Joey Alcock explores the future ramifications for investors’ portfolios of the UK’s decision to leave the EU
Since the EU referendum held in the UK on 23 June, we have observed elevated volatility across global capital markets. The immediate reactions to the Leave vote were sharp falls in the sterling and equity markets, while bond markets rallied. A rebound in equity markets has seen most regions recover the losses from the initial sell-off.
This may have delayed the crystallising of earlier assurances of policy support by the Bank of England and other central banks. Nonetheless, market uncertainty surrounding Brexit lingers, as evidenced by sterling’s trading at historical lows versus the US dollar.
Contingencies in place
While the referendum result was universally surprising to the managers, their portfolios were not “caught out”. Most managers saw little upside potential from a Remain vote, as this had already been priced into markets. However, they saw substantial downside potential for equities from a Leave vote.
Given this asymmetric expected return profile, managers were comfortable prior to the vote to say hedge out exposure to sterling or trim allocations to European and UK financial stocks. These strategies ultimately dampened the negative impact on their portfolios relative to broader market falls.
Window of opportunity
Generally, managers that approach company selection from a bottom-up, fundamental perspective viewed the post-referendum sell-off more as an opportunity to pick up bargains than the start of a sustained downturn. Certain stocks fell to target price ranges, meaning the managers could exploit this window of opportunity. Most expect to continue doing so in the coming months.
There was a clear message nothing had yet led managers to conclude the result as a reason to review and/or alter their investment approaches beyond some extra caution around shorter-term volatility. Beyond the managers’ conviction in their own strategies over the cycle, this also seemed due to insufficient information being available on how a Brexit may cause any broader systematic changes.
There is no consensus view as to how a Brexit may impact markets longer term. Certainly, there is caution around direct and indirect exposures to the UK financials and real estate sectors, with a series of UK-based REITs managers restricting investor redemptions adding to the anxiety.
One area of broad consensus is that Brexit should be another driver of lower global growth for longer. Even so, we see a number of managers highlighting that, should further central bank easing occur, this should provide some tailwind for equities. A number of managers have also pointed out that effects of the global financial crisis and drawn-out deleveraging of the world economy have thrown up a steady series of market dislocations, and that a Brexit could be just another one of these, with others still to come.
All managers agreed more volatility in equity markets and the financial system was to be expected, as well as on the importance of balancing opportunities and risks arising when constructing portfolios. Active stock pickers on the whole are optimistic around their ability to identify and exploit periods of volatility to generate outperformance over the medium term.
Equity strategies more reliant on momentum may find the upcoming environment especially challenging, as they do not typically cope well with repeated shocks and rapid market changes. Investors with such exposures may wish to consider the degree of exposure to such approaches in this context.
For anyone struggling to determine how the EU referendum will impact their portfolio, note many other experienced investors are facing the same concerns. Despite the waves of Brexit-related media, we remain in the early days of a post-referendum, pre-Brexit world and can take comfort that fund managers are not overly worried and even see potential opportunity over the medium term.
Joey Alcock is senior associate for public markets at bfinance