock market.
"There would undoubtedly be volatility in the early days as politicians negotiate for their particular policy initiatives, but this would settle down over time. When it comes down to it, a weak government would not be able to diverge very far from the current status quo, which markets would like."
In this environment, sterling would almost certainly weaken, so there may be some short-term benefit for industrial companies with sizable overseas exposure, he said.
Of course there is still a debate as to whether managers should be concerned about the election at all. A look at past data from election years shows there was only a minor response to Tony Blair's substantial victory over the Conservatives in May 1997, with 10-year gilt yields falling by six basis points. Meanwhile in 2010, yields only rose by one basis point following the formation of the Conservative/Liberal Democrat coalition.
The FTSE All Share index has also returned positive annual returns in all but three election years since 1970 - although 1974's hung parliament, which led to two elections that year, saw the index fall significantly.
"Politicians' pre-election rhetoric tends to subside the moment the polls close," explained Neil Veitch, manager of the SVM UK Opportunities fund.
"Of course, inductive reason and the assumption that previous patterns will be repeated is one of the main failures of critical analysis. Investors need to switch to deductive reasoning and ask themselves whether there is any particular reason why politicians' policy prescriptions would not mellow post-election."
And although Westminster might impact some sectors, it will never control the outcomes of the UK equity markets, according to Franklin Templeton's Morton.
"Companies and those involved in the markets are generally more robust than perhaps they are given credit for. The strength of the UK equities market lies in the size and scale of the multinational companies involved, such as Unilever and GlaxoSmithKline, which cannot solely rely on Westminster but will be equally concerned with the geo-political landscape."
Jeremy Lang, partner at Ardevora, added: "People love to second guess the result and it is terribly exciting in a perverse way. But it is also a complete waste of time and this year is no different. Governments do not make a difference unless they completely screw it up."
Everything to play for
According to Stephen Massey, chairman of Canaccord Genuity Wealth Management, with five weeks until polling day, much could change: "If the election results were solely based on the basis of economic competence, the Conservatives would be returning to Downing Street in May. However, the issues affecting the public are broader than that, which is why there is all to play for."
Rathbones' Chillingworth agreed. He said: "Over the last 25 years, things change very quickly during the run-up to an election. Look at John Major in 1992. He was not carded to win, but Labour's conference in Sheffield undid [Labour's Neil] Kinnock as people were underwhelmed by his overconfidence. It unsettled the electorate in an interesting way and Major was the overall winner.
"This year's campaign still has time to run and politicians have a big habit, at some stage or another, of saying the wrong thing at the wrong time - remember Gordon Brown's Rochdale interview in 2010? This time that might be David Cameron."
Click below to hear a one-minute clip of J.P. Morgan Asset Management's global market strategist David Stubbs discussing which political party would be best for UK business.
