Analysis: Fund manager reaction to the CSR

A day later, fund managers are putting a positive slant on how the Comprehensive Spending Review (CSR) will affect British asset classes and stocks, although the CSR left many wider economic questions unaddressed.

Investors seemed by and large relieved that the government had not announced massive cuts to infrastructure, defence and environmental spending, as a number had bet on stocks in those areas, including the larger outsourcing companies.

Specialist investors such as Giles Frost, a director for the International Public Partnerships investment trust, said their sectors stood to benefit, along with more generalist managers such as Andy Brough, the manager for pan-European mid and small cap equities at Schroders, Aruna Karunathilake, who runs Fidelity’s UK Aggressive fund, and Jeremy Thomas, the chief investment officer for UK equities at RCM.

A number rightly pointed out that among the large caps in particular, a minority of earnings now come from Britain, and active managers can underweight domestic stocks if they so choose.

But despite stoicism in the face of announcements from chancellor George Osborne, practically no-one took shadow chancellor Alan Johnson up on his contention that the CSR’s cuts could leave the British economy resembling Ireland’s, if the private sector fails to make up for lost public sector job cuts.

Leaving the severe effect on British debt markets aside, an Irish scenario could impact top-down investments in the British stock market. A basket of large caps might look less attractive in Britain than in a country which boasts a strong domestic economy as well as big overseas earners. (article continues below)

Outside of the fund management industry, the British Chambers of Commerce (BCC) were one of the few voices to observe the government has no large-scale strategy to replace government job cuts with private sector employment.

To be fair to the coalition, Labour’s policy proposals do little better. On its website, the BCC helpfully links to a speech by Peter Mandelson, Labour’s primary strategist at the last election, which proposes more or less the same policies as the coalition has now.

Azad Zangana, a European economist at Schroders, tackles the issue directly, saying that strong job creation in the private sector—323,000 in the first half of this year alone—indicates it could create 2.2m jobs to replace those lost through cuts.

However, various factors mean the rate of hiring could be slower in future. Companies had spent 2009 cutting costs savagely and pouring time and money into repairing balance sheets. Although it is difficult to aggregate the psychology of individual companies, strong hiring at the start of 2010 might reflect cost-cutting going too far the previous year and companies rehiring to make up lost ground.

Companies’ financial assets, particularly stocks, also witnessed a deterioration in the second and third quarters, which might lead them to spend more on share buybacks, dividends and debt management rather than hiring.

The outlook for the British economy also worsened off the back of the eurozone crisis, which confirmed cuts might need to be on the deep side to keep international creditors at bay.

Investment opportunities also look better in many overseas countries than in Britain, particularly as Britain still lacks blanket corporate incentives such as sharp tax cuts or targeted boosts such as deregulation.

The idea that quantitative easing and a weakening sterling will boost exports has been shredded by an international currency war and by a record trade deficit in July, despite sterling’s weakness over the latter stages of the financial crisis.

Zangana is due to give Fund Strategy his response tomorrow.