There have been more stories in the media this week about the dire situation of the UK public finances. The fiscal problems are getting worse, with UK government bond yields hitting the highest level since 1998. This means the interest payments for the government are increasing, putting further pressure on trying to balance the books. This could have real consequences for UK stocks, so it’s worth going through some of the implications for investors.
Pending tax increases
With the public books not in great shape, this situation could lead the way for tax increases on businesses and consumers alike. This could help to raise money that to offset government spending. For stocks, this could put pressure on companies that mostly operate in the UK and sell directly to UK customers.
Therefore, one takeaway is for an investor to check the UK stocks they hold and see which are multinational and which aren’t. The global companies that are listed on the FTSE 100 and FTSE 250 could be more insulated from any negative impact. After all, their revenues are diversified from around the globe.
Opportunities for insurers
The FTSE 100 is home to some large insurance companies. Higher bond yields generally improve insurers’ investment income. Life insurers and pension providers hold large fixed-income portfolios to back their long-term liabilities. When yields rise, reinvested premiums and maturing assets can be placed into higher-yielding bonds. This acts to boost long-run profitability, improve solvency ratios, and make their balance sheets look healthier.
However, there are near-term risks. Rapid increases in bond yields can cause losses on existing bond holdings. This can impact short-term valuations, even if insurers plan to hold assets to maturity. This was seen during the 2022 liability-driven investment (LDI) crisis.
Volatility could help asset managers
I think it’s likely that we’ll see higher volatility in both the bond and stock markets in the coming months due to the UK’s situation. This could benefit asset managers such as Aberdeen (LSE:ABDN).
The stock is up 27% over the past year, with a dividend yield of 7.8%. The business makes money primarily through management fees on assets under management (AUM) across a wide range of assets. It has various funds linked to bonds, so the managers should be able to capitalise on the moves we are seeing right now. It also has exposure to equities. If investors decide to pull money out of bonds, they could allocate it to other assets such as stocks. This would help maintain high revenue from management fees.
Of course, one risk is that investors get so spooked that they decide to simply sit on cash. In this case, it could negatively impact revenue for Aberdeen in the future.
I think the business is well-positioned to take advantage of any volatility in the stock market. With a price-to-earnings ratio of 12.2, it’s also not overvalued. So even if the fiscal situation calms down in coming months, I feel there are good reasons to consider buying the stock.
