20th June, 2016
IC Quick Response: Preparing for ‘Brexit’…
With just days to go before the UK votes on its relationship with the European Union, we argue it’s important to remain grounded and not get too flustered by the noise.
At no point in the lead up to the referendum have the polls indicated a closer battle between “remain” and “leave”. With little to split the two possible outcomes, uncertainty has never been higher, and we believe it’s important our investors understand how we are contextualising the debate in our investment strategy.
In the build-up, the media headlines have focussed on equity markets, but in actuality, the recent movements have been nothing but noise and speculation. Currency markets have probably been the most volatile reflection of the risks, with sterling moving sharply against most currencies as the vote gets closer, based around nothing more than the results of opinion polls. Those of you who read our blog a few months ago should note that we are still finding it difficult to differentiate the longer term economic argument of either “leave” or “remain”, given the absence of facts and a crystal ball (we actually looked for one on EBay). That is, we do not think this decision is the biggest driver of how our economy will perform when you look further out, but it should not be underestimated.
This is not to say we won’t get a short-term market reaction though. In fact, we expect volatility in the first few days whatever the result. This volatility would probably continue for longer under a leave vote, purely because the uncertainty will last longer. In any case, if care is taken, and the risks negotiated, there will inevitably be opportunities to take advantage of.
Looking back at our recent experiences of the UK election and the Scottish referendum, we were able to position the portfolios to take advantage of the volatility. We have been prepared to allow for ‘panic’ in markets for some time, and invariably, such panic is likely to be short term, though nonetheless, it may well drive asset prices down. If you have pre-identified areas that are likely to react positively, once the noise subsides, you are well positioned. This is the opportunity.
Aside from panic, we look at key themes. For example, one of the predictable outcomes so far has been the weaker Pound. This has actually helped the UK stock market this year, but not all stocks. The UK stock market becomes attractive for foreign investors when the currency is weak. In contrast, UK companies that import from abroad are likely to struggle in this environment. So it’s good for some, and not so good for others. Of course, this could all reverse itself reasonably quickly if the vote is to stay, hence the reason that liquidity in our portfolio’s is important. We have recently reduced some of our more illiquid positions in commercial property (it is hard to convert to cash because it’s invested in bricks and mortar) to allow us to take advantage of short window opportunities.
Our portfolios can hold both passive (buying the wider index) and active (stock specific) strategies. We are currently very light on passive investing. We don’t believe buying an index in these conditions is sensible. Active investment improves opportunity through being more strategic, and can potentially reduce risk through greater diversification, relevant to the prevailing conditions.
It’s also important to remember that our portfolios are highly diversified across asset classes, geographies, and manager styles, and whilst some holdings may be effected negatively by an outcome, others should benefit. The portfolios typically look towards the longer term, but have a keen eye on the short term issues, since they might create a threat and an opportunity. Brexit is no different and once the dust settles, we hope to return to more normal investment conditions. More global issues such as the trend of Chinese growth, corporate investment, and excessive government debt levels, were concerns preceding the Brexit debate, and will remain key global challenges long after it has dissipated. We will continue to work tirelessly to manage these threats and pick the opportunities where appropriate.